NY Court of Appeals Clarifies Circumstances Triggering Liability Arising From Solicitation of Former Employer’s Client

In Bessemer Trust Co., N.A. v. Branin (decided April 28, 2011), the New York Court of Appeals addressed the following question, which was certified to it by the U.S. Court of Appeals for the Second Circuit in 618 F.3d 76:

What degree of participation in a new employer’s solicitation of a former employer’s client by a voluntary seller of that client’s good will constitutes improper solicitation?

The Second Circuit also sought guidance on “whether the following two sets of actions, taken together, make out ‘improper solicitation'” under New York law:

(1) the active development and participation by the seller, in response to inquiries from a former client whose good will the seller has voluntarily sold to a third party, of a plan whereby others at the seller’s new company solicit a client, and

(2) participation by the seller in solicitation meetings where the seller’s role is largely passive.

Here are the facts:

Defendant Francis Branin Jr. (“Branin”) joined, and eventually became a principal and then CEO, of investment management company Brundage, Story & Rose, LLC (“Brundage”)e he advised high net-worth clients.  In 2000, Brundage shareholders agreed to sell the company’s assets, including its client accounts and related “good will”, to plaintiff Bessemer Trust Co., N.A. (“Bessemer”).  The purchase agreement imposed no express restrictive covenants on the Brundage principals, who became “at will” employees of Bessemer without any ownership stake in the company.

Two years later, Branin decided to leave Bessemer, and subsequently joined Stein Roe Investment Counsel LLC (“Stein Roe”), a Bessemer competitor.  After Branin joined Stein Roe, some of his former Bessemer clients contacted him and eventually chose to transfer their accounts to Stein Roe.  One such account was Branin’s largest client at Bessemer (the “Client”).

Upon discovering that Branin left Bessemer, a Client representative contacted Branin, who told the Client that he joined Stein Roe.  Client requested a meeting with Stein Roe and sought information about the company.  In advance of the meeting, Branin provided Stein Roe with information relating to the Client.  Branin attended, but played a largely “passive” role at, the meeting.  After Branin traveled (at Client’s invitation) to Client’s home state and explained how Client’s account would be managed and what fees would be charged, Client moved its accounts to Stein Roe.

Bessemer thereafter sued Branin, alleging that Branin “improperly solicited his former clients … thereby impairing the good will that Branin had sold to Bessemer in connection with Bessemer’s acquisition of Brundage.”

The Law:

The court began by reciting the New York common law principle that “a seller has an implied covenant or duty to refrain from soliciting former customers, which arises upon the sale of the good will of an established business.”  (Citing Mohawk Maintenance Co. v. Kessler, 52 N.Y.2d 276 (1981)).  The rationale for the rule is that, in essence, “a man may not derogate from his own grant” or “destroy or depreciate the thing which he has sold”.  (Citing Von Bremen v. MacMonnies, 200 N.Y. 41 (1910)).

The court then summarized the law regarding the so-called implied obligation regarding solicitation:

A seller’s implied covenant not to solicit his former customers is a permanent one that is not subject to divestiture upon the passage of a reasonable period of time. … [U]pon the sale of good will, a purchaser acquires the right to expect that firm’s established customers will continue to patronize the business[].  This is so because [t]he essence of [these types of] transaction[s] is, in effect, an attempt to transfer the loyalties of the business’ customers from the seller, who cultivated and created them, to the new proprietor.

Notwithstanding this implied covenant, a buyer assumes certain risks when he purchases an existing business and attempts to transfer the loyalties or good will of that business as his own. For example, the customers of the acquired business, as a consequence of the change in ownership, may choose to take their patronage elsewhere[].  Indeed, the occurrence of a certain amount of attrition is one of the risks that the purchaser must assume when he acquires an established business[].

Moreover, the seller of a business is free to subsequently compete with the purchaser and even accept[] the trade of his former customers, provided that he does not actively solicit such trade[]. To militate against these risks, which extend beyond the limited scope of a seller’s implied covenant, a purchaser is free to negotiate an express covenant, reasonably restricting, for instance, a seller’s right to compete in a particular geographical area or field of endeavor[].  (Internal quotation marks and citations omitted.)

Though it declined to articulate a “hard and fast rule in determining whether a seller of ‘good will’ has improperly solicited his former clients”, the court outlined some general guidelines that a trier of fact “ought to consider”:

  • A seller may not initiate contact, or take affirmative steps to directly communicate, with his former customers or clients.  Examples of such improper conduct are sending “targeted mailings” or making “individualized telephone calls to his former customers informing them of his new business ventures”.
  • “[A]bsent an express or restrictive covenant not to compete, a seller of ‘good will’ who lawfully competes with a purchaser may advertise to the public” as long as the advertisement is “general in nature … and not specifically aimed at the seller’s former customers”.
  • While a seller may not “tout his new business venture simply because a former client has fortuitously communicated with him first”, not all discussions between a seller and former client are impermissible.  “While the ‘implied covenant’ places certain barriers on a seller’s conduct, it in no way prohibits a former customer or client from gathering information about that seller.”
  • “In the context of the financial services industry [as here] … a former client, contemplating the transfer of his business from the purchaser back to the seller, will invariably conduct due diligence and seek factual information pertaining to topics such as investment strategy, resources available to the seller, personnel, and fee structure. Given the competitive nature and the complexity of the financial services sector, these types of questions are entirely appropriate and, indeed, expected, especially in a case … where the [client] placed a great deal of personal trust in [the seller]. … Thus, a seller of ‘good will’ may answer the factual inquiries of a former client, so long as such responses do not go beyond the scope of the specific information sought.”
  • “Nevertheless, the ‘implied covenant’ places some limitations on a seller’s right to answer all the questions posed by a former client.  A seller of ‘good will’ engages in improper solicitation when, even if prompted, he disparages the purchaser of his business.  In relinquishing the ‘good will’ of his business to a purchaser, a seller loses his right to explain, for example, why he believes his products or services are superior. This rule comports with the purpose of the ‘implied covenant,’ which precludes a seller from ‘destroy[ing] or depreciat[ing] the thing which he has sold’”.
  • “A seller of ‘good will’ … is free to convey certain information about his former client to his new employer.  In the context of the financial services industry, appropriate topics may include items such as a former client’s investment preferences, financial goals, and tolerance of risk”.  This discussion may not, however, “include information that is proprietary to a purchaser of ‘good will.’”
  • “A seller may also aid his new employer in preparing for a ‘sales pitch’ meeting requested by a former client and may be present when such meeting takes place, although the ‘implied covenant’ imposes some restrictions on the seller’s level of involvement during such a meeting.  So long as a seller’s role is limited to responses to factual matters, his participation in such a meeting will not violate the ‘implied covenant.’”

The court concluded by adhering to its Von Bremen and Mohawk precedents, holding that

the ‘implied covenant’ bars a seller of ‘good will’ from improperly soliciting his former clients” and that “while a seller may not contact his former clients directly, he may, ‘in response to inquiries’ made on a former client’s own initiative, answer factual questions. Furthermore, under the circumstances where a client exercising due diligence requests further information, a seller may assist his new employer in the ‘active development . . . of a plan’ to respond to that client’s inquiries. Should that plan result in a meeting with a client, a seller’s ‘largely passive’ role at such meeting does not constitute improper solicitation in violation of the ‘implied covenant.’ As such, a seller or his new employer may then accept the trade of a former client.

While these principles undoubtedly provide significant guidance, further refinement will of course come in the form of cases applying them to new facts.