On January 11, 2007, the United States Court of Appeals for the Second Circuit issued a decision that affects all employers who provide deferred compensation to employees in the state of New York. At issue was whether an employer may alter the duties or compensation potential of an at-will employee who has been awarded deferred compensation that is contingent on the employee's agreement not to resign and compete. The case, Morris v. Schroder Capital Management Int’l, defined the contours of New York’s "employee choice doctrine." In affirming judgment for Pillsbury client Schroder Investment Management North America Inc., the Second Circuit clarified that employees’ dissatisfaction with their duties or potential compensation does not allow them to escape the restrictive conditions of deferred compensation plans, unless their working conditions are so intolerable as to meet the rigorous standard of constructive discharge.

The Second Circuit had certified to the New York Court of Appeals the question of whether the federal constructive discharge standard applies to determinations of involuntary termination under the employee choice doctrine. The New York Court of Appeals answered in the affirmative.

Like most jurisdictions, New York disfavors restrictive covenants, such as non-competition agreements, and subjects them to a "reasonableness" test. Under New York’s employee choice doctrine, however, restrictive covenants in deferred compensation plans are not subject to such strict scrutiny if the employee voluntarily leaves his employment. In such circumstances, the employee is afforded a choice between either staying and receiving his deferred compensation or forgoing the deferred compensation in order to leave and compete.

The plaintiff in the case, Paul Morris, had resigned from Schroders after the assets under his management had been sharply reduced. Morris started a hedge fund and then sued in the U.S. District Court for the Southern District of New York when Schroders effected forfeiture of his deferred compensation awards due to his voluntary departure and what it deemed subsequent competition. Morris alleged that Schroder’s business decisions rendered his resignation involuntary and that he was therefore entitled to the forfeited deferred compensation. On behalf of Schroders, Pillsbury successfully moved for judgment on the pleadings on the basis that the allegations in the Complaint precluded Morris from establishing a constructive discharge, as a matter of law.

Morris appealed, arguing that the employer’s continued willingness to employ in a comparable position should be the standard for determining involuntary termination under New York’s employee choice doctrine. The Second Circuit decided that this issue was an unsettled area of New York law. The Second Circuit accordingly certified to the New York Court of Appeals the questions:

  • "Is the factual determination of ‘involuntary termination’ (i.e., whether an employee quit or was fired) under the New York common law employee choice doctrine governed by the ‘constructive discharge’ test from federal employment discrimination law?
  • If not, what test should courts apply?"

The New York Court of Appeals held that the constructive discharge test in fact is the correct standard in employee choice cases for determining whether a termination was voluntary. The Second Circuit adopted that standard in affirming the judgment for Schroders, holding that Morris’s allegations about his working conditions at Schroders failed to meet the constructive discharge standard. In the Second Circuit, therefore, courts will enforce forfeiture of deferred compensation awards if an employee resigns to compete, regardless of the reasonableness of the restriction, unless the employee can establish that "the working conditions at his former place of employment were so difficult or unpleasant that a reasonable person in his shoes would have felt compelled to resign."

This outcome protects both employers and employees. By adopting the constructive discharge standard in this circumstance, the Second Circuit and New York Court of Appeals have made it practical for employers to continue to provide significant incentives to employees and have provided necessary clarity that will enable employees who participate in deferred compensation plans to make informed choices about their post-employment options.

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