N.C. Court Of Appeals On Brink Of Slippery Non-Compete Slope


Wall,JonBy Jonathan Wall

In Beverage Sys., LLC v. Associated Beverage Repair, LLC, 368 N.C. 693, 784 S.E.2d 457 (2016), the North Carolina Supreme Court clarified that North Carolina adheres to the “strict blue pencil rule;” that is, a trial court may strike distinct unreasonable restrictions in a noncompetition agreement but may not re-write provisions in order to make them enforceable, even if the parties, in the contract, authorize judicial revisions.  The court sent a message it is not interested in expanding blue-penciling, noting no good could come from changing the role of the trial court:

Allowing litigants to assign to the court their drafting duties as parties to a contract would put the court in the role of scrivener, making judges postulate new terms that the court hopes the parties would have agreed to be reasonable at the time the covenant was executed or would find reasonable after the court rewrote the limitation. We see nothing but mischief in allowing such a procedure.

Id. at 700, 462.  While the Beverage Systems decision indicated the doctrine should not be expanded, a new N.C. Court of Appeals opinion appears to do just that, spelling trouble for future courts and contracting parties.

In Security Nat. Inv., Inc. v. Rice, No. COA16-215 (N.C. Ct. App. Nov. 15, 2016) (unpublished), a former employer (a spa) sought to enforce a noncompetition agreement against a former nail technician who while employed had become licensed as a hair stylist through a third party and began hair-styling at the spa.  He then resigned and sought to open his own hair salon.  The agreement prevented the stylist from:

… directly or indirectly, either for himself or in behalf of any other person, firm, or corporation, engag[ing] in any activity in competition with all or any portion of the type of business of the Company.  This is to include doctor offices, chiropractic offices, fitness centers or any place of business offering services similar to those of the [employer].

The covenant was to be enforced for two years within a seven-mile radius of the employer’s location.  The trial court found the duration and geographic territory overly broad and granted summary judgment to the former employee on the noncompetition agreement claims.

Reversing, the Court of Appeals first found that the time and geographic limits were reasonable.  The court observed that covenants will not be enforced if they are overly broad and not a reasonable protection of the employer’s business.  The protection of customer relations against misappropriation by a departing employee has been recognized as a legitimate interest of the employer, the court noted.

The court then reasoned that as written, the provision was too broad because it prevented employment at a host of establishments – doctor’s offices, chiropractors, fitness centers – that were not in competition with the spa.  The court opined, however, that it could salvage – and therefor enforce – the covenant if it utilized the blue-pencil rule and excised the overly broad sentence in its entirety.  Finding the revised covenant enforceable, the court reversed the summary judgment determination in favor of the former employee, and remanded.

Although unpublished opinions are not “controlling legal authority” and their citation is disfavored, they can be cited for guidance. See N.C. R. App. Pro. 30(e)(3).  Thus, the Rice case is interesting in regard to noncompetition agreements on several fronts.

First, it is representative of a string of cases that have ignored that the blue-pencil rule is an equitable doctrine.  As such, a court is charged with discretion whether or not to employ the rule at all.  Although case law adopting the blue-pencil doctrine made clear the court may choose not to utilize the doctrine, few if any courts make any initial determination whether circumstances warrant an equitable intervention.   See Hartman v. W.H. Odell & Assocs., Inc., 450 S.E.2d 912, 917 (N.C. App. 1994) (“equity will neither enforce nor reform an overreaching and unreasonable covenant,’” but may choose not to enforce distinctly severable part of covenant in order to render provision reasonable) (quoting Beasley v. Banks, 368 S.E.2d 885, 886 (N.C. App. 1988).

There should be some special circumstance or reason for a court to invoke its equitable powers to re-work a contract.   Generally, contracts may not be equitably reformed absent mutual mistake of fact, or unilateral mistake accompanied by fraud.  See Matthews v. Shamrock Van Lines, Inc., 142 S.E.2d 665, 667 (N.C. 1965); Welch v. Sun Underwriters Ins. Co., 146 S.E. 216, 218 (N.C. 1929).  Further, where one party overreaches or contracts based on a misapprehension of the law, the courts will not step in to “fix” the problem for one party.  See Wright v. McMullan, 107 S.E.2d 98, 101 (N.C. 1959) (“It is settled that mere ignorance of the law, unless there be some fraud or circumvention, is not a ground in equity to set aside a conveyance or avoid the legal effects of acts which have been done”) (emphasis in original) (internal citations omitted).

Rice is indicative of a trend to foist noncompetition agreements on relatively low wage earners.  See Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses (White House May 5, 2016, available at https://www.whitehouse.gov/sites/default/files/non-competes_report_final2.pdf  (about 15 percent of workers without a college degree are subject to noncompetition agreements, which results in lower job mobility, decreased worker bargaining power, and less entrepreneurship).  Given these trends and the unequal bargaining power of employer and prospective employee, courts should, before invoking the blue-pencil rule, perform an initial analysis of whether circumstances warrant their invocation of equitable principles at all.

Second, early blue-pencil cases were limited to honing the geographic territory.  Once permitted, ingenious management lawyers quickly devised “multilevel” geographic territories well-suited for blue-penciling but leaving the parties in the dark as to what was intended or prohibited, such as:

… As used herein, the territory shall consist of (a) the continent of North America, but if that territory is found invalid, then the territory shall consist of (b) the United States; but if that territory is for any reason unenforceable, then the territory shall consist of (c) the Southeastern United States, comprised of the states of Florida, Georgia, South Carolina, North Carolina, and Virginia; but if such territory is found for any reason to be unreasonable, then the territory shall consist of (d) the State of North Carolina; but should such territory be found unreasonable, then the territory shall consist of (e) the Piedmont area, compromised of the counties of Davidson, Forsyth, Guilford, Rockingham, Randolph, Stokes, and Surry counties; but if said region is found unreasonable, then the territory shall be defined as (f) Guilford County; and if for any reason the previous territories are declared unreasonable or otherwise unenforceable, then the territory shall be the city of Greensboro, North Carolina.

Rice extends the blue-pencil rule from the geographic territories to, apparently, the entire agreement.  Presumably, or predictably, some management attorneys will now employ the same drafting techniques to draw as broad – but distinctly severable – restrictions as possible.  We can expect “multilevel” time restrictions as well as multilevel conduct or function restrictions.   Of course such an agreement would beg the ultimate contract question, “Has there been any meeting of the minds?”  When the contracting parties have no idea what is actually allowed or prohibited, and must depend on the determination of a particular judge, on a particular day, several years later to elucidate the contract’s contours, the answer must surely be “No.”

Third, Rice begs for closer inspection as to what legitimate interest is protected by the noncompetition provision in regard to “service customers.”  It is hornbook law that noncompetition agreements are “disfavored under law” and that ordinary competition is not a legitimate, protectable interest.   CNC/Access, Inc. v. Scruggs, 2006 WL 3350854 (Burke County Super. Ct., Nov. 15, 2006) (for over 60 years, N.C. courts have repeatedly noted disfavor with noncompetition agreements); Cox v. Dine-A-Mate, Inc., 501 S.E.2d 353, 356 (N.C. Ct. App. 1998) (ordinary competition is not a legitimate, protectable interest).

In a similar vein, the Department of Justice, Antitrust Division has recently emphasized that “non-poaching agreements” between employers are illegal.  See Antitrust Guidance for Human Resource Professionals (Oct. 2016) at https://www.justice.gov/atr/file/903511/download.  While the Antitrust Guidance makes clear it does not address the legality of noncompetition provisions in specific employer-employee contracts, there is an argument that such an agreement, particularly a non-solicitation-of-employees provision, is just a limited version of an anti-poaching agreement.  You have an employer agreeing with an “inchoate employer” that the inchoate employer will not hire the employee.

In any event, we would all agree that there are circumstances when an employer-client relationship should be protected from a former employee’s encroachment.  A wealth management company, for example, who hands an associate a few clients with several million dollars of assets under management should not have to worry about the associate jumping ship with those clients.  But what about a hair stylist?  What legitimate interest does a salon have in preventing a stylist from competing with the salon.

Some courts have suggested that the salon is responsible for the “goodwill” associated with the client relationship.  Others have questioned that premise, asserting that the goodwill developed belongs to the individual hair stylist and does not result from anything promoted or performed by the salon.  While different circumstances might warrant different results, under circumstances similar to Rice, courts have found the employer had no legitimate business interest and refused to enforce the agreement.  See Moda Hair Designs, Inc. v. Dechert, 2006 Ohio App. LEXIS 599 (Ohio Ct. App. 2006) (court properly refused to enforce non-compete where employee was a “basic stylist” and possessed no special “inside information” or trade secrets on how business was run); Invidia, LLC v. DiFonzo, 2012 Mass. Super. LEXIS 273 (Mass. Super. Ct. 2012) (employer failed to prove likelihood of success on merits where it was unclear to whom client good will belonged – the salon or the hair stylist – and employer thus failed to show it protected legitimate business interest).

The Rice opinion represents a jump in enforcement of noncompetition agreements. Because such an expansion is unwarranted and would lead to unintelligible contracts, its reasoning should not be adopted.