Wednesday, September 9, 2009, 11:46 PM

North Carolina Court of Appeals Finds Restricted Stock To Be Insufficient Consideration

The North Carolina Court of Appeals issued a decision that serves as a good reminder for businesses that when offering consideration to support a non-compete agreement, the consideration cannot be illusory.

In the case of MSC Industrial Direct Co. v. Steele, the employee worked for the company for 12 years before he was asked to sign an agreement with a non-compete provision. In consideration for the agreement, the employee was offered 85 restricted shares of the company’s stock. (Remember, in North Carolina, continued employment is insufficient consideration to support a non-compete agreement entered into after the employment relationship has begun.) The first 50% of the stock would not vest for three years, and the remaining 50% would vest over the two years following that. If the employee was terminated at any time before vesting, the shares were forfeited. In addition, before the shares vested, the employee had none of the attendant rights usually associated with stock, such as the ability to transfer the shares, receive dividends, or to vote the shares.

Under these facts, the Court of Appeals held that the award of shares was illusory consideration, and ruled that the non-compete agreement was not enforceable. The court reasoned that the company could divest the employee of the shares by terminating him “only moments after signing" the agreement. On that basis, the court found the restricted shares were insufficient consideration to support a non-compete.

As a final point, the Court of Appeals also noted that since the employee had worked for the company for 12 years, the company could not rely on the fact that it continued to provide him with access to confidential information as consideration to support the agreement. The court concluded that since he already had access to the information prior to the agreement, the company was not providing anything new of value to the employee.

This case serves as a good reminder that where it is critical to bind current employees to a non-compete agreement, the better course is to tie the agreement to an increase in compensation, a promotion, a signing bonus, or some other type of consideration that is of immediate benefit to the employee.


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