North Carolina Courts Are Forbidden To “Blue Pencil” An Unenforceable Non-Compete

by Seyfarth Shaw LLP
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Reversing a 2-1 decision of the North Carolina Court of Appeals, the state’s Supreme Court held unanimously that an assets purchase-and-sale contract containing an unreasonable territorial non-competition restriction is unenforceable.  Further, a court in that state must strike, and may not modify, the unreasonable provision. Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, No. 316A14 (N.C. Sup. Court, Mar. 18, 2016).  The Court of Appeals’ decision, now reversed, is published at 762 S.E.2d 316 (2014) and was the subject of a Trading Secrets blog dated August 27, 2014.

Status of the case The trial court entered summary judgment for the defendants as to all claims.  That ruling, which was reversed by the Court of Appeals, has been reinstated.

The purchase-and-sale transaction. Thomas Dotoli owned Imperial Unlimited Services which serviced soft drink dispensers in parts of North and South Carolina.  His wife and their son, Loudine, owned Elegant Beverage Products which sold premium coffee and tea in the same areas.  In 2009, the three Dotolis sold Imperial and Elegant to a new company, Beverage Systems of the Carolinas, which was owned by Loudine Dotoli’s wife, Cheryl.  In connection with the purchase-and-sale transaction, the sellers executed a five-year non-compete covenant, encompassing the entirety of North and South Carolina, for which they were paid $10,000.  The covenant provided that a court could revise the temporal and geographic limits if they were deemed unreasonable.

Competition, and a lawsuit, ensue. When Associated Beverage began installing and servicing beverage dispensing machines in North and South Carolina, Beverage Systems sued Cheryl, her company, and Loudine.  He was accused of breach of contract.  All of the defendants were charged with tortious interference and unfair and deceptive practices.  The defendants responded that the covenant was unenforceable because of its allegedly overbroad temporal and territorial restrictions.

Ruling of the trial court. Agreeing with the defendants that the covenant included geographic restrictions beyond those necessary to maintain the plaintiff’s customer relationships, the trial court entered summary judgment against Beverage Systems.

Reversal by the appellate court. The Court of Appeals reversed and remanded.  The appellate court’s majority okayed the five-year restriction but held that the trial court should have blue-penciled the unreasonable territorial limitation.  Further, the appeals court majority said disputed issues of material fact precluded summary judgment.  Dissenting, one appellate jurist stated that the contract only allowed blue-penciling as “permitted by law,” that North Carolina judges can strike — but are not authorized to rewrite — unreasonable restrictions, and that there were no contested factual disputes.  The dissenter would have affirmed.

The Supreme Court’s view. The Supreme Court emphasized that, in the instance of the sale of a business, a geographic restriction limited to the locations where the seller operates is permissible.  Here, however, the restricted territory encompassed what the Court called “large swaths” of both North and South Carolina in which Beverage Systems had no customers.  The Court held that territorial limitations are enforceable “as written or not at all.”  Since striking the unreasonable provision results in “no territory left within which to enforce the covenant not to compete, . . . blue-penciling cannot save the Agreement.”  Nor could the parties “contract to give a court power that it does not have.”

Rejecting Beverage Systems’ allegations of interference with contract, the Supreme Court stated there was no evidence of contracts between Beverage Systems and its customers. Rather, the jurists held that the evidence only showed general business relationships.  Thus, the defendants “were free to engage in routine business competition with Beverage Systems.”

Takeaways. The blue-pencil doctrine has significant variations in different states.

  • Judges in a few jurisdictions are not permitted to modify contracts under any circumstances.
  • In states that do permit blue-penciling, courts reason that the parties’ intent to have a contractual relationship sometimes is furthered by substituting reasonable terms for unreasonable ones (but judges sometimes decline to assist the drafters of contracts containing unduly onerous provisions).
  • In North Carolina and several other jurisdictions, blue-penciling can only be used to strike contractual provisions, not to alter them.  In Beverage Systems, striking the geographical limitations invalidated the non-compete.

Because of these significant variations, companies that have multi-state operations need to understand each relevant jurisdiction’s blue-penciling and other rules of contract interpretation. In order to enforce similar contracts in different jurisdictions, some terms may have to be tailored to fit the law of the places where litigation may ensue.

Further, in any given jurisdiction a particular restrictive covenant in contracts for the sale of a business may be enforceable whereas the same provision is unenforceable in employment contracts.

For all of these reasons, consultation with experienced legal counsel is advised.

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