I decided some time ago that I wanted my first substantive Justice Matters blog entry to be about covenants not to compete. I made that decision, not for the exciting subject matter, but because I thought it would be simpler to write about these covenants than many other topics. I was wrong. As I continue to wind through the topic mentally, I have decided to split my entry in two, so that I can go ahead and post this first part.
Contracts containing covenants not to compete (or non-competition agreements) have become more commonplace in business and are a fertile area of lawsuits and threatened lawsuits. For this reason employers (and others who seek to use these agreements) should make sure the covenants they use are carefully drafted and should make sure to keep their covenants up to date because this area of law is subject to change. For the same reason, employees (and others agreeing to covenants) should read them carefully, make sure to understand them, and know that one day such an agreement may prevent employment in the only line of work they have ever known in the only city in which they have ever worked.
The two parts of this article will address covenants not to compete in the employment context and will briefly touch on the related topics of non-disclosure agreements and the North Carolina Trade Secrets Protection Act. The covenants not to compete included in contracts for the purchase of a business are governed by standards similar to those governing employee covenants not to compete. However, the same covenant is more likely to be enforced when it arises from the sale of a business than if it were in an employment situation. See, e.g., Jewel Box Stores v. Morrow, 272 N.C. 659, 158 S.E.2d 840 (1968); Bicycle Transit Authority, Inc. v. Bell, 314 N.C. 219, 333 S.E.2d 299 (1985).
Historically, North Carolina courts have tended to be critical of non-competition agreements because such agreements create restraints on trade. The case reports are replete with the admonition that covenants are “not viewed favorably…” Nevertheless, lawyers have grown adept at drafting covenants to “fit” the guidelines developed by the courts, and well-drafted covenants are now often enforced.
North Carolina courts have proscribed five requirements for a covenant arising from employment to be enforceable.
Under North Carolina law, a covenant not to compete is valid and enforceable if it is (1) in writing; (2) made a part of the employment contract; (3) based on valuable consideration; (4) reasonable as to time and territory; and (5) designed to protect a legitimate business interest.
Okuma America Corporation v. Bowers, 181 N.C.App. 85 (2007)
The first requirement is simple – oral non-competition agreements are invalid. All parts of the agreement should be clear and in writing.
Like the first requirement, the second is seldom an issue – the non-competition agreement must be a part of the employment contract. This does not mean that the agreement must be signed at the beginning of the employment. However, the third requirement does impose additional prerequisites to enforcement if the agreement is not signed when the employee begins work. Hejl v. Hood, Hargett & Assoc., Inc., 196 N.C. App. 299, 674 S.E.2d 425 (2009)
The third requirement is less straightforward than the first two, and continues to produce legal opinions defining what is “valuable consideration” in this context. If an agreement is signed at the beginning of the employment, the employment itself serves as sufficient consideration. However, employers often decide after the fact to add a covenant to an employee’s contract or to change a covenant because of a change in circumstance. In such situations, continued employment is not sufficient consideration. Young v. Mastrom, Inc., 99 N.C.App. 120 (1990). The Court of Appeals has, however, held that a $500 payment was sufficient consideration to an employee who signed a covenant fourteen years after he was hired. Hejl v. Hood, Hargett & Associates, Inc., 674 S.E.2d 425 (N.C. Court of Appeals, 2009).
The fourth requirement imposed by North Carolina courts is that the covenant be “reasonable both as to time and territory.” Okuma America Corporation v. Bowers, 181 N.C.App. 85 (2007). This is the legal issue most often contested in fights over non-compete covenants. In analyzing this fourth requirement, the courts look at the time and territory restrictions together – in other words, if the time period is very short, a broader geographic area is more likely to pass muster than if the time period were longer. “[T]he time and geographic limitations of a convenant-not-to-compete must be considered in tandem, such that a longer period of time is acceptable where the geographic restriction is relatively small, and vice versa.” Kinesis Adver., Inc. v. Hill, 187 N.C.App. 1, 13-14 (2007). To do so, the courts look at many factors.
When considering the time and geographic limits outlined in a covenant not to compete, we look to six overlapping factors: (1) the area, or scope, of the restriction; (2) the area assigned to the employee; (3) the area where the employee actually worked or was subject to work; (4) the area in which the employer operated; (5) the nature of the business involved; and (6) the nature of the employee’s duty and his knowledge of the employer’s business operation.
Okuma America Corporation v. Bowers, 181 N.C.App. 89 (2007)
Note that when the courts look at time restrictions, they do not look just at the time restricted on the face of the contract. For instance, if a covenant prevents competition for two years after termination, including not providing services to anyone who was a client of the employer within one year before termination, the courts will consider that to be a three-year restriction.
Finally, the covenant must be designed to protect a legitimate business interest of the employer. The covenant should always set forth the legitimate business interest that the employer seeks to protect and an acknowledgement by the employee that it is a legitimate interest. For example, a covenant which is designed to protect the employer’s customer list or other valuable information about the employer’s business is reasonably necessary to protect a legitimate business interest. United Laboratories, Inc. v. Kuykendall, et al. 322 N.C. 643, 650 (1988).
Part two of this discussion will include a brief review of non-solicitation and non-disclosure agreements, the Trade Secrets Protection Act, N.C.G.S. § 66-152 et seq., and whether the Court of Appeals has opened the door to overcoming some of the long-standing protections afforded to employees by the use of artful drafting by enterprising lawyers.
Scott
