North Carolina Court Of Appeals Prods Supreme Court To Update Analysis On Non-Competes

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The executive and legislative branches in North Carolina have made efforts recently to encourage the relocation and expansion of businesses in the State in a continuing quest to make North Carolina more business friendly.  Now, it appears that it is the judiciary’s turn.  In a recent decision by the North Carolina Court of Appeals – Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, et al., No. COA14-185, August 5, 2014 – the court for the first time squarely focused on changing the law with respect to the enforcement of non-compete agreements, at least in the limited context of a purchase and sale of a business, to avoid the harsh application of the strict blue-pencil rule and to reflect the changing environment of business needs in the State today.

The facts of Beverage Systems are not extraordinary.  The Plaintiff was formed following the acquisition of assets of two existing businesses, Imperial Unlimited Services, Inc. (”Imperial”) and Elegant Beverage Products, LLC (”Elegant”), which supplied, installed and serviced beverage products and dispensing equipment.  The transaction was memorialized by an Asset Purchase Agreement.  The Agreement provided for the sale of Imperial’s and Elegant’s assets, trade names, customer lists, account receivables, customer contracts, equipment and real estate.  The Agreement included a non-compete agreement which applied to “the states of North Carolina or South Carolina” “until the earlier of (i) October 1, 2014 [five years out from the purchase] or (ii) such other period of time as may be the maximum permissible period of enforceability of this covenant (the ‘Termination Date’).”  The Agreement also contained the following provision:

“If, at the time of enforcement of any provisions of Sections 1, 3 or 4 hereof, a court holds that the restrictions stated herein are unreasonable under the circumstances then existing, the parties hereto agree that the maximum period, scope or geographical area that are reasonable under such circumstances shall be substituted for the stated period, scope or area, and that the court shall be allowed to revise the restrictions contained in Sections 1, 3 and 4 hereof to cover the maximum period, scope and area permitted by law.”

At the trial court level, the defendants moved for summary judgment, arguing, in part, that the non-compete was not enforceable as a matter of law and that under North Carolina’s strict blue-pencil rule, the provision could not be saved.  Moreover, the defendants argued that the saving clause was in direct conflict with North Carolina law and therefore, even with the admonition in the Agreement that it could be revised “to cover the maximum period, scope and area permitted by law,” the court’s hands were tied and the provision could not be re-written by the court.  The trial court agreed with defendants, granting summary judgment on the breach of the non-compete agreement, as well as other claims.  This appeal ensued.

In a split decision by the Court of Appeals, the Court reversed the trial court’s decision, finding that while the non-compete agreement was too broad as to its geographic scope, the trial court was specifically empowered by the parties’ Agreement to revise the term to make it more reasonable.  The Court of Appeals paid due deference to the long-standing ”blue pencil doctrine” in North Carolina which generally prohibits judges from re-writing non-compete agreements and only permits judges to strike severable provisions of the non-compete agreement.  But the Court noted that the law in North Carolina has long afforded non-compete agreements in the context of a sale or purchase of a business ”greater latitude” than in the traditional employer-employee relationship.    See Seaboard Indus., Inc. v. Blair, 10 N.C. App. 323, 333, 178 S.E.2d 781, 787 (1971).  Under this more liberal approach, the Court had no problem finding the time reasonable and further found that the trial court should have itself modified the geography to make it more reasonable:

“Given the fact that non-competes drafted based on the sale of a business are given more leniency than those drafted pursuant to an employment contract since the parties are in relatively equal bargaining positions, the trial court should not have held the trial court’s power to revise and enforce reasonable provisions of the non-compete be limited under the ‘blue pencil doctrine.’  Instead, the trial court should have invoked its power under paragraph six and revised the non-compete to make it reasonable based on the evidence before it.”

The Court of Appeal’s decision marks the first time a North Carolina appellate court has squarely and abruptly broken with the “blue pencil doctrine.”  There has been some prior rattling by the Appellate Court on the need to revise the strict “blue pencil doctrine” to take into account the changing business needs in the State.  Indeed, the Court of Appeals even referred to this early intonation of discontent.  Id. fn. 3, citing Judge Steelman in MJM Investigations, Inc. v. Sjostedt, 205 N.C. App. 468, 698 S.e.2d 202 (No. COA09-596) (July 20, 2010) noting “The law of restrictive covenants should be re-evaluated by our Supreme Court in the context of changing economic conditions.”  See also prior post:  QUESTION POSED: IS THE TRADITIONAL ANALYSIS USED FOR DETERMINING THE VALIDITY OF NON-COMPETES IN NORTH CAROLINA OUTDATED? Clearly for this Court, the Supreme Court was not taking up the baton quick enough.  Faced with the conflict between the strict blue pencil doctrine and the changing business environment, the Court of Appeals in Beverage Systems chose to act — as much and as far as it could — to perhaps force the Supreme Court to itself relieve the burdens it imposes through its unwavering treatment of restrictive covenants:

“Finally, in recognizing the importance of allowing parties who agree that provisions of a non-compete may be revised in an effort to enforce them, we believe that this practice makes good business sense and better protects both a seller’s and purchaser’s interests in the sale of a business. . . .  This is especially true in North Carolina where our Supreme Court has been unwilling to adopt a more flexible approach to the ‘blue pencil doctrine,’ leaving the courts with few options to try to enforce non-competes in a rapidly changing economy.”

Although clearly limited to the context of a purchase or sale of a business, the ruling, if upheld, is significant for businesses in the State.  Judge Elmore filed a dissent, arguing that there is no basis to save a non-compete, even in this context, as the “blue pencil doctrine” is universal and without exception.  If the decision is appealed, perhaps the Supreme Court will rule to relax the doctrine, at least in this context.  Time will tell.

 

Topics:  Employee Rights, Employer Liability Issues, Non-Compete Agreements, Restrictive Covenants

Published In: Civil Procedure Updates, General Business Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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