John F. Gelson is a Certified Civil Trial attorney and head of the litigation department with McLaughlin, Gelson, D’Apolito & Stauffer, LLC. Mr. Gelson represented the plaintiff in Totaro, Duffy, Cannova and Co., LLC. v. Lane, Middleton & Co., LLC, discussed in the article.

NEW JERSEY LAW JOURNAL THE STATE SUPREME COURT YEAR IN REVIEW, 2006-2007
September 3, 2007 edition of New Jersey Law Journal

Restrictive Covenants

Even where a defendant can establish that clients would have followed him away from his former employer absent a solicitation concededly in violation of a restrictive covenant, he may still be liable for damages resulting from his solicitation. So held the Supreme Court in Totaro, Duffy, Cannova and Co., L.L.C. v. Lane, Middleton & Co., L.L.C., 191 N.J. 1 (2007).

In that case, the defendant accountant had a solo accounting practice dating back to 1978. In 1996, the defendant decided to change the concentration of his practice, shifting his focus from compliance work, which includes services such as preparing tax returns, general bookkeeping, payroll, etc., to financial and estate planning. Around that time, the defendant agreed to form a new accounting practice with David Middleton. Although the resulting firm was known as Lane, Middleton & Co., the firm was wholly owned by Middleton, and the defendant had a consulting agreement with Lane, Middleton. Approximately four years later, Lane, Middleton was sold to the plaintiff. One of the terms of the sale was the defendant’s agreement, in exchange for certain consideration, to be bound by a nonsolicitation provision, prohibiting him from soliciting compliance work from Lane, Middleton clients for a period of four years. Shortly thereafter, the defendant opened his own firm across the hall from the plaintiff, and sent out solicitation packages to approximately 150 clients the defendant had agreed not to solicit. Part of that solicitation package included a draft “disengagement” letter for the clients to send to the plaintiff. Within two months of the defendant’s departure, the plaintiff was, daily, receiving 10 to 20 of the disengagement letters drafted by the defendant. The plaintiff sued the defendant, alleging breach of contract and numerous business torts. By the time the parties had a bench trial, the plaintiff had apparently abandoned the tort theories, and aside from the injunctive relief, the trial court’s decision addressed only the breach of contract.

During the bench trial, the defendant conceded breach but argued that the plaintiff had failed to offer proof that it had suffered damages because the solicited clients were all long-time clients of the defendant who, even absent the solicitation, would not have remained with the plaintiff upon the defendant’s departure. While acknowledging that the calculation of damages was difficult, the trial court determined there was “no question” that the plaintiff suffered damages. The court then developed a complex calculation in which it first pared down the list of clients at issue and then calculated a sum representing lost work from the remaining clients. Then, the trial court subtracted an estimated attrition rate based on testimony by one of the plaintiff’s principals, related to his prior experience in purchasing accounting firms. Next, the court applied a profit rate based on the plaintiff’s historical net profits, and finally, that amount was multiplied by three for the number of years remaining in the nonsolicitation agreement. (The trial court determined that by the time the defendant breached the nonsolicitation agreement, the plaintiff had already received the benefit of the restriction for that calendar year). The defendant appealed.

The majority of the appellate panel upheld the trial court, relying on the close proximity between the solicitations and the plaintiff’s receipt of disengagement letters. One panel member dissented, arguing that the trial court erred by failing to consider a “proximate cause analysis to link the mailing of the solicitation letter to the damages plaintiff suffered.” The lone dissenter further determined that the majority had “erred in confusing uncertainty of proof of liability for any damages with mere uncertainty as to the appropriate amount of damages.”

Thus, the sole issue before the Supreme Court was whether the trial court erred in failing to apply a proximate cause analysis. Although a “seemingly simple” inquiry, the determination required the following three-prong test: (a) was a “but for” analysis appropriate in light of the conceded breach; (b) if not, “what [was] the appropriate relationship...between the conceded breach and the asserted loss”; and (c) was the evidence in the record sufficient to support the trial court’s calculation of damages.

First, the Court concluded that a “but for” analysis was not appropriate. The trial court had based its findings of liability on basic contract principles. Before the Appellate Division and Supreme Court, however, the defendant’s argument of “but for” proximate cause sounded in business tort theories. Therefore, the Court reasoned that there was no basis to apply a tort-based proximate cause query. Instead, applying basic notions of contract law, the Court determined that “a party who breaches a contract is liable for all of the natural and probable consequences of the breach of that contract”...and that the “exact amount of the loss need not be certain.” The Court went on to determine that it was clear that the loss of clients was a foreseeable consequence of the defendant’s breach. Although the defendant was relying on the argument that the clients would have terminated their relationship with the plaintiff even absent his solicitation, the Court concluded that the relevant inquiry was not “whether they would have left eventually,” but instead, “whether they would have left when they did.”