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Commercial Division Finds Restrictive Covenant Acceptable and Rejects Unpled Partnership Theory

On October 4, 2016, Justice Singh issued an order denying a defendant’s motion to dismiss a claim for breach of a restrictive covenant, finding that the covenant serves an acceptable purpose.  See Tarro v. McOsker, No. 653880/15, slip. op. (N.Y. Sup. Ct. Oct. 4, 2016).   The court also ruled that while it could not resolve a breach of fiduciary duty claim on a motion to dismiss, it would not entertain a new theory of duty that a plaintiff did not plead in his complaint.

The dispute in Tarro centered on an alleged letter agreement between Plaintiff Mike Tarro and Defendant Thomas R. McOsker.  Tarro is the manager of a limited liability company, TRACE, LLC (“TRACE”), which, when formed, offered the only portfolio assignment and back-end transfer service for real estate tax liens.  Tarro and McOsker agreed that McOsker would receive a 25% equity interest in TRACE in exchange for providing “exclusive deal flow” to the TRACE platform.

The parties failed to reach an operating agreement for TRACE because, according to Tarro, McOsker failed to obtain permission from his employer to permit McOsker to be a minority owner of TRACE.  That being said, according to Tarro the parties agreed to the terms of a letter agreement, but that agreement was not signed by either party.  McOsker disputed the authenticity of that letter agreement.

The asserted letter agreement provided that “McOsker’s services are ‘unique, extraordinary and essential to the business of the company,” and that because McOsker would be granted access to customer and client lists, as well as trade secrets, he would not directly or indirectly compete with a similar business for a year should he leave TRACE. 

Eventually, McOsker desired to purchase another platform, BloxTrade, using funds from TRACE’s escrow account.  Tarro objected, and McOsker circumvented TRACE and purchased BloxTrade with his own funds.  Following that transaction, McOsker allegedly stopped providing deal flow to TRACE, creating a competing product, LienClear, and providing deal flow to LienClear through the BloxTrade platform.

The Restrictive Covenant

The first issue for the court was the reasonableness of the non-compete covenant included in the alleged letter agreement.  The court noted that under New York law, “a promise to refrain from competition is unreasonable and unenforceable where the promise is not ancillary either to a contract for the sale of a business or to existing employment or a contract of employment.”  Zellner v Stephen D. Conrad, M.D., P.C., 183 A.D.2d 250, 254 (2d Dep’t 1992).  Further, any restrictive covenant must be “reasonable in time and area, necessary to protect the employer’s legitimate interests, not harmful to the general public, and not unreasonably burdensome to the employee.”  BDO Seidman v Hirshberg, 93 N.Y.2d 382, 389 (1999).

As to the first prong, whether the non-compete agreement was ancillary to a business relationship, accepting the allegations in the complaint as true, the court found that “some type of business relationship may have existed between Tarro and McOsker regarding the TRACE platform.” 

As to the second prong, Justice Singh addressed the time and area limitations, the employer’s interest, and the burden on the employee separately.  As to time and area, the court found that a one-year restriction that was limited to only back-end transfer services was not an unreasonable restraint on trade.  Along the same lines, the court ruled that the restrictive covenant was not unreasonably burdensome to McOsker, because he was still able to practice his vocation and earn a living on the front-end side of the tax lien business.  Lastly, the court concluded that TRACE had a legitimate interest in protecting itself from unfair competition.

Breach of Fiduciary Duty

The court also addressed Tarro’s breach of fiduciary duty claim against McOsker.  Tarro alleged that McOsker engaged in self-dealing and diversion of corporate opportunities in violation of the alleged written agreement.  Justice Singh reasoned that there was a question of fact with regard to the authenticity of the written agreement and ultimately whether McOsker was actually a member of TRACE.  As a result, the claim could not be resolved on a motion to dismiss.

Separately, Tarro argued in his opposition brief that even in absence of an agreement, the court should treat the relationship between the parties as an implied partnership.  The court found that while an implied partnership could exist on the basis of conduct, intention, or the relationship of the parties, Brodsky v Stadlen, 138 A.D.2d 662, 663 (2d Dep’t 1988), Tarro could not assert this separate legal claim in his opposition brief when he had failed to do so in his complaint.

Conclusion

Justice Singh’s opinion adds to the established body of law explicating when a New York court will enforce a restrictive covenant.  Such covenants are disfavored, but a narrow provision that leaves open a party’s ability to earn a living is likely to be enforced.  Further, the Tarro decision underscores the importance of listing all available legal theories in a plaintiff’s initial complaint.  A court is not likely to entertain a new theory of liability asserted for the first time in opposing a motion to dismiss.