The Business Court Opens Its Door Wide To "Intellectual Property" Disputes

The Business Court doesn't often discuss its interpretation of the statutory bases for a designation to the Court, all of which are contained in G.S. sec. 7A-45.4.  So its published Order this month in Southeastern Automotive, Inc. v. Genuine Parts Co. 2016 NCBC 61, is worth noting.

The issue in Southeastern Automotive was whether the Complaint qualified for designation to the Business Court under G.S. §7A-45.4(a)(5), which says that a party may designate as a complex business case:

Disputes involving the ownership, use, licensing, lease, installation, or performance of intellectual property, including computer software, software applications, information technology and systems, data and data security, pharmaceuticals, biotechnology products, and bioscience technologies.

The statute, before the amendments effective October 1, 2014, mentioned only "disputes involving '[i]ntellectual property law, including software licensing disputes." Op. 19 (referencing former version of G.S. §7A-45.4(a)(5)). 

The Southeastern Complaint did not directly raise issues regarding the ownership of intellectual property. It centered around the Defendant's acquisition of the Plaintiff, and Plaintiff's claims that it had not been fully compensated in the sale.  The shortfall, according to the Plaintiff, was caused by the inadequate operation of Defendant's software programs with respect to the inventory which the Plaintiff had sold.

Judge Gale saw the 2014 amendment as expanding the Court's role in intellectual property lawsuits.  He held:

The Court concludes that the 2014 amendment to section 7A-45.4(a)(5) expanded the scope of disputes within the statute’s purview to include a dispute that involves a material issue regarding the use or performance of intellectual property, including computer software and data, without requiring a dispute regarding ownership of the intellectual property or another dispute that may require application of principles of the body of law known as intellectual property law.

Order 20.

In the end, this analysis by Judge Gale was unnecessary, as the amount in controversy, per the Southeastern Complaint, was in excess of five million dollars.  That made this a case in which designation would be mandatory regardless of whether it was requested by one of the parties.  Order 4 (referencing G.S. §7A-45.4b)(2)).

I frequently look at the Orders from the Chief Judge of the Business Court on challenges to designations (the Chief Judge handles all of the Oppositions to Designation) and don't find much to write about as they usually say nothing more than something like "the allegations in the Complaint fall within the mandatory jurisdiction of the Business Court,"  I collected a number of those unpublished Orders in this 2008 post.

That said, every once in a while the Business Court says something significant about the scope of its mandatory jurisdiction.  For example, in its unpublished Order in  Sonic Automotive, Inc. v. Mercedes-Benz USA, LLC, the Court spoke about its broad approach to designations involving antitrust matters (per G.S. §7A-45.4(a)(3).  

The NC Business Court On Non-Solicitation And Non-Inducement Provisions

There is more discussion of non-solicitation clauses and non-inducement clauses in Judge McGuire's opinion last week in Sandhills Home Care, LLC v. Companion Home Care-Unimed, Inc., 2016 NCBC 59, than I think that I've ever seen before in a North Carolina court decision.  Non-solicitation clauses prohibit a former employee from trying to get business from his former employer's clients.  Non-inducement clauses prevent a former employee from encouraging other employees of the former employer from leaving to join him in his new employment.

Yesterday's post covered the non-competition restrictions in the Sandhills agreement.

Let's start with the non-inducement provisions of the Sandhills agreement:

Non-Inducement Provisions Are Enforceable

Non-inducement provisions are enforceable in North Carolina and they receive the same analysis as non-solicitation provisions (Op. ¶42).  More about that standard for analysis is below.

The Defendants in the Sandhills case raised a novel (and completely unsupported) argument about why the non-inducement provisions before the Court were invalid.  They said that the restrictions violated their right to engage in concerted activity under the National Labor Relations Act, and that they suppressed competition in "North Carolina's home healthcare market." 

Judge McGuire shot down that argument, stating that "North Carolina's appellate courts have held that such restrictions on inducing a former employer's employees can be enforceable" and that the Defendants had "cited to no source for the contention that there is a North Carolina public policy in favor of protecting employee concerted activity."  Op. ¶47

Non-Solicitation And Non-Inducement Provisions Are Subject To The Same Analysis As Non-Competition Provisions

I think that I had been successful in the past in persuading a North Carolina Judge that a provision preventing a former employee from soliciting his former employer's customers did not have to satisfy the same standard as a non-compete.

That argument won't work any longer, if it ever did.  A valid non-solicitation provision, like a provision restricting competition, must be:

(1) in writing, (2) entered into at the time and as part of the contract of employment, (3) based on valuable consideration, (4) reasonable both as to the time and territory embraced in the restrictions, (5) fair to the parties, and (6) not against public policy.

Op. ¶29.

But the standard for reviewing the validity of a non-solicitation provision is more liberal than the standard applied to a covenant not to compete.  Judge McGuire said that:

North Carolina courts are more willing to enforce non-solicitation provisions targeted to the former employer's customers or prospective customers than provisions prohibiting entirely the former employee from working for certain employers or in certain regions.

Op. ¶31.

A Non-Solicitation Agreement Doesn't Need To Be Tied To A Specific Territory

The Sandhills non--solicitation provision was not limited to a specific territory.  It was limited instead to the "book of business" of the Plaintiff.

Judge McGuire said that an argument  made by the Defendants --- that a non-solicitation restriction could not be enforced if it was not tied to a specific geographical description -- had been rejected by the NC Court of Appeals.   Op. ¶33 (citing Farr Associates, Inc. v. Baskin, 138 N.C.App. 276, 281, 530 S.E.2d 878, 882 (2000)).  So, he held that:

North Carolina's courts will enforce a covenant prohibiting a former employee from soliciting his former employer's customers even when not tied to a specific geographic region where 'the terms and conditions of this contract clause were reasonably necessary to protect the employer's legitimate business interests.'

Op. ¶33.

You are more likely to have a customer based restriction enforced if the time period of the restriction is not long.  Time and territory restrictions are evaluated "in tandem."  Op. ¶18.  In the case before Judge McGuire, it was limited to one year, short enough that a geographic restriction was not necessary.

Can A Non-Solicitation Provision Extend To Clients With Which The Employee Had No Contact?

It seems to be an open question whether a non-solicitation covenant can prohibit contact with all of a former employer's customers, or just those customers or prospective customers with whom the employee had personal contact." Op. ¶34

Judge McGuire avoided having to resolve that issue saying that he could not rule the restriction covering all of the former employer's clients to be unreasonable at "this very early stage of the case."  Op. ¶35.

A Non-Solicitation Provision Cannot Cover Prospective Customers Of The Former Employer

Judge McGuire didn't need to break new ground in ruling that language in the restriction prohibiting the solicitation of prospective customers was "unreasonably broad." Op. ¶37.

The NC Court of Appeals reached that conclusion several years ago, in Hejl v. Hood, Hargett & Assocs., 196 N.C. App. 299, 674 S.E.2d 425 (2009).  It held there that:

Defendant's attempt to prevent Plaintiff from obtaining clients where Defendant had failed to do so, is an impermissible restraint on Plaintiff.

Id. at 307, 674 S.E.2d at 430.

Don't include prospective clients in your non-solicitation agreements. This Plaintiff was lucky that the inclusion of prospective customers didn't invalidate its entire non-solicitation provision.  Since that "provision [was] a separate and divisible obligation contained in a separate sentence of the covenant, the Court was able to "blue pencil" it out and leave the remaining restriction on solicitation standing. Op. ¶37.

 

 

A Few Things To Avoid When Drafting A North Carolina Covenant Not To Compete

The Business Court closely examined a set of restrictive covenants last week in Sandhills Home Care,, LLC v. Companion Home Care-Unimed, Inc., 2016 NCBC 59. This decision collects a number of North Carolina Court of Appeals decisions assessing the validity of covenants not to compete (and non-solicitation and non-inducement covenants) and highlights language contained in many restrictions which is probably invalid.

Don''t Overreach In Describing The Activities That Will Be Restricted

The Plaintiff's covenant against competition said that its former employee could not "work for, provide services for, consult with, or otherwise assist any individual or entity who is in the home health or personal care business competing with the Employer" in the North Carolina counties in which the Plaintiff was providing services at the time of the employee's separation.

This restriction could be read to prohibit the employee from providing any type of service to or for a competitor, entirely different from the type of work the former employee had done for the Plaintiff.  That was unreasonably broad, ruled Judge McGuire.  He held that:

Covenants that restrict an employee from working for in any capacity or providing services of any type to competitors, and are not restricted to prohibiting the employee from performing the same type of work or services, are unreasonable. 

Op. ¶21.

 

Don't Include  "Advising" Or "Holding Any Ownership Interest" In A Similar Business In Your Definition Of "Compete"

Judge McGuire ruled that the Plaintiff's prohibition of its employee from "advising" or "holding any ownership interest in" any home health care business was unreasonable and unenforceable. Op. ¶28.

The word "advising" was

broad enough to sweep within it all sorts of employment and other services that would not impinge on Plaintiff's interests in any way.

Op. ¶28. Judge McGuire gave this example:

an employee might become employed by an interior design or decorating business that advises a home health care provider on decorating its corporate offices, or a technology company providing consulting services to a home health care provider regarding its computer network needs.

Op. ¶28.  Restricting a former employee from employment with a competitor which is unrelated to the job performed for the former employer went beyond a protection of the Plaintiff's legitimate interests.

As for the restriction on "holding any ownership interest in a competitor, Judge McGuire said that this language, "read literally, would prohibit the employee from owning shares of a mutual fund that had a tiny holding in a publicly-traded home health care company." Op. ¶28.

Judge McGuire found that there were no facts to support such a "broad prohibition."  Op. ¶28.

Don't Prohibit The Employee From Providing "Any Work Or Services" For  Any Client Of Her Former Employer

Many covenants not to compete bar the former employee from doing any work at all for an existing client of the employer, even if the employee had no contact with that client.  The Sandhills covenant said that the former employee would not do "any work or services for any customer or account" which the employer (not the employee) had serviced in the six months prior to termination of employment.

A covenant prohibiting the former employee for performing any type of service for a client of his employer, regardless of whether that employee had any contact with that client, is unreasonably broad.  Op. ¶29.

So is a restriction prohibiting the former employee from providing "any work or services" for the clients with whom she did have contact valid?  Probably not.  See above.

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There was so much worth writing about in this Opinion (39 pages!) that I've divided this post into two parts, today's post dealing with non-competition provisions, and a second part (coming tomorrow) on non-solicitation and non-inducement provisions.

By the way, I have never drafted a covenant not to compete, though I have pursued the enforcement of many of them.  You don't want a covenant not to compete drafted by your partner to be ruled to be unreasonably broad.  (I've dreaded having to tell a partner that, but never had to actually deliver that bad news). Tell them to avoid using language like that contained in the Sandhills covenant.