Enforcement of Non-Competition Clauses in Employment Contracts North Carolina

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1 Enforcement of Non-Competition Clauses in Employment Contracts North Carolina Of the states neighboring Virginia, North Carolina is among the closest to Virginia's employer-friendly legal setting for enforcement of non-competition clauses. As in Maryland, the courts in North Carolina are quite concerned with an employee's ability to make a living. As such, they look particularly harshly on clauses that impose undue hardship on the former employee. As in West Virginia, continued employment is not sufficient consideration to sustain a restrictive covenant that is signed after employment has begun. And like Maryland, West Virginia, and Tennessee, North Carolina courts employ a version of the "blue pencil" approach to covenant enforcement, though they initially utilized the "all or nothing approach, like Virginia. Doctrinally, North Carolina courts examine a number of factors when determining the reasonableness of a non-competition clause. In Asheville and Associates v. Miller, the court found that, "such covenants will be enforced if they are no broader than reasonably necessary for the protection of the employer's business and do not impose undue hardship on the employee, due regard being given the interests of the public." 121 S.E.2d 593 (N.C. 1961); see also Harwell v. Heim, 173 S.E.2d 316 (N.C. 1970) (presenting a similar formulation of the doctrinal test for determining the reasonableness of a non-competition clause). It does not seem matter whether the employee quit or was fired because as a general rule the doctrinal test does not vary with the method of termination. In 1944, the Supreme Court of North Carolina refused to enforce a non-competition agreement between a deliveryman/bill collector and his employer because of the unduly harsh nature of the covenant. Kadis v. Britt, 29 S.E.2d 543 (N.C. 1944). After working for the plaintiff for several years, the defendant signed an agreement prohibiting him from having any interest in "any firm or corporation engaged in any business or businesses such as is conducted by [plaintiff]... in Wayne County, North Carolina, for a period of two years." Id. at 545. The restriction also prohibited any member of the defendant's family from "engag[ing] in any business that is herein restricted" within the same territory. Id. at 545. Two years later, the defendant was terminated because of a lack of work, and he subsequently found work in a clothing business similar to plaintiff's. Id. Looking at the 1

2 grave consequences of unemployment on the community, the court refused to enforce the covenant against this low-level employee, despite the employer's "substantial right" which the covenant protected, namely the "unique assets of his business." Id. at 546. The hardship that would be imposed on Britt was too extreme and would require him to abandon "the only occupation for which he is fitted." Id. at 549. See also Delmar Studios of the Carolinas, Inc. v. Goldston, 105 S.E.2d 277 (N.C. 1958) (enforcing a restrictive covenant prohibiting competition in most of three states for two years against a school photographer who had worked for the plaintiff for just one and a half years because he could return to the type of photography he did before). A secondary rationale for not enforcing the covenant at issue in Kadis was that it lacked consideration. 29 S.E.2d at 548. Generally, employment is sufficient consideration to support a non-competition agreement. In Kadis, however, the court held that additional consideration was required to support such a restrictive covenant where the agreement was signed after the employee had been employed for years and none of the terms of employment except the restriction changed. Id. at 549. One concern the court had with employment at will and non-competition agreements signed after employment began was the threat of termination for failure to sign such agreements might be coercive, forcing an employee to sign the covenant for fear of immediate unemployment. Id. at 548. Therefore, the obligations of the employer must be additionally modified when an employee signs a non-competition agreement after his employment has commenced. Id. at 549. See also Worth Chem. Corp. v. Freeman, 136 S.E.2d 118 (N.C. 1964) (refusing to enforce a restrictive covenant, prohibiting competition for twelve months within 225 miles, signed by a chemical salesman two weeks after he began employment for lack of consideration); James C. Greene Co. v. Kelley, 134 S.E.2d 166 (N.C. 1964) (holding a non-competition agreement prohibiting competition for four years within seventy-five miles signed by an insurance adjuster void, because it was entered into one year after employment began without any additional consideration); Henley Paper Co. v. McAllister, 117 S.E.2d 739 (N.C. 1960) (refusing to enforce a non-competition agreement prohibiting direct and indirect competition for three years and within 300 miles of any of plaintiff's four offices that was signed several months after employment began because it lacked consideration and 2

3 was overbroad). But see Brooks Distrib. Co., Inc. v. Pugh, 378 S.E.2d 31 (N.C. 1989) (finding employer stated a claim for breach of non-competition agreement, even though there was nothing in the writing reciting the consideration received, where the employer alleged sufficient consideration in the complaint). Initially, North Carolina's philosophy of enforcement was similar to Virginia's "all or nothing" approach. In Noe v. McDevitt, 45 S.E.2d 121 (N.C. 1947), the court refused to enforce a non-competition agreement that was overly broad regarding the territory involved. The restriction prohibited the former salesman from soliciting former clients and "own[ing] or operat[ing] any company or business selling the same type of merchandise as that sold by the [plaintiff]... for a period of five (5) years" in all of North and South Carolina. Id. at 122. After terminating his employment with the plaintiff, the defendant became employed by a direct competitor of his former employer's, selling similar products to customers in the Carolinas, including plaintiff's former clients. Id. at 122. The court held that the restriction was more broad than necessary for the employer's protection, because the plaintiff could only show clientele in eastern North Carolina. Id. at 123. Given that the covenant included the western part of North Carolina, as well as South Carolina, the court was unwilling to "make a new contract for the parties" by shaving off the extraneous territory; rather the agreement "must stand or fall integrally." Id. See also Henley Paper Co. v. McAllister, 117 S.E.2d 739 (N.C. 1960) (holding a restrictive covenant overbroad and unenforceable because it prohibited the defendant, a salesman of fine paper, from working for a paper manufacturer, even though plaintiff was only a paper distributor). However, the court changed its approach just seven months after Henley was decided. The court enforced a geographically overbroad restriction only with respect to the city in which the defendant worked. Welcome Wagon Intern., Inc. v. Pender, 120 S.E.2d 739 (N.C. 1961). Upon her employment, Pender, a hostess in Fayetteville, North Carolina, signed a covenant that she would not "for a period of five whole years" work "in the same kind or similar business" as the plaintiff in (1) Fayetteville, or (2) any town or city within North Carolina where Welcome Wagon provided its service, or (3) & (4) any town or city where Welcome Wagon rendered its service or planned to provide its service anywhere in the United States. Id. at 740. After working as a hostess for ten years, the defendant quit 3

4 her employment and began her own competitive business, taking all of her sponsors with her. Id. at 741. The court found sufficient business interests in need of protection. Specifically, Welcome Wagon had trained Pender in the "methods, plans and systems invested and used by" her former employer. Id. The court was able to justify the "blue pencil" approach because the agreement was divided by the parties with respect to the territories covered. Id. at 742. Continuing the temporary restraining order until a hearing on the merits with respect to (1) Fayetteville, the court could not say that five years was unreasonable as a matter of law. Id. at 743. However, the court held that the restriction was unreasonable and unenforceable with respect to any city where Welcome Wagon provided or intended to provide its services throughout the entire United States. The chancellor would have to determine the reasonableness of prohibiting competition in any city in North Carolina where Welcome Wagon provided services. Id. at 742. But cf. Welcome Wagon, Inc. v. Morris, 224 F.2d 693 (4 th Cir. 1955) (holding unduly oppressive and therefore unenforceable the same clause as it pertained to a hostess in Gastonia who quit after her sponsors left and subsequently went to work for them. She was not a highlevel employee with access to trade secrets or confidential information and had built up the business herself). Similarly, the court enforced a non-competition agreement with respect to soliciting clients, despite the fact that the competitive activities also listed in the covenant might have been overly broad. Whittaker Gen. Med. Corp. v. Daniel, 379 S.E.2d 824 (N.C. 1989). Upon the defendant's promotion to salesperson, which included a substantial salary increase, she signed a contract that included a covenant not to "'call upon, solicit or interfere with or divert in any way any customers served by' the plaintiff[]" for two years. Id. at 826. The contract also prohibited the defendant from "manufacturing, selling, renting or distributing any goods manufactured, sold, rented or distributed by" the employer. Id. at 828. Nine years later, Daniel resigned from plaintiff's employ and began working for one of their competitors, soliciting many clients away from the plaintiff. Id. at 826. The court upheld a jury verdict for the former employer that had been set aside by the trial court. Id. at 828. In doing so, the court found that although one provision of the agreement purported to prevent the defendant from working in a manufacturing capacity, despite the fact that the 4

5 plaintiff did not engage in manufacturing. However, the separate provision prohibiting solicitation of plaintiff's clients was separable and reasonable and, therefore, enforceable. Id. Like West Virginia, however, North Carolina courts will not shave down the territory in a geographically unlimited provision. Prof'l Liab. Consultants, Inc. v. Todd, 468 S.E.2d 578, (N.C. App. 1996), rev'd, 478 S.E.2d 201 (N.C. 1996), reh'g denied, 483 S.E.2d 175 (N.C. 1997). Relying on the dissenting opinion of the lower court's decision, the Supreme Court of North Carolina held that the unlimited geographical restriction was unreasonable and unenforceable. 478 S.E.2d at 210. At issue was a covenant between an insurance agency and a sales/service representative prohibiting him from "(i) contact[ing] or in any way attempt[ing] to solicit insurance business from any[one]" who was a customer of plaintiff's in the past three years or "(ii) disclos[ing] any information... which would enable any[one]" else to solicit business from those clients. 468 S.E.2d at 579. After four years, the defendant resigned and opened his own insurance agency, in direct competition with the plaintiff. Id. The dissenting judge found that the lack of a geographic restriction was "so broad that it cannot claim to serve any legitimate business interest." Id. at 582. Additionally, by failing to provide information about where its customers were located, the former employer failed to show that such restriction was reasonable. Id. The dissenting judge also thought five years was too long a time for such a broad provision, given that it amounted to an eight year restriction, by including clients who ceased to do business with the plaintiff up to three years before the defendant left. Id. at 583. The dissent found the prohibition "'patently unreasonable'" and "severing the overly broad time and territory provisions would eliminate clauses inherently necessary to" the covenant. Id. at 583. Although North Carolina courts provide a more employer-friendly environment for the enforcement of non-competition agreements than Virginia s neighbors to the north and west, there are several remarkable differences. Continued employment, which is sufficient consideration to support a restrictive covenant in Virginia and Tennessee, is not adequate in North Carolina (or Maryland or West Virginia). Additionally, North Carolina courts, like Maryland, West Virginia, and Tennessee, are able to judicially modify overly broad restrictive covenants. 5

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