Noncompetition agreements (“non-competes”) present thorny issues. In most cases, you have a former employee who has signed a black-and-white contract prohibiting him or her from engaging in certain employment, and the employee goes and does the one thing that the contract specifically prohibits. Not that long ago, most judges would view the matter purely as a contract issue, and once an employee’s attorney admitted that yes, that was the client’s signature on the agreement, they did not want to hear much else, with visible disinterest giving way to agitation the longer the argument proceeded.
On rare occasions, if the employee could present special circumstances, the trial courts would do more than pay lip service to the maxims like “noncompetes are strongly disfavored in North Carolina.” Was the territory much more expansive than where the employee actually operated? Was this really a lower-level employee, with the noncompete designed to keep the employee hostage rather than protecting legitimate employer interests?
For the most part, however, it seemed that trial courts would not scrutinize too closely the many hurdles that can arise in noncompete cases. The North Carolina Business Court played a significant in role in changing the noncompete litigation landscape. In balanced, thoughtful opinions, the Business Court developed the law of noncompetes in an evenhanded fashion in several areas; for example, it issued opinions addressing the implications of mergers and acquisitions on the enforcement of noncompetes. See, e.g., Covenant Equip. Corp. v. Forklift Pro, Inc., 2008 NCBC 10, 2008 NCBC LEXIS 12 (Mecklenburg County Super. Ct. May 1, 2008) (asset-purchaser could enforce non-compete upon date of sale but not upon employee’s subsequent termination); Artistic S., Inc. v. Lund, 2015 NCBC 109, 2015 NCBC LEXIS 113 (Wake County Super. Ct. Dec. 9, 2015) (noncompetition obligation began to run on date of asset sale, not employee’s subsequent termination).
Fourth Circuit Enters Noncompetition Fray
Although federal courts are often utilized to enforce noncompetition agreements, they are hesitant to expound or expand the law in this area because it is grounded in state law. In RLM Communications, Inc. v. Tuschen, ___ F.3d ___, 2016 U.S. App LEXIS 13726 (4th Cir. July 28, 2016), however, the Fourth Circuit Court of Appeals significantly elaborated on North Carolina noncompetition and trade secrets law.
RLM Communications was in the cyber security/information technology business. In 2007, it hired Amy Tuschen. On her first day of work, Tuschen signed a noncompetition agreement stating that for one year after her employment she would not “directly or indirectly participate in a business that is similar to a business now or later operated by Employer in the same geographical area.” Id. at *8.
Tuschen rose in the ranks to Director of Information Assurance, with responsibilities that included oversight of large government contracts. In 2013, she quit and began working for eScience, a nearby competing federal contractor. Although initially it appeared the two would part amicably – with RLM providing gift cards and a “giant bouquet of roses” as parting gifts – RLM soon changed its tune.
It learned that Tuschen and eScience were attempting to land a large government contract serviced by RLM that was up for re-bidding. Not only that, Tuschen was contacting RLM employees to line them up in the event eScience successfully won the contract bid. RLM filed suit and quickly secured an injunction. The district court later, however, granted summary judgment in Tuschen’s favor, finding the agreement lacked adequate consideration. RLM Communications, Inc. v. Tuschen, 66 F. Supp.3d 681 (E.D.N.C. 2014).
On appeal, the Fourth Circuit focused on the overbroad nature of the restrictions. The court cited North Carolina cases holding that restrictions “must be no wider in scope than is necessary to protect the business of the employer.” Id. (citing Manpower, Inc. v. Hedgecock, 42 N.C. App. 515, 257 S.E.2d 109, 114 (1979). That means covenants cannot restrict employees from working in capacities unrelated to their previous jobs. Here, the restrictions were too broad:
Even ignoring for a moment the bar on indirect participation in similar businesses, the noncompete is overly broad by preventing direct participation in similar businesses. Tuschen is not merely prohibited from working for RLM competitors in a position like the one she held at RLM. She may also not mow their lawns, cater their lunch businesses, and serve as their realtor.
Id. at *9 (emphasis in original). The court goes on to outline various arrangements that would be prohibited by the noncompete, such as selling computer software for a business or investing her retirement accounts in mutual funds that owned a competing company.
The court also concluded that any attempt to “blue-pencil” the covenant would be futile. Citing the N.C. Supreme Court’s recent decision, Beverage Sys., LLC v. Associated Beverage Repair, LLC, 784 S.E.2d 457, 461 (N.C. 2016), the court noted that North Carolina adheres to the “strict blue pencil doctrine,” which while allowing the striking of distinct overly broad terms, prohibits re-writing covenants to make them enforceable.
Thus, the court found the noncompete overly broad and therefore unenforceable, affirming the district court’s grant of summary judgment in Tuschen’s favor.
Trade Secrets: Access and Suspicion Not Enough to Force Trial
The RLM decision is also remarkable for its holding on trade secret misappropriation. RLM alleged – and Tuschen admitted – that she had access to trade secrets while she was employed by RLM. Tuschen denied, however, that she used any of the information in her subsequent employment.
The court noted misappropriation requires that the user “[h]as a specific opportunity to acquire it for disclosure or use or has acquired, disclosed or used it without the express or implied consent or authority of the owner.” Id. at *15 (citing N.C. Gen. Stat. § 66-155). The court reasoned that the language was open to alternative interpretations. Applying one interpretation in a summary judgment context would allow an Employer to survive summary judgment just by showing it had given the employee access to trade secrets during the regular course of employment.
The court reasoned that such a literal interpretation would lead to absurd results. It also cited North Carolina cases indicating that something more is required before an employer can require an employee to stand trial for misappropriation. After analyzing various interpretations, it crafted a rule sufficient for the case before it: “When an employer brings a misappropriation claim against an employee, admitting that the employee had authorized access to its trade secrets at all relevant times, the employer must raise an inference of actual acquisition or use of trade secrets to survive summary judgment.” Id. at *23 (emphasis added).
Wholesale copying of files shortly before exiting the company or evidence of use of the trade secrets by a competing company might suffice to avoid summary judgment. But here, RLM had presented no “fishy circumstances” surrounding Tuschen’s departure, and no evidence of the trade secrets’ use in her new employer’s work. Thus, the court concluded, summary judgment had been properly granted to the former employee.
Jonathan Wall is a partner with Higgins Benjamin, PLLC,and a former Chair of the NCBA Labor & Employment Law Section. This item originally appeared in L3: Long Leaf Pine, the blog of the North Carolina Bar Association, at http://ncbarblog.com/2016/09/fourth-circuits-rlm-communications-llc-v-tuschen-tackles-noncompetition-and-trade-secret-misappropriation-issues/.
The North Carolina Supreme Court rejected the notion that private parties can enlist the courts to re-write overly broad noncompetition provisions so that they can be enforced. Rejecting the lower court’s straying from the strict blue-pencil rule, Justice Edmunds reasoned that “[a]llowing litigants to assign to the court their drafting duties as parties to a contract would put the court in the role of a scrivener, making judges postulate new terms that the court hopes the parties would have agreed to be reasonable at the time the contract was executed or would find reasonable after the court rewrote the limitation. We see nothing but mischief in allowing such a procedure.” Beverage Systems, LLC v. Associated Beverage Repair, LLC, ___ N.C. ___, ___ S.E.2d ___, No. 2016 N.C. LEXIS 177 (March 18, 2016) (emphasis added).
Beverage Systems involved a non-compete provision in a sale-of-a-business context. In partial consideration to the sale of a business, the seller covenanted not to operate a competing business in the states of North and South Carolina. Evidence indicated that the seller and buyer, however, conducted operations in only a few counties in South Carolina and less than half of the counties in North Carolina. The agreement also provided that if the noncompetition territory were found to be overbroad, the court could re-write the agreement to make it enforceable. The trial court found the territory overbroad and refused to enforce it.
The Court of Appeals reversed and held that North Carolina’s “strict blue pencil rule” did not apply because the contract provision imbued the court with authority to re-write the territory. The strict blue pencil rule allows a court to strike through overbroad restrictions and enforce the remaining reasonable provisions, but it does not permit the court to rewrite provisions. The appellate court reversed and remanded to the trial court with instructions to “to revise the territorial area of the noncompete to [make it enforceable].”
As noted, the Supreme Court rejected that approach. It cited long-standing case law holding that courts are without power to vary or reform private parties’ agreements. “Parties cannot contract to give the court power that it does not have,” the Court observed, before concluding that the contract was unenforceable and could not be saved by the Court.
Now that the N.C. Supreme Court has acted to reign in the proliferation of noncompetition agreements, perhaps it is time for the legislature to act as well.
There is a misperception that noncompetition agreements are “good for business.” Most executives actually hiring talent, however, believe the opposite, as noncompetes serve to strangle the labor market and squelch innovation and entrepreneurship. Thus, much of Silicon Valley’s success is attributed to California’s ban on noncompetition agreements altogether. Other tech-savvy regions, like Boston, Washington State, and Utah have been attempting to reign in noncompetition restrictions, hoping to spur more entrepreneurial growth.
Our legislature could boost Research Triangle industries and the Triad’s nanotechnology and bio-sciences sectors in attracting new businesses with some simple restrictions on noncompetition provisions, like limiting their duration and providing an “earnings floor” below which they would not be enforced. See On Amir & Orly Lobel, Driving Performance: A Growth Theory of Noncompete Law, 16 Stanford Tech. L. Rev. No. 3, p. 833 at 846, 857-62, 865-66 (2013) (reviewing research outlining negative effects of noncompetition agreements on labor market, job creation, and the economy).
If you would like to discuss an issue involving Noncompetition Agreements or Trade Secrets, contact Jon Wall at (336) 273-1600, ext. 134, or email@example.com.
By Jon Wall, Member, Higgins Benjamin, PLLC
Beverage Systems, LLC v. Associated Beverage Repair, LLC, 762 S.E.2d 316 (N.C. Ct. App. 2014) is headed to the North Carolina Supreme Court for review. The Court should reverse the Court of Appeals’ decision, as it represents a significant departure from our jurisprudence on noncompetition agreements (also called “noncompetes”).
Beverage Systems involved a non-compete provision in a sale-of-a-business context. Tangential to the sale of a business, the seller covenanted not to operate a competing business in the states of North and South Carolina. Evidence indicated that the seller and buyer, however, conducted operations in only a few counties in South Carolina and less than half of the counties in North Carolina. The agreement also provided that if the noncompetition territory was found to be overbroad, the court should re-write the agreement to make it enforceable. The trial court found the territory overbroad and refused to enforce it.
The Court of Appeals reversed and held that North Carolina’s “strict blue pencil rule” did not apply because the contract provision imbued the court with authority to re-write the territory. The strict blue pencil rule allows a court to strike through overbroad restrictions and enforce the remaining reasonable provisions, but it does not permit the court to rewrite provisions. The appellate court reversed and remanded to the trial court with instructions to “to revise the territorial area of the noncompete to [make it enforceable].” Judge Elmore dissented.
Because of the split decision, the case is now before the North Carolina Supreme Court, which should carefully consider all of the implications raised by the lower court’s decision. These include:
There is a misperception that noncompetition agreements are “good for business.” Many believe the opposite, as noncompetes serve to strangle the labor market and squelch innovation and entrepreneurship. Thus, much of Silicon Valley’s success is attributed to California’s ban on noncompetition agreements altogether. Likewise, Massachusetts Governor Deval Patrick is advocating for a ban on noncompetition agreements (while strengthening protections for trade secrets), hoping to spur more entrepreneurial growth. How will Research Triangle and the Triad’s nanotechnology and bio-sciences sectors fare in attracting new businesses if the Court of Appeals’ decision stands? See On Amir & Orly Lobel, Driving Performance: A Growth Theory of Noncompete Law, 16 Stanford Tech. L. Rev. No. 3, p. 833 at 846, 857-62, 865-66 (2013) (reviewing research outlining negative effects of noncompetition agreements on labor market, job creation, and the economy).
Permitting courts to rewrite contract provisions ignores long-held tenets of contract law. Foremost, a contract is to be a “meeting of the minds,” yet it is clear the rewritten provisions were not within the parties’ consciousness at the time the contract was entered. The court’s revisions constitute a “reformation” of the contract. Until now, there have been strict limitations on when a court may reform a contract, limited to those situations involving some type of fraud or mistake. As none of those circumstances are present here, the Court should not entertain any type of reformation.
Private parties cannot enlist our courts to make their agreements for them. Acknowledging, let alone enforcing, such provisions sets a bad precedent. In an analogous case, the court observed that “the parties have no right to grant or accept a power held only by the judiciary.” Ibele v. Tate, 594 S.E.2d 793, 795 (N.C. App. 2004) (consent order’s provision that agreement could be enforced using the court’s contempt powers would not be given effect, as it was not within private parties’ power to dictate the business or powers of the court). Courts should not become the parties’ scriveners when they fail to exercise reasonableness and restraint themselves.
Restraints on trade are illegal in North Carolina. Noncompetition agreements are partial restraints of trade, and as such there is a substantial body of case law reciting that “[c]ontracts restraining employment are looked upon with disfavor in modern law.” Kadis v. Britt, 224, N.C. 154, 160, 29 S.E.2d 543, 546 (1944). Are we to pay mere lip service to these tenets by creating special rules of enforcement for noncompetition agreements, ensuring their extra-contractual, universal enforcement?
While the agreement under review involved the sale of a business rather than a post-employment noncompete, the same principles have been applied in reviewing enforceability of both types of noncompetes. In the employment context, the courts’ post facto rewriting of noncompetes in order to enforce them is especially troubling because it encourages employers to draft overly broad and oppressive clauses. See, e.g., Tradesman, Int’l, Inc. v. Black, 724 F.3d 1004, 1018 (7th Cir. 2013)(employers have powerful incentive to draft oppressive clauses if court will rewrite them; in the few cases that go to court, the employer can retreat to reasonable position without suffering any penalty or disadvantage of its oppressive drafting). Moreover, for every case that gets heard in court, hundreds more go unchallenged as employees assume the clauses are enforceable and lack the resources to challenge them. This in terrorem effect was noted over 50 years ago. Harlan M. Blake, Employee Agreements Not To Compete, 73 Harv. L. Rev. 625, 682-83 (Feb. 1960). Thus, the Court of Appeals’ decision would be especially troubling if it were affirmed without unmistakable clarification that the new rule did not apply in the employment context.
Because the Court of Appeals’ decision disregards years of well-reasoned precedent and would be harmful to our State’s economic growth, the N.C. Supreme Court should reverse the decision.
If you would like to discuss an issue involving Noncompetition Agreements, contact Jon Wall at (336) 273-1600, ext. 134, or firstname.lastname@example.org.
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By Jon Wall, Member, Higgins Benjamin, PLLC
The North Carolina Court of Appeals recently affirmed a long line of North Carolina cases refusing to enforce overly broad noncompetition agreements. Noncompetition agreements, also called “noncompete clauses” and “covenants not to compete,” are contract clauses used to prevent an employee (or former business owner) from leaving employment and going into competition with a different employer. They generally purport to restrict the future employment of the employee for a length of time in a particular territory or region.
In Copypro, Inc., v. Musgrove, No. COA 13-297, 2014 N.C. App. LEXIS 120 (N.C. Ct. App. Feb. 4, 2014), Judge Ervin of the North Carolina Court of Appeals refused to enforce a noncompetition agreement on the ground that it was overly broad. There, an office equipment salesman agreed not to own or to work for any business like the employer’s in 33 counties for a period of three years. The trial court granted a preliminary injunction against the employee, prohibiting him from (1) divulging or utilizing certain information and (2) working for a competitor, including his then-current employer.
Reversing, the Court of Appeals observed that the noncompetition agreement prohibited the employee from working for, or “being connected in any manner with,” a competitor in any capacity. As such, the agreement would purportedly estop the employee from janitorial work for a competitor, even though such work never formed any part of
the employee’s work for the plaintiff business. The court explained, “As our decisions reflect, we have held on numerous occasions that covenants restricting an employee from working in a capacity unrelated to that in which he or she worked for the employer are generally overbroad and unenforceable.” Id.
The court distinguished Precision Walls, Inc. v. Servie, 152 N.C. App. 630, 568 S.E.2d 267 (2002)
. In that case, the defendant employee was a project manager with access to sensitive information in a number of areas. In Copypro
, however, the record did not reflect that the employee had such far-reaching knowledge of sensitive information. Thus, the court found the covenant overbroad in prohibiting the defendant employee from any type of work with a competitor and reversed the trial court’s issuance of the preliminary injunction in regard to the noncompetition agreement [the court left intact the injunction prohibiting certain disclosures, which had not been challenged on appeal].
Copypro is important for two reasons. First, it affirms that noncompetition provisions crafted in an overly broad fashion will not be enforced. Thus, in drafting, any limitation should be specifically tailored to that employee’s position. Second, proper development of the record is paramount in any litigation involving noncompetition agreements. While here it does not appear that the employer could have overcome the over breadth of its noncompetition clause, the court hinted that it would have had a more difficult decision if the record had indicated that the employee had greater responsibilities and more access to sensitive information.
The time may be ripe to ban or severely curtail noncompetition agreements. Other states have recognized that trade secrets laws, like the North Carolina Trade Secrets Protection Act, N.C. Gen. Stat. § 66-152 et seq., already protect against use or disclosure of truly sensitive information. Noncompetition agreements substantially and unfairly hinder fluidity in the key entrepreneurial labor force. Thus, forward-thinking, business-friendly states have advocated for the “the outright elimination of enforceability of non-competition agreements.” Testimony of Gregory Bialecki, Secretary of Executive Office of Housing & Economic Development, before Massachusetts legislature (Sept. 13, 2013).
Both the Triangle and Triad have attempted to foster research and innovative economies. Securing the talent necessary for these industries “is considerably more difficult if employees are legally unable to move between jobs…” Id. If North Carolina wants to compete with Boston and Silicon Valley, it needs to address noncompetition agreements, which too often are (1) of uncertain enforceability, (2) costly to litigate, and (3) too often used as a sword rather than a shield, trapping employees at their current job. Like Massachusetts, we should give serious consideration to eliminating them.
If you would like to discuss an issue involving Noncompetition Agreements, contact Jon Wall at (336) 273-1600, ext. 134, or email@example.com.
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