Bring Out the Body Bags: Seller’s Covenant, In Asset Sales Agreement, Not To Compete Within 150 Miles For 10 Years Unenforceable

by Seyfarth Shaw LLP
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Palmetto bought the assets of Knight Systems’ mortuary transport business. The agreement of purchase and sale included (a) Palmetto’s commitment to buy body bags, at specified discounted prices, exclusively from Knight Systems for 10 years, and (b) Knight Systems’ promise not to provide mortuary transport services within 150 miles of Palmetto’s offices for the same period.  Notwithstanding the non-compete covenant, a few years later Knight Systems submitted a timely proposal — and was selected — to provide those services to a Palmetto customer within the 150-mile territory.  Palmetto sued Knight Systems for breach of contract, won below, but lost in the South Carolina Court of Appeals.

Status of the case.  By consent, Palmetto’s complaint and Knight Systems’ counterclaim were tried before a court-appointed referee.  Concluding that the geographic restriction in the non-compete was reasonable, he ruled in favor of Palmetto and awarded $373,000.  The Court of Appeals reversed and remanded. Palmetto Mortuary Transport, Inc. v. Knight Systems, Inc., No. 2014-001819 (S.C. Court of Appeals, May 4, 2016).

Background. Four years after the purchase and sale transaction, Palmetto customer Richland County published a RFP with regard to providing mortuary transport services to the county for five years.  The day before the deadline for responding, Knight Systems accused Palmetto of purchasing body bags from others in violation of its commitment to buy those products exclusively from Knight Systems.  Palmetto replied that it had spent a minimal amount, less than $450 (1% of the aggregate amount it had paid Knight Systems), for products covered by the contract’s exclusivity provision.

Knight Systems was the only source for the odor-proof body bags required by the RFP. Shortly before the contract was awarded, it informed Richland County that it (Knight Systems) intended to take those products off the market.  This would leave Palmetto unable to satisfy a contractual condition.  Whether for this reason or otherwise, and despite Palmetto’s contention that it had submitted the most favorable proposal, Knight Systems was awarded the contract.

Reversal of the referee’s decision. The only issue addressed on appeal was the reasonableness of the geographic limitation in the assets sale agreement.  According to the court, the referee cited two bases for his conclusion that the limitation was reasonable.

  • Palmetto’s owner testified that it wanted the 150-mile restriction included in the purchase and sale agreement because, although Knight Systems did mortuary transport business in only two South Carolina counties, Palmetto was considering an expansion of the territory.  The appellate tribunal held that this testimony did not justify a restriction encompassing parts of three states, especially since there was insufficient “evidence of definitive planning, acquisitions, or other overt acts” in support of possibly enlarging the service area.
  • A Knight Systems owner testified that the company did not object to including the restriction in the agreement because, at that time, Knight Systems had not intended to get back into the business after the sale to Palmetto.  The court said Knight Systems’ “intention of not returning to the mortuary transport business is [not] a relevant factor for analyzing whether a territorial restriction is reasonable.”

Lastly, the Court of Appeals addressed the possibility of “blue penciling” the 150-mile restriction. That would be permissible under South Carolina law, the judges said, only if the agreement authorized redrawing the provision.  The Palmetto-Knight Systems contract did not so authorize.  Accordingly, blue penciling would mean inserting “an arbitrary term” as to which the parties neither negotiated nor agreed.

Takeaways. Many judicial opinions state that restrictive clauses in a non-compete contained in an employment agreement must be reasonable or they are subject to being invalidated. Palmetto makes the same point regarding restrictions in an assets sale contract.

Palmetto also teaches that when drafting a non-competition and/or a non-solicitation clause for an employment or sales agreement, consider authorizing a decision-maker to modify unreasonable geographic and duration provisions.  However, trade secret confidentiality clauses — not involved in the Palmetto case — rarely are invalidated because of allegedly unreasonable territorial or time restrictions (such clauses are subject to being stricken in their entirety by a court holding that there is no substantial risk of disclosure).

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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