When is it Improper for the Seller of a Business to Solicit his Former Customers?
The purchaser of business goodwill will often require the seller to enter into an express "covenant not to compete" prohibiting the seller from engaging in the type of business that he sold. The seller will also often be required to enter into an express "non solicitation" agreement prohibiting him from soliciting his former customers. These practices are intended to allow the purchaser of good will to develop a relationship with the customers that he purchased without the interference of the seller.
In some cases a purchaser of the good will of a business may hire the seller to work for him after the sale in an effort to allow the seller to introduce his customers to the purchaser. This practice may have the unintended effect of further solidifying the relationship between the seller and his former customers. When the seller later leaves the purchaser's employment the express restrictive covenant provisions contained in the purchase agreement may have expired, leaving the purchaser with only the express restrictive covenants that may be contained in the seller's employment agreement with the purchaser. Unfortunately for the purchaser, express restrictive covenants that are tied to employment relationships are more difficult to enforce than express restrictive covenants that are tied to the sale of a business.
However, a purchaser of good will who finds himself without an express restrictive covenant or with an inadequate express restrictive covenant is not completely without protection from a seller who may seek to solicit his former customers. Under the "Mohawk Doctrine", which has evolved from a 1981 New York Court of Appeals decision, a seller of the good will of an established business has an "implied covenant" to refrain from soliciting former customers which arises upon the sale. Unlike other express post-employment restrictive covenants not involving the sale of a business, this implied covenant is a permanent one not subject to divestiture upon the passage of a reasonable period of time. However, it is not always clear what constitutes improper solicitation of former customers by a seller under the Mohawk Doctrine.
Although the New York Court of Appeals refused to create a hard and fast rule in determining whether a seller of good will has improperly solicited his former customers, the highest court in the state recently offered some guidance to aid lower courts in answering this question when it issued its ruling in Bessemer Trust Co., N.A. v. Branin, 16 N.Y.3d 549 (2011).
Although a purchaser of the goodwill of a business acquires the right to expect that the selling firm's established customers will continue to patronize the business being purchased, the Court noted that a purchaser assumes certain risks when he purchases an existing business and attempts to transfer the loyalties or "good will" of that business as his own. 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, in the absence of an express covenant prohibiting him from doing so, 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.
In making an assessment as to whether a seller of "good will" has improperly solicited former customers, the Court offered the following principles that lower courts ought to consider when making this determination:
Since the implied covenant not to solicit former customers bars a seller from taking affirmative steps to directly communicate with his former customers, a court ought to consider whether the seller initiated the contact. While a seller may not send targeted mailings or make individualized telephone calls to his former customers informing them of his new business ventures, absent an express "covenant not to compete", he may advertise to the general public.
The Court also cautioned that a seller is not free to tout his new business venture simply because a former customer has fortuitously communicated with him first. However, a seller may answer the factual inquires of a former customer, so long as such responses do not go beyond the scope of the specific information sought.
The implied covenant does place some limitations on a seller's right to answer all the questions posed by the former customer. A seller engages in improper solicitation when, even if prompted, he disparages the purchaser of his business because in relinquishing the good will of his former business to a purchaser, the seller loses his right to explain, for example, why he believes his products or services are superior.
Since the seller of good will may—in the absence of an express restrictive covenant—compete with a purchaser, certain activity within a new employer's firm must be permissible. For example, a seller would be free to convey certain information about his former customer to his new employer as long as this information is not proprietary to the purchaser. A seller may also aid his new employer in preparing for a "sales pitch" meeting requested by a former customer 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 the seller's role is limited to responses to factual matters, his participation in such a meeting would not violate the implied covenant.
Analysis of what may or may not constitute improper solicitation requires a case-by-case analysis, and may involve a number of industry-specific factors that may not be present in all cases. This article is intended only as a general summary of some of the relevant factors courts consider, and any business decisions made in connection with these issues should only be made after consultation with counsel.
If you have any questions about this case and its potential impact on your business, please feel free to contact Peter Weishaar at email@example.com or (585) 546.2500