Covenants Not To Compete

This case interpreted South Carolina law — different than North Carolina law — on the enforceability of a confidentiality agreement that the Defendant argued was overly broad.

The South Carolina precedent is Carolina Chemical Equipment Co. v. Muckenfuss, 471 S.E.2d 721 (S.C. 1996), where the South Carolina Supreme Court  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). 

In this case, the North Carolina Business Court 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 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. 

The North Carolina appellate case on the issue of enforceability of confidentiality agreements is 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.

Full Opinion

Brief in Support of Motion to Dismiss

Brief in Opposition to Motion to Dismiss

Reply Brief in Support of Motion to Dismiss

The North Carolina Business Court rejected a novel argument regarding the validity of post-employment consideration for a covenant not to compete.  It also dealt with the issue of the validity of a summons issued in the wrong name.

On the non-compete side, Plaintiff signed the non-compete with the cleaning company for which she had worked three years after she began employment.  Defendant argued that it had held off from firing the Plaintiff in exchange for her execution of the agreement, and that this was valid consideration.

Judge Tennille disagreed, holding:

"The Court is not aware of any prior decisions holding that a decision not to fire someone is adequate consideration for a non-compete. Instead, this state has found that ‘[w]hen the relationship of employer and employee is established before the covenant not to compete is signed there must be consideration for the covenant such as a raise in pay or a new job assignment.’ Whittaker Gen. Med. Corp. v. Daniel, 324 N.C. 523, 527, 379 S.E.2d 824, 827 (1989) (citing Chemical Corp. v. Freeman, 261 N.C. 780, 136 S.E.2d 118 (1964)). That consideration can NOT be the continuation of employment. Mach. Co. v. Miholen, 27 N.C. App. 678, 686–87, 220 S.E.2d 190, 196 (1975). Indeed, under Defendants’ theory, every employer could offer an employee the option of being fired or signing a non-competition agreement and argue that ‘consideration’ had been paid. That is not the law in North Carolina. The restrictive covenant in this case was invalid."

The issue involving the validity of the summons arose because Plaintiff had sued a company called Molly Mops, LLC, but had meant to sue a different company, Molly Mops Cleaning Service, LLC.  Plaintiff discovered the error promptly, and amended her complaint before any responsive pleading was filed, but never had a new summons issued.

Plaintiff sought leave to amend the original summons to properly name Molly Mops Cleaning Service, LLC.  Judge Tennille denied the Motion, even though the right party had notice of the lawsuit, holding:

This is not a case of misnomer. The wrong entity was named in the summons which was never amended. There is no doubt that MMCS had notice; however, that does not cure the defect. It may well be that plaintiff intended to sue MMCS and was confused; however, that does not cure the defect. Plaintiff did file an amended complaint; however, that did not cure the defect. A proper summons was never served on MMCS and thus no action has been commenced against it.

* * *

In this case, Plaintiff made a substantive mistake and sued the wrong entity. That mistake was fatal. The court does not have jurisdiction over MMCS because no valid summons was issued and served on MMCS.

Full Opinion

Brief in Support of Motion for Summary Judgment

Brief in Opposition to Motion for Summary Judgment

Brief in Support of Motion to Amend Summons

Brief in Opposition to Motion to Amend Summons

The Court denied a Motion for a Temporary Restraining Order.  The Motion sought enforcement of covenants not to compete executed by the Defendants, who were loan officers with the Plaintiff, a mortgage broker.

The covenants stated that the Defendants:

will not directly or indirectly, in any capacity work for any company, entity or individual, including himself/herself, who originates or sells residential housing loans in any state in which LO has originated a loan in the six (6) months preceding the termination of LO’s employment with the Company [Integrity].

The Court found this to be too broad a restriction, holding:

the individual Defendants would not merely be prevented from working as loan officers for other mortgage brokers, but would also be prevented from doing even wholly unrelated work at any firm that competes with the Plaintiff.

The Court also noted that the Defendants contended that the Plaintiff had breached its agreement by failing to pay them, and held:

Our courts have held that “[i]njunctive relief to enforce the terms of a contract will not be granted a party who has himself breached the terms of the contract when his breach is substantial and material and goes to the heart of the agreement."

Full Opinion

Brief in Support of Motion for Temporary Restraining Order

Service of process can be made by leaving the Summons and Complaint at the Defendant’s residence, even though not in literal compliance with Rule 4, if the Defendant has evaded service.

The Defendant will waive an objection to service (and to jurisdiction) by filing a Notice of Designation to the North Carolina Business Court, because "the filing of a Notice of Designation in an action constitutes a general appearance for the purpose of personal jurisdiction."  To keep such objections alive, the Notice of Designation must contain an objection to personal jurisdiction. 

On a covenant not to compete issue, the Court followed the principle it set out in Better Bus. Forms & Prods., Inc. v. Craver, 2007 NCBC 34 (N.C. Super. Ct. Nov. 1, 2007) regarding the right of an asset purchaser to to enforce a non-compete entered into between the seller and an employee. The buyer has the option to enforce the noncompetition agreement or to enter into a new agreement. As the Court held: "a noncompetition agreement that has been sold as part of an asset sale, as opposed to the sale of a business, gives the buyer the right to enforce the noncompetition agreement as of the date of the sale but not to enforce the noncompetition agreement as if it had been entered into originally by the buyer."

Full Opinion

Brief in Support of Motion to Dismiss

Brief in Opposition to Motion to Dismiss

Reply Brief in Support of Motion to Dismiss

The Court granted a preliminary injunction on a covenant not to compete even though defendant denied that he had signed the agreement and presented a handwriting expert who testified that his signature had been forged. The Court found that New York law applied to the covenant, that New York law permitted blue pencilling, and that it therefore could modify the scope of the restriction.

Full Opinion

Brief in Support of Motion for Preliminary Injunction

Brief in Opposition to Motion for Preliminary Injunction

Reply Brief in Support of Motion for Preliminary Injunction

The Court discussed the consideration element of a post-employment covenant not to compete, nothing that an increase in compensation or a job promotion can be sufficient consideration.

The Court held the non-compete at issue invalid for other reasons, however, involving its temporal and geographic scope. First, the Court held that the covenant prevented the defendant from having even an indirect ownership in a competing company. It therefore did not protect a legitimate business interest of the former employer.

The Court futher found the time period of the restriction to be unreasonable, as the wording of the restriction required it to "look back" to a period of time when the employee began serving the customers as to which the restriction was sought.

The restriction also attempted, invalidly, to prevent the employee from dealing with "prospective customers," which the Court found to be "an undefined, and, therefore, unduly vague group."

Given that the covenant was customer based, as opposed to geographically based, the Court found the covenant to be invalid.

Full Opinion

Defendant had entered into a covenant not to compete with his employer, BBF. The assets of BBF, including its contract rights, were acquired by GDX. GDX then terminated defendant’s employment per the agreement, and hired him directly. There was no new non-compete agreement entered into directly between GDX and defendant. Years later, GDX filed for bankruptcy, and its assets were purchased by the plaintiff.

The Court held that a covenant not to compete can be assigned as the part of the sale of a business. Therefore, GDX would have been entitled to enforce the covenant against defendant if defendant had left GDX at the time of the sale and begun to compete. The Court further held, however, that GDX was obligated to negotiate a new non-compete if it wished to continue the covenant in place. (The Court held that the answer would have been different if GDX had acquired the stock of BBF, as opposed to its assets). It stated "when an employer sells its assets, including its right to enforce a restrictive covenant in an employment contract, the period of the restrictive covenant begins to run because the employment relationship has been terminated. The former employee and the new employer have the choice of either not entering into a new agreement and having the old covenant enforceable or entering into a new agreement with a new restrictive covenant."

On the issue of the entitlement of a purchaser of assets at a bankrupty sale to enforce a covenant not to compete, the Court held "this Court is doubtful that the appellate courts of this state will sanction the purchase and enforcement of restrictive covenants by bidders for assets of the bankrupt employer."

Full Opinion

The Court denied a motion for preliminary injunction on two covenants not to compete.  It found that one covenant was overly broad, since it had no geographic scope whatsoever.  Another covenant was also overly broad, as it restrained the defendant from working for a competitor in any capacity at all, including as a security guard or a custodian.  The defendant had been plaintiff’s Director of Software Engineering. The Court refused to blue-pencil the covenant. 

The covenant was also invalid becasue it unreasonably prevented the defendant from having an interest in a mutual fund which held shares in a publicly traded competitor, and because it attempted to prevent contact with future customers.  The Court found that a restriction on future customers did not protect any legitimate interest of any employer. 

At the conclusion of its opinion, the Court rejected plaintiff’s argument that the Court was making a decision that was "bad for business," and therefore inconsistent with its mandate.  The Court held that "the North Carolina Business Court was created to provide judicial specialization in complex business litigation. This Court’s judges do not, however, decide cases based on the prevailing economic winds, nor do we consider how best to promote a litigant’s business interests. Our oath is the same as that of any judge of this state—to apply the law and decide cases without regard to the parties who are before us."

Full Opinion

Plaintiff’s former employee was subject to restrictive covenants in an Amended Employment Agreement. He was also subject, however, to what he claimed were conflicting restrictions in a subsequently executed Stock Purchase Agreement. The former employee asserted that the claims under the Amended Employment Agreement should be dismissed.

The Court denied the Motion and struck the employee’s defense on this basis. It held that the restrictive covenants, although not consistent, could be enforced concurrently, and that there was not a novation or a substitution of the contract. Nor did the merger clause in the subsequent agreement eliminate the restrictions in the earlier agreement.

The Court also addressed plaintiff’s motion to disqualify defendant’s counsel, who had represented him in connection with the Stock Purchase Agreement. It denied the Motion, holding that plaintiff had to meet a high standard of proof to obtain disqualification. The issue was whether the prior representation was "substantially related" to the matter before the Court. The Court found that it was not, since plaintiff’s claims were lodged under the Amended Employment Agreement, not the Stock Purchase Agreement. The standard for whether a matter is substantially related to another is that there must be a "virtual congruence of issues."

Also, there was no risk that the law firm had obtained confidential information in its prior representation, which had occurred five years earlier, which would have materially advanced its new client’s interest in the litigation. The Court contrasted cases in which there was a high risk of the lawyer having access to such information.

Full Opinion

Plaintiff, the former employer of the defendant insurance broker, sued to enforce his amended employment agreement. Defendant moved to dismiss, claiming that the agreement had been superceded by an exit agreement, that a later stock purchase agreement had served as a novation of the employment agreement, and finally that the non-competition provisions in the employment agreement were unenforceable.

The Court rejected the first argument, which was premised on the presence of a merger clause in the exit letter. The Court held that in order to determine the impact of the merger clause, it would have to make a fact intensive inquiry inappropriate on a motion to dismiss. On the novation argument, the Court found that the stock purchase agreement was not referenced in the pleadings and that it was inappropriate for it to consider that agreement on a motion to dismiss. The Court found, in any event, that whether a novation had occurred was a fact question.

The Court then discussed the general standards for the validity of non-competition agreement, and concluded that the plaintiff’s claims for violation of that agreement would survive. It held the term, which was potentially as long as four years because of a "look back" provision, was reasonable. It further found that a client-based restriction, in lieu of a specific territorial restriction, can be valid.

It held this restriction invalid, however, because it created a conclusive presumption that if any client of plaintiff did business with defendant’s new firm, even clients with whom defendant had not worked, that would be deemed to be a violation of the covenant. The Court blue penciled this provision of the restrictive covenant and let stand the claim on the remainder. (There was no claim before the Court for injunctive relief).

Full Opinion