Category Archives: business contracts

May a Party be Bound to an Executed Operating Agreement That Was Not Intended to be Final?

In Fabrau, L.L.C. v. Prashant Shah, et. al., No. A-4464-10T3 (N.J. Super. Ct. App. Div. July 11, 2012), the Appellate Division of the Superior Court of New Jersey was presented with the following question: Should parties be bound by an executed operating agreement that was not intended by all the parties to be final when there is evidence that a subsequent operating agreement was created but was not signed?

In that case, Fabrau, L.L.C. (“Fabrau”) filed a complaint against two of its alleged members, Prashant Shah (“Shah”) and Srinivisa Nallamotu (“Nallamotu”) (collectively “Parties”) for breach of the confidentiality and non-competition provisions of an operating agreement. Id. at 2.

Fabrau sought to develop low-cost, transparent software to assist in setting prices for pharmaceuticals sold by smaller pharmaceutical companies to government entities.  Chester Schwartz (“Schwartz”) was approached to help with sales and marketing, Nallamotu was approached because he was also interested in a more affordable alternative to a government pricing system and Shah was approached to help develop the product.  A draft amended operating agreement was created naming the members as Fabriczi (one of the creators of Fabrau), Rau (the other creator of Fabrau) (collectively “The Creators”), Nallamotu, Schwartz and Shah.  However, Shah sent an email explaining that there was changes he wished to discuss as per his lawyer’s suggestion.  At some point either before or after this e-mail, an undated draft operating agreement was executed by everyone except Nallamotu in a parking lot.

Fabrau argued that the signed agreement was final and binding on both Shah and Nallamotu because, although Nallamotu did not sign it Nallamotu had written an e-mail to a customer announcing that he had formed a company with a few people from the industry.  See Id. at 5.  Fabrau contended that this evidenced Nallamotu’s intention to be bound by the operating agreement. See Id. 

In contrast, Shah asserted that he was induced to sign the agreement by The Creators’ representation that Schwartz would not do his part of the work unless an agreement were signed; Shah also claimed that all who signed in the parking lot acknowledged that the agreement was not binding. See Id.  Nallamotu asserted that the fact that he never executed the agreement at issue should have been enough to show that he was not bound by its terms. 

The Appellate Division pointed to evidence that showed that sometime after the execution of the initial agreement, another member was recruited to the company.  The operating agreement was amended to reflect Christopher Biddle’s (“Biddle”) name, however, it was never executed.  A subsequent email was sent to all of the members asking that the document be executed and a few days after that another email listed the execution of the agreement as one of the “Company Action Items.” Id. at 7.  The Parties contended that the unexecuted document further evidenced that no agreement was ever reached.

After months of struggling to make sales of the pricing system, and after months of no communication between the members, The Creators decided to contact an outside vendor to see about converting the Shah-designed government pricing system to a web-based application.  Then they contacted a venture capital company (“Company”) to promote the product. Unbeknownst to The Creators, Shah and Nallamotu had also contacted the Company for help with the same product.  As a result of intellectual property concerns, the Company made inquiries that led to The Creators and Shah and Nallamotu finding out that each group was trying to promote the product. The Creators consequently filed a lawsuit against Shah and Nallamotu.

At trial, the Superior Court of New Jersey, Law Division, found that because Shah was admittedly the sole creator of the product, he had an ownership interest in the software.  Further, they found that no certificate of formation of Fabrau named Shah and Nallamotu as members of the company.  The Law Division concluded that a viable partnership agreement had never been reached by the parties.

On appeal, the Appellate Division agreed with the Law Division and also found that there was no meeting of the minds with respect to the operating agreement. It remained unexecuted in the Parties’ eyes at the time it was presented to Biddle and thereafter (as evidenced by the e-mail asserting that execution of the agreement was on the “Company Action Items” list). See Id. at 15. Ultimately, the Appellate Division found that the agreement that was executed in the parking lot was a sham designed to mislead Schwartz into believing that his expectations would be protected if he proceeded.  The parties’ conduct failed to manifest intent to be bound by their initial agreement.  See Id. at 17.  The Appellate Division affirmed the Law Division’s holding that no contract existed, and Shah and Nallamotu could not be bound.  See Id.

Proof of execution of an agreement is not the only thing that courts use to determine the rights and obligations of parties.  As shown in Fabrau, a court might consider the intent of the parties in conjunction with electronic communication that evince a contrary intention than what is displayed in the agreement.  The parties should have a common understanding of their expectations and responsibilities under the agreement.  Most importantly, it is vital that any correspondence or documentation between the parties reflect what they intend. This will serve to increase the agreements enforceability in court.

Comments/Questions: gdn@gdnlaw.com

© 2012 Nissenbaum Law Group, LLC

When Are Non-Solicitation Covenants in an Employment Agreement Enforceable?

A recent case offers guidance to New York employers concerning their ability to restrict former employees from attempting to take away the employer’s customers.

In that case, a former employee of USI Insurance Services, LLC (“USI”) signed an employment agreement that included a provision restricting the employee’s ability to solicit the business of former clients for 24 months following the termination of the agreement.  USI Insurance Services LLC v. Miner, No. 10 Civ. 8162, 2011 WL 2848139 (S.D.N.Y. July 7, 2011). Yet just days after the the employee, Jeffrey Miner, left the company and triggered the termination of the employment agreement, he mass e-mailed USI’s current customers in an attempt to solicit business.  In this case, the U.S. Federal District Court for the Southern District of New York Court concluded that Miner’s actions constituted solicitation as a matter of law and granted partial summary judgment to USI on this issue. Id. at 13. Miner’s mass e-mail to USI’s current customers was a clear attempt to solicit business in violation of the employer’s contractual rights. Therefore, it was prohibited conduct.

In New York, non-solicitation covenants – also known as restrictive covenants – are provisions in an agreement that restrict others from actively engaging in certain business development activities (i.e. soliciting an employer’s customers). A non-solicitation covenant may restrict a former employee from contacting his employer’s customers by way of mailings, e-mails, personal calls or through other means that would constitute solicitation.  Id. at 11. According to the Court, non-solicitation covenants are enforceable if they are:

a) necessary to prevent disclosure of trade secrets or confidential information, or
b) where an employee’s services are unique or extraordinary.

Id.

Additionally, the covenants cannot impose undue hardship on the employee or be injurious to the public. Id. at 14 [quoting IBM Corp. v. Visentin, No. 11 Civ. 399, 2011 WL 672025, 8 (S.D.N.Y. Feb. 16, 2011)].

However, a non-solicitation covenant alone may not be enough to restrict a former employee from taking customers. In an unrelated case, the New York Court of Appeals noted that “‘absent an express or restrictive covenant not to compete,’ advertising to the general public . . . [would] not be considered solicitation, so long as such advertisements are not specifically aimed at the seller’s former clients.” Id. at 12 [quoting Bessemer Trust Co. v. Branin, 2011 WL 1583932, 5 (N.Y. Ct. of Appeals Apr. 28, 2011]. Accordingly, a former employee can continue to compete in the same industry.  Id.  Also, a customer can contact his former employee for the purposes of obtaining factual information and such interaction would also be permissible “so long as the response .  .  . [does] not go beyond the specific information sought.”  Id.

This is a significant decision for companies that are including non-solicitation covenants in their employment agreements. The Court’s decision gives an indication of what type of covenant would be reasonable to be enforced.

Comments/Questions: gdn@gdnlaw.com

© 2011 Nissenbaum Law Group, LLC