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Court invalidates restrictive employment covenant.

The Court of Appeals of Georgia ruled that a CPA firm could not enforce an employment termination agreement against former firm members who had left and formed a competing firm. On April 19, 1991, Richard Greenwald, Richard Denzik and Charles Davis left Dougherty, McKinnon & Luby (DML) (formerly Dougherty, McKinnon & Greenwald) to form Greenwald, Denzik & Davis (GDD). A number of DML clients switched to the new firm.

DML subsequently sued GDD to enforce the employment agreement signed by its former members and to recover liquidated damages covered in the agreement.

The agreement said that if a shareholder or employee left DML for any reason other than death, retirement or permanent and total disability and performed services for DML clients within three years after leaving the firm, the shareholder or employee must pay damages equal to 125% of the amount billed to the former DML clients for the fiscal year immediately before the year of termination or the year the clients were taken, whichever was later. The trial court ruled in favor of GDD and refused to enforce the damages provision.

On appeal, DML argued the agreement did not constitute a covenant not-to-compete because it did not prohibit competition. The payment of liquidated damages was not a penalty for competition, the firm said, but rather a recognition that DML must repurchase the departing accountant's stock at a price that is difficult to calculate.

The court, however, characterized the damage amount called for in the agreement not as a "purchase price" of stock but, rather, a severe penalty triggered by competition. The agreement's ultimate effect was to prevent competition against DML for three years unless a steep price was paid. Although the court recognized DML's need to protect itself from the risk an employee may "pirate" clients, its efforts to avert competition were too great.

The agreement also was too broad, the court said, because it prohibited working with former DML clients regardless of who initiated the contact. Furthermore, the agreement had set no geographic or territorial limits. Consequently, the court found the agreement to be, in effect, a covenant not-to-compete, which was unreasonable in several respects and, therefore, unenforceable against the former firm members. (Dougherty, McKinnon & Luby P.C. v. Greenwald, Denzik & Davis P.C. 447, S.E. 2d 94)

--Edited by Wayne Baliga, CPA, JD, CPCU, president of Aon Technical Insurance Services.
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Article Details
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Author:Baliga, Wayne
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Mar 1, 1995
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