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)

N.C. Supreme Court Reaffirms Strict Blue Pencil Doctrine for Restrictive Covenants

The North Carolina Supreme Court reaffirmed in a March 2016 decision that the power of North Carolina courts to “blue pencil” restrictive covenants is extremely limited, even when an agreement purports to give a court express authority to revise and rewrite unreasonable provisions.

North Carolina has long applied a “strict blue pencil doctrine” under which courts cannot change or add to the language of an agreement.  Rather, courts are limited to striking unenforceable portions while enforcing divisible and reasonable portions. 

However, in Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, No. 316A14 (March 18, 2016), the parties sought a contractual workaround to the “strict blue pencil doctrine” by expressly providing in their agreement that a court could revise the agreement’s temporal and territorial restrictions should a court find them to be unreasonably broad.

The Court of Appeals found that the limitations of the “strict blue pencil doctrine” did not apply where the agreement expressly authorized a court to revise unreasonable temporal and territorial restrictions to make them reasonable.  It found that the agreement’s territorial restriction of “the states of North Carolina or South Carolina” was overbroad because it included areas not necessary to maintain customer relationships, and remanded the case with instructions to the trial court to revise the territorial restriction to make it reasonable.

The North Carolina Supreme Court reversed that decision.  Rejecting an effort to broaden the doctrine, the Supreme Court reasoned that the agreement in question could not be “rewritten, blue-penciled, or revised.” 

First, the Court held that the agreement could not be rewritten.  It held that a court may not amend the terms of an unreasonable covenant not to compete; rather, a court should simply not enforce it.  For example, if the parties have agreed on a territorial restriction that is overbroad, a court cannot rewrite the agreement to include new, reasonable subdivisions of the overbroad territory.  The covenant must be enforced “as written or not at all.”

Next, the Court held that the agreement could not be blue-penciled, because it did not set out both reasonable and unreasonable restricted territories.  The Court agreed that restricting competition “in the states of North Carolina or South Carolina” was unreasonable, but noted that striking the unreasonable portions left no territory where the covenant not to compete could be enforced.  (In other words, the agreement did not list subdivisions like counties where a court could strike some and leave others.)

Finally, the Court held that the agreement could not be revised even though there was a contractual provision allowing a court to modify the agreement.  It reiterated that courts may not rewrite contracts for parties, and held that “parties cannot contract to give a court power that it does not have.”  The Court also raised concerns about the prudence asking judges to determine what the parties would have agreed to be reasonable.

This affirmation of North Carolina’s “strict blue pencil doctrine” is a reminder to contracting parties that relying on courts to revise overbroad restrictive covenants is not a viable strategy in North Carolina.  If restrictive covenants are important to your business and they are governed by North Carolina law, it is essential to make sure that they avoid well-recognized drafting errors and contain narrowly tailored terms.

Co-authored with Brent F. Powell and Blair L. Byrum

N.C. Court of Appeals Reverses Order Denying Injunction in Trade Secret and Non-compete Case

On New Year's Eve, the North Carolina Court of Appeals stepped in to reverse an order denying a preliminary injunction to a company seeking to stop a former employee from misappropriating trade secrets and breaching a non-compete agreement.  According to the decision, the employee originally worked for TSG Finishing, a fabric finishing company that applies chemical coatings to fabrics for various customer applications.  The employee, Keith Bollinger, left TSG to take a job with a competitor at a location just five miles away.  At his deposition, Bollinger admitted that he was working with some of the same customers of TSG with his new employer, and that he was responsible for performing some of the same tasks as he had performed at TSG.

TSG sued and asked the North Carolina Business Court to enter a preliminary injunction to prevent Bollinger from misappropriating TSG's trade secrets and working with a direct competitor in violation of his non-compete agreement.  The Business Court denied the injunction, concluding that TSG had not presented a sufficient showing of trade secret misappropriation, and that the non-compete agreement (which was subject to Pennsylvania law) had not been properly assigned to TSG following a bankruptcy.  TSG appealed. 

In a unanimous published decision, the North Carolina Court of Appeals reversed the order, and took the additional step of ordering the trial court to enter the preliminary injunction.  In a detailed analysis, the Court of Appeals concluded that TSG had shown a likelihood of succeeding on its trade secret claim, and that injunctive relief was appropriate.  In addition, applying Pennsylvania law to its review of the non-compete issues, the Court concluded that the non-compete agreement had been properly assigned to TSG in a prior bankruptcy proceeding, and that the 2-year restriction applying to the textile finishing field in North America was reasonable and enforceable under Pennsylvania law.

The case is TSG Finishing, LLC v. Bollinger, and the Court of Appeals decision can be found here.