Case 4-9

Eminent Domain: Whose Rights Should be Protected?

The leading New York court case concerning the enforcement of postemployment protective covenants concerned BDO Seidman v. Hirschberg, 93 N.Y.2d 382 (1999). The case demonstrates why accounting firms should include carefully drafted protective covenants in their employment, partnership, and shareholder agreements.

In BDO Seidman, the defendant Hirschberg was an accountant whose local Buffalo firm had been acquired by BDO. When Hirschberg was promoted to manager at BDO, he signed an agreement that prohibited him from servicing BDO's clients for 18 months after the termination of his employment. In addition, it required that if Hirschberg violated the agreement, he would have to pay BDO 150% of a particular client's fees from the fiscal year prior to his departure from BDO. When Hirschberg resigned four years after his promotion, he then provided accounting services to several BDO clientsthe equivalent of $138,000 in revenues to BDO in the year prior to hisdeparture.

The New York Court of Appeals examined BDO's agreement with Hirschberg to determine whether it was enforceable. The law is clear that, regardless of the actual language in the covenant, only reasonable restrictions will be enforced. A "restraint is reasonable only if it: ( l) is no greater than is required for the protection of the legitimate interest of the employer, (2) does not impose undue hardship on the employee, and (3) is not injurious to the public."

The court scrutinized Hirschberg's covenant to determine whether BDO was indeed protecting a legitimate interest. and whether the covenant was tailored only as restrictively as necessary to protect that interest. The court ultimately held that the covenant was overly broad because it prohibited Hirschberg from servicing all BDO clientseven those Hirschberg himself recruited prior to joining (BDO) and those with whom Hirschberg had not developed any relationship as the result of his employment. Rather than simply discarding the overly broad covenant, however, the court next considered whether the covenant should have been enforced to the extent that it ',vas reasonable. It found no evidence of BDO's deliberate overreaching, bad faith, or coercive abuse of superior bargaining power.

Because of this, the court rewrotethat is, "blue-penciled" the covenant to effectively narro',v it by precluding Hirschberg only from servicing those clients with whom he had developed a relationship as a result of his employment with BDO. The court then sent the case back to the trial judge to determine 'Whether BDO was entitled to receive damages based on the formula of 150% of the client's prior year's revenue, as specified in the covenant.

This case demonstrates how valuable protective covenants can be in guarding an accounting firm's business interests. But BDO Seidnzan also highlights the importance or choosing appropriate covenants for given employees and carefully drafting such covenants so that they contain reasonable and clearly defined terms.

In addition to being clearly defined. a firm's protective covenants must be reasonable in scope. As BDO Seidman illustrated, courts will not enforce overly broad covenants. Thus, firms must be reasonable in defining their protected interests and their employees' prohibited conduct. Firms should not overreach; if a court sees overreaching, coercion, or bad faith by a firm, it may decline to partially enforce the agree and it 6? protective covenant in entirety.

Questions

l. Do you believe covenants not to compete, such as the one in BDO Seidman, are ethical? Do they violate any rules of conduct in the AICPA Code?

2.Who are the stakeholders in the BDO case and what are their interests? How might the various interests in a covenant be evaluated to determine whether these agreements are in the public interest?

3.Do you believe Hirschberg should have been allowed to service all of the clients he serviced while at (BDO) after leaving the firm?

4.Assume you are in Hirschberg's position and the NY Court of Appeals ruled you could not snice any of the clients you serviced while at BDOboth the ones you brought in and those assigned to you by BDO. After the ruling, (BDO ) approaches you and offers to rehire you at the same pay and give you the same client assignments. Would you accept the offer?