What is a Non-Compete Contract?
Non-compete agreements are contracts used by employers to protect their business interests by agreeing that the employee will not participate in certain activities for a defined period of time following the termination of employment. Non-compete agreements are particularly common in professional services, sales, computer programming, and technical fields. Although non-compete agreements are often used colloquially to encompass all restrictive covenants, the North Carolina courts have repeatedly observed that a non-compete agreement is actually a subset of a larger contractual category.
North Carolina courts have identified three main types of restrictive covenants that may be contained in an employment contract: (1) a non-compete agreement, (2) a customer non-solicitation agreement or 3) a confidentiality agreement. Non-compete agreements are intended to prevent competition by limiting the circumstances under which an employee can work with a former employer’s competitors following the termination of employment , including but not limited to the former employer’s direct competitors or those who provide similar products or services, depending on the terms of the agreement.
Customer non-solicitation agreements are intended to prevent customer solicitation by either restricting a former employee from assigning customers, or contacting the former employer’s current or former customers. In contrast, confidentiality agreements are intended to restrict an employee from using or disclosing confidential or trade secret information.
If the non-compete agreement is deemed to be valid (i.e., reasonable as to time and geographic scope), then its enforceability within an employment contract will be governed by the agreement; however, if the non-compete agreement expressly allows the former employer to terminate the employment relationship at will, it is reasonable to conclude that the former employer may terminate the relationship with or without cause and in its sole discretion.
Enforceability Under North Carolina Law
The enforceability of non-compete agreements in North Carolina is dictated by the common law stated in the N.C. Supreme Court’s thoughtful decision in July 2012 in the case of Advanced Auto Parts v. Baines. The Baines court provided helpful explanations on what at "the three elements for a Full Covenant" to be enforceable under North Carolina law:
The first two prongs [of the three prong test hydrafacials] are relatively easy to interpret. First, there must be consideration – which requires the employee to sign at the outset of employment. Even if the non-compete is later changed (and signed again) that initial signing can satisfy this baseline requirement. Understand however that modifying or adding new provisions of a non-compete agreement signed earlier may result in the court concluding that the restated agreement needs to satisfy the original "severability" (not moving the prior agreement into new employment). Second, the agreement must [in the eyes of the N.C. Supreme Court] be "reasonably necessary to protect" the employer’s "legitimate business interest". The definition of "legitimate business interests" is evolving but generally includes trade secrets, confidential information and customer relationships (many of which we have discussed previously on this blog). What protects or risks the legitimate business interests of an employer is impacted by North Carolina courts willingness to review individual facts and to balance employer vs. employee interests of harm and benefit as well as consider potentially different interests between various jurisdictions of North Carolina. The third prong of the Baines court decision was very interesting as much of Baines was focused upon the reasonableness of geographic or temporal "territoriality" of the agreement. The N.C. Supreme Court found "[i]n determining reasonableness, the trial court must consider the time duration and the territorial, or geographic scope of the covenant in light of the interests protected by the covenant, the interests of the employee, and the interests of the public." It was thus not surprising that further clarification is already being provided by a later court’s interpretation of what a reasonable area may actually be.
Essential Aspects of Enforceable Non-Competes
Key Elements of Valid Non-Compete Agreements in North Carolina
Not all non-compete agreements in North Carolina are enforceable. To be enforceable, the provision must: (1) be reasonable with respect to time and territory; (2) protect a legitimate business interest of the employer; and (3) be supported by consideration, such as valuable employment or continued employment. If drafted too broadly in the sense that it is not tailored to the circumstances of the parties, the agreement will not be enforced.
The first element—reasonableness of time and territory—does not lend itself to bright line rules. The non-compete must align with the employer’s legitimate business interests. While three to five years has been deemed reasonable as a matter of law in some jurisdictions, no North Carolina cases have expressly adopted these limits. The court’s ruling will depend on many factors, including the nature of the business, the type of employee subject to the agreement, the territory of the business, and whether the business is local, regional, national, or international. To the extent reasonably necessary, the time limits may be defined to strike an appropriate balance between the employer’s ability to gain protection for a legitimate business interest and the employee’s right to earn a living. A two year restraint in certain industries or regions has been upheld as legitimate protection against unfair competition.
For the second element, "legitimate business interests" are those valuable interests that the employer seeks to protect through the non-competition provision. In determining whether an employer has a legitimate business interest at stake, the court is likely to consider the employee’s heighted bargaining power over the employer. If the employer has offered a competitive salary to entice a highly qualified individual, then the employer has more to protect, and its business interest is likely to be legitimate.
The final element relates to consideration for the agreement. To be enforceable, the non-compete must be supported by a contractual exchange of consideration. An ongoing employment relationship is usually sufficient, even if the term of employment is undefined, because the employer’s continued employment of the employee constitutes consideration for the covenant. A non-compete agreement signed independent of an employment offer, however, might require additional consideration, such as an incentive payment or stock options.
Recent Case Law and Emerging Trends
The enforceability of a non-compete agreement in North Carolina becomes a complex and fact-intensive analysis. Thankfully, in recent years there has been an increase in court rulings across the state that provide a greater understanding of how the law affects non-compete agreements. In the 2017 case of Triad Imp., Inc. v. Morgan, the North Carolina Court of Appeals sided with an employee entering into a non-compete with his employer. In that ruling, the employee’s non-compete was deemed as overbroad and unenforceable because it permanently prohibited a former employee from working anywhere within the entire state of North Carolina—even though the non-compete squarely limited the business interests of the employer. This decision illustrates to employers that while they wish to protect their business, even broadly drafted non-competes can be ruled as unenforceable if they are not drafted with sufficient care. Similarly, the 2016 decision in The ProDoc of Cleveland, LLC v. Lewis provided a unique ruling on the jurisdictional boundaries of an employer’s potential claims against a former employee and whether a forum selection clause would be binding upon the employee. In that ruling, the court sought to limit the extent of a non-compete to the county of the employer’s headquarters, thus implying that when it comes to geographical boundaries, the "home ground" of a non-compete is the employer’s home turf—and not the employee’s home county. The enforceability of a non-compete is a fluid question that must be analyzed from all angles in order to best determine whether a non-compete will be upheld against an employee. While there have been individual court rulings on the validity violations of non-competes, as of the date of this writing there are no known appellate rulings on how a violation to a non-compete is enforced.
Penalties for Breaching a Non-Compete
The potential legal consequences of violating a noncompete agreement can be substantial for both the employee and employer. If a former employee breaches a non-compete agreement, the employer may either be forced to seek an injunction to prohibit the former employee from further competition or to sue the former employee for damages. If a former employee breaches a non-compete agreement, the employer may seek damages for loss of profits and other losses caused by the former employee’s actions. The employer may also seek its attorneys’ fees incurred in connection with enforcing the non-compete agreement. If the employer is granted a permanent injunction, the employer may also seek to recover its attorneys’ fees from the former employee.
Injunctive relief is an equitable remedy that stops the wrongful conduct that is causing or will cause the employer a loss. A permanent injunction prevents a former employee from further engaging in the wrongful conduct (e.g. working for a competitor). A temporary injunction does the same thing for a temporary period of time. If a temporary injunction is issued , a hearing likely will be held within two to three months to determine whether a permanent injunction should be issued.
If the court finds that a contract provision is unreasonable and therefore not enforceable, the court may refuse to enforce the contract provision, but it will not nullify the contract as a whole. Some courts will modify the provision in order to make it reasonable. In North Carolina, if an agreement is unreasonable with respect to geographic scope or duration, but "otherwise reasonable," the court will modify the agreement in order to make it reasonable.
Whether a non-compete agreement is enforceable in North Carolina is very fact-specific and based on the policy considerations underlying the North Carolina General Statute regulating noncompete agreements. Typically, the former employee will suffer the greatest financial loss from an injunction. However, to the extent the employee is permitted to work, the employee may be halting a perception that he or she quit, was fired, laid off or was otherwise terminated without cause which may disadvantage the employee in seeking future employment.
Helpful Hints for Crafting Non-Compete Contracts
Practicing good preventive law involves following some practical guidelines when drafting a non-compete agreement. Not only should the agreement comply with the law, but it should be clear and fair to the parties.
• Choose the Right Jurisdiction for Enforcement
North Carolina courts will uphold agreements governed by the laws of other states only if the agreement satisfies the strict requirements of that state’s law. That can disfavor employers based in North Carolina that may be viewed less favorably in other jurisdictions. Local counsel can help. Some courts will enforce non-compete agreements that are signed in "restraint of trade" jurisdictions other than North Carolina, such as South Carolina. However, non-competes have been invalidated based on the application of the law of a state with an express restraint of trade statute, even if neither party resides there.
• Use the Right Keywords
The term "person" or "party" is not found in the statute defining "unfair competition", and does not limit the applicability of non-compete agreements to individuals. For this reason, many courts have found that corporations and other business entities can be covered by non-compete agreements. The author believes that "employee" is a better word than "party" and "company or corporation" is a better choice than "party."
• Know the "Starling" Non-Compete Agreement
The former Director of Employment Security in North Carolina says there are two types of non-compete agreements: A "starling agreement" restricts the making of contact with current employees, in-house suppliers, and in-house customers and clients of the company or corporation. Starling restrictions allow the employees to continue to recruit, or sell services to former customers and suppliers. A "crabtree agreement," after a case decided by the North Carolina Court of Appeals, prohibits the solicitation of former employees and former customers and clients of the company or corporation.
• Avoid train wrecks
One train wreck for non-compete agreements occurs when they restrict competition in more than one area of commerce. The court of appeals stated: In interpreting the term "in commerce" as used in G.S. 75-1.1 and G.S. 66-54 and pursuant to the 1997 revision to Section 1.3 of the Restatement (Second) of Contracts, we hold that when non-compete agreements restrict competition as to more than one area of commerce or trade, the agreement is NOT "in commerce." It thus does not come under the provisions of 66-53 of the NC Attorney General’s Act as a type of restraint on commerce or trade prohibited by the act. Instead, such an agreement is simply an otherwise valid noncompetition agreement governed by the common law of contract.
Another train wreck is the case where the non-compete agreement has a built-in severability clause. If a contract has a severability clause provisions, it must be enforced as to parts not in violation of a statute. Briefly, in one case a non-compete agreement had a provision saying that if any part of the agreement was covered by a statute prohibiting (or otherwise restricting) the enforcement of covenants not to compete, then that portion was void and the remainder of the contract is binding. This "severability clause" negated the agreement as a whole. A new agreement simply provided by separate addendum removing the language that had been found to violate the statute. The court held for the employer on the ground that no further requests were necessary to inform the employee of the agreement.
• Send Updates to All Employees
Fairness dictates honesty, including notifying employees of changes in policy. This writer recommends a few samples be sent around to senior staff so that younger staffers do not feel singled out or embarrassed.
Non-Compete Contract Alternatives
One alternative is the use of a nondisclosure agreement. A nondisclosure agreement is a contract by which one party agrees not to disclose to another party certain confidential information received in connection with the relationship between the parties. While the nondisclosure agreement does not bind the departing employee from competing with the employer or soliciting the employer’s customers, it does prohibit the departing employee from using or disclosing to others the confidential information acquired during the employment . Therefore, the obligation not to disclose information could protect the employer against its own employees misusing that information to compete with it after separation from employment.
Similar to a nondisclosure agreement, a non-solicitation agreement does not prohibit a former employee from competing against the employer, but it can limit the former employee’s ability to solicit customers and employees. Non-solicitation agreements are commonly enforced in North Carolina.
For an employer that is concerned about the future activities of a departing employee and competing business threats, there may be effective means to address the situation without the use of a non-compete agreement.
