Can a confidentiality agreement be too broad to be enforced?  The North Carolina Business Court said it can be, under some circumstances, in Covenant Equipment Corp. v. Forklift Pro, Inc.

Before you keep reading, know that the case involved South Carolina, not North Carolina, law. North Carolina law on this point looks to be pretty different, as discussed at the very end of this post, but the case is still worth a look.

The facts are typical for a lawsuit against a former employee: Caldwell had sold his forklift business to the Plaintiff and became Plaintiff’s employee. As a part of the sale, Caldwell agreed that he “w[ould] not, directly or indirectly, disclose or furnish any non-public, proprietary or confidential information obtained from or relating to the Business.” 

Caldwell left the Plaintiff and started a new competitive business. The Plaintiff sued, arguing that Caldwell had breached his confidentiality obligations. Caldwell moved to dismiss this claim, arguing that under South Carolina law the confidentiality provision was overly broad and unenforceable.

The motion to dismiss was based on the South Carolina Supreme Court’s 1996 decision in Carolina Chemical Equipment Co. v. Muckenfuss, 471 S.E.2d 721 (S.C. 1996), where it held that a broad confidentiality agreement, which would have the effect of a covenant not to compete, will be subject “to the same scrutiny as a covenant not to compete.” The confidentiality agreement at issue in Muckenfuss prohibited the use of virtually all of the knowledge which Muckenfuss had gained during his employment with the plaintiff. The South Carolina Supreme Court held that this broad provision was tantamount to a covenant not to compete, and that it was invalid because it contained no restrictions as to time or territory.

The following year, however, the South Carolina Legislature overruled Muckenfuss, at least in part, by enacting the South Carolina Trade Secrets Act. A provision of that statute provides that “a contractual duty not to disclose or divulge a trade secret, to maintain the secrecy of a trade secret, or to limit the use of a trade secret must not be considered void or unenforceable or against public policy for lack of a durational or geographical limitation.” S.C. Code Ann. §39-1-30(D) (2007). (There is no counterpart to this provision in the North Carolina Trade Secrets Protection Act). 

Judge Tennille, finding no definitive guidance from South Carolina’s courts on the interplay between the court decision and the statute, interpreted South Carolina law to be as follows:

South Carolina law, as it applies to this case, prohibits an employer (or business purchaser) from enforcing a restriction on the use of information that would amount to an unlawfully broad restrictive covenant preventing a person from using the general skills and knowledge acquired as an owner or employee of a business. On the other hand, expiration of a restrictive covenant does not permit a former employee or business owner to use proprietary and confidential information or trade secrets of a business that are otherwise protectible.

Thus, Judge Tennille observed, South Carolina law would permit the Plaintiff to restrict Caldwell from using “specific customer or supplier pricing information” he had learned before leaving the company. But South Carolina law would not permit the Plaintiff to restrict Caldwell “from using his general knowledge of how prices are set in the forklift repair business to compete.”

The Court then denied the motion to dismiss, interpreting the confidentiality provision to be permissibly  limited to prohibiting Caldwell’s use of non-public, proprietary information to which he had access at the business he had sold, and which had been part of the assets purchased by the Plaintiff. 

There is no North Carolina appellate decision I’m aware of which analyzes a confidentiality agreement under the same factors applicable to non-compete agreements.  That approach was rejected by the Court of Appeals In Chemimetals Processing, Inc. v. McEneny, 124 N.C.App. 194, 476 S.E.2d 374 (1996), where the Court held:

An agreement is not in restraint of trade, however, if it does not seek to prevent a party from engaging in a similar business in competition with the promisee, but instead seeks to prevent the disclosure or use of confidential information. Such agreements may, therefore, be upheld even though the agreement is unlimited as to time and area, upon a showing that it protects a legitimate business interest of the promisee.

Chemimetals might leave room for a North Carolina court to say that a confidentiality agreement seeking to protect all information of a former employer is invalid because the breadth of such a restriction doesn’t protect "a legitimate business interest" of the former employer.  The Covenant decision might be of some help in an argument like that.

The photo at the top came from Tom Arthur’s Photostream on Flickr.