North Carolina Business Court Decision Could Impact Enforceability of Many Non-Competition Covenants
A recent decision in the North Carolina Business Court could
have significant implications on non-competition covenants in employment
agreements that contain a very common automatic renewal term. The decision, if followed by North Carolina courts
in other cases, could signal an important development in the law and call into
question the enforceability of many non-competition covenants.
On June 26, 2017, in the case of American Air Filter
Company, Inc. v. Samuel C. Price, Jr. and Camfil USA, Inc., the North Carolina
Business Court dismissed, without prejudice, a company’s claim of breach of a non-competition
covenant against a former employee in North Carolina, finding that the
employment agreement lacked consideration to support the covenant. The rule at issue in the case is sometimes
called the “additional consideration” rule.
Under the law of many states, a non-competition covenant entered into
after the employment relationship begins is not enforceable unless the employee
is given some additional consideration beyond continued employment, such as a
bonus, pay increase, promotion, etc.
In 2006, the employment agreement at issue was entered into seventeen
years after the employee started working.
Importantly, the employment agreement contained a very common automatic
renewal provision (sometimes called an “evergreen” provision) that stated that
the agreement would automatically renew from year to year. In ruling on the employee’s motion to
dismiss, the Business Court found the company adequately alleged that it
provided the employee with sufficient additional consideration for the
agreement when it was signed. However,
because the Company did not allege that the employee received new consideration
for each of the subsequent automatic renewal terms, the Business Court
concluded that there was no legal consideration alleged in the complaint to
support the non-competition covenant after the first year of the term expired.
On that basis, and without citing to any precedent for this
specific point, the court concluded that the agreement, including its covenant
not to compete, was unenforceable as to the years subsequent to the initial
term. Thus, the Court held that an employer’s
failure to allege that it provided additional consideration for an employment
agreement’s renewal “breaks the chain” of employment and renders the employment
agreement unenforceable as to subsequent years.
Two points are very important in the analysis of this case
and its potential implications. First,
the Business Court was applying Kentucky law to this contract claim. However, North Carolina, like Kentucky and
many other states, also requires additional consideration for a post-employment
restrictive covenant and has a well-established body of precedent on that point. Nothing in the decision suggests that the
Business Court’s reasoning would be any different if North Carolina law were
applied. Second, this decision is not
issued by the North Carolina appellate courts, so it is not binding on North
Carolina courts unless such reasoning is one day affirmed in the appellate
courts. Importantly, however, the
Business Court has jurisdiction over many non-competition matters and many such
cases are litigated in that court. Its
decisions, particularly regarding restrictive covenants, are often persuasive
authority to other courts, including the North Carolina appellate courts.
If this decision is followed in cases applying North Carolina law, it would represent a substantial development in the law of restrictive covenants, which deserves the close attention of any business using restrictive covenants for employees in North Carolina. At a minimum, businesses with restrictive covenants contained in automatically renewing employment agreements should be prepared to address this argument in future enforcement actions and should consult with counsel to consider whether changes to standard agreements are warranted.
(with Theresa M. Sprain, Richard L. Rainey, and Patricia I. Heyen)
If this decision is followed in cases applying North Carolina law, it would represent a substantial development in the law of restrictive covenants, which deserves the close attention of any business using restrictive covenants for employees in North Carolina. At a minimum, businesses with restrictive covenants contained in automatically renewing employment agreements should be prepared to address this argument in future enforcement actions and should consult with counsel to consider whether changes to standard agreements are warranted.
(with Theresa M. Sprain, Richard L. Rainey, and Patricia I. Heyen)
Labels: Consideration, Kentucky Law, Non-Compete, North Carolina Business Court, North Carolina Law
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