The North Carolina Court of Appeals held that the covenant’s territorial restriction was overbroad. Notwithstanding the state’s “strict blue pencil doctrine,” which limits a judge’s authority to revise a non-compete clause, the appellate court directed the trial judge to rewrite the invalid restriction and then to try the issue of whether the clause was violated. Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, No. COA 14-185 (N.C. App., 8/5/14) (Hunter, J., joined by McGee, J.; Elmore, J., dissenting).
Summary of the Case
In connection with a purchase and sale of two companies, the parties executed a five-year non-competition, non-solicitation and confidentiality agreement. Subsequently, the purchaser sued the sellers in a North Carolina court, alleging that they were violating the non-compete covenant and engaging in other wrongdoing. Without giving any specific reasons, the lower court granted the defendants’ motion for summary judgment. A few days ago, in a 2-1 decision, the appellate tribunal reversed, remanded, and directed the trial judge “to revise the territorial area of the non-compete to include” only those areas where the acquired companies had customers at the time of the transaction. The appellate court also held that the plaintiff presented evidence showing genuine issues of material fact which precluded summary judgment.
The Asset Sale
Beverage Systems was organized in 2009 to provide and service beverage dispensing equipment, and to sell beverage products. In September of that year, the company bought the assets of two entities engaged in those activities. The purchase price included $10,000 specifically for the non-compete covenant.
The agreement of purchase and sale provided that, for the earlier of five years or “such other period of time as may be the maximum permissible period of enforceability,” the sellers shall not have any involvement with a North or South Carolina company engaged in the same business as the purchaser. Although not mentioned by the appellate court, the agreement (a copy of which is in the record on appeal) also stated that the parties believe the restrictions as written “are reasonable and necessary to protect the [purchasers’] legitimate business interests” and “are not overbroad, overlong or unfair.” Further, the parties consented (a) to substituting “automatically” the maximum reasonable period, scope and geographical area for any stated period, scope or area “held to be invalid, illegal or unenforceable in any respect,” and (b) to allowing a court “to revise the restrictions contained [in the covenant] to cover the maximum period, scope and area permitted by law.”
North Carolina’s “strict blue pencil doctrine.”
A judge in that state is permitted, but not required, to alter “a distinctly separable part of a [restrictive employment] covenant in order to render the provision reasonable.” However, a jurist “may not otherwise revise or rewrite the covenant.”
The Trial Court’s Decision
The parties’ briefs in the trial court focused on the question of whether the territorial restrictions were reasonable. Without expressly answering that question, the court entered summary judgment for the defendants and explained only that the decision was based on “review of the file, the Briefs . . . and upon consideration of oral argument of counsel for all the parties.”
The Appellate Decision
The appellate tribunal’s majority concluded that the broad territorial restriction, encompassing some areas where the sellers had not been engaged in business, was invalid. Citing Outdoor Lighting Perspectives Franchising, Inc. v. Harders, 747 S.E.2d 256 (N.C. App. 2013), a case not mentioned by the parties in any brief in the trial or appellate courts, the majority said that the purchase and sale agreement as written rendered the “strict blue pencil doctrine” inapplicable. Accordingly, the trial judge was ordered “to revise the non-compete provisions after determining where in North Carolina and South Carolina it would be reasonable to enforce” those provisions. Then, “once the trial court revises the non-compete to include only those areas reasonably necessary to protect plaintiff’s business interests,” that court must decide whether the covenant has been violated.
The Outdoor Lighting Case
The majority said Outdoor Lighting construed “similar language” and indicated “a willingness of our Courts to recognize and enforce revised non-compete agreements when the parties contract for the right to” make revisions. There, a franchise agreement gave the franchisor “the right to modify the non-competition provision” by reducing its scope. The franchisor attempted to exercise that right, but the propriety of this “private ‘blue penciling’” was not adjudicated because, even as modified, the provision was held to be unreasonable.
Judge Elmore’s Dissent in Beverage Systems
Judge Elmore expressed his opinion that Outdoor Lighting provides no basis for the Beverage Systems majority to direct “the trial court to undertake the revising and rewriting of the non-compete.” He stated that Outdoor Lighting “addressed a franchisor’s (a party to the non-compete), . . . right to modify a non-compete outside the scope of a business sales contract.” That case, he said, was distinguishable. It did not concern an assets purchase and sale transaction, did not involve a contractual provision allowing a non-party to revise a non-competition clause, and did not reflect an appellate tribunal’s direction to a trial judge to rewrite the clause.
Judge Elmore continued: Under the blue pencil doctrine, a “trial court has the authority to enforce portions of a non-compete that are reasonable and disregard the remaining portions if the non-compete divides the restricted area into distinct units. While the non-compete in the case at bar divides the restricted territory into North Carolina and South Carolina, . . . neither of those restrictions taken separately [is] reasonable.” Further, he disagreed with the majority’s conclusion that there were material disputed issues of fact. Thus, in his view, summary judgment for the defendants was proper.
The Beverage Systems contract contained the parties’ stipulation that they considered the non-competition, non-solicitation, and confidentiality provisions to be reasonable and that, if invalidated, they should be salvaged to the maximum extent possible. The contract also stated that a court could redo the duration, territory, and scope of prohibited activities clauses to the extent they were determined to be illegal. The lesson learned is that, in the instance of a non-compete in a purchase and sale transaction, careful drafting might serve to persuade a judge to rewrite an unreasonable provision. This result could be achieved notwithstanding a “strict blue pencil doctrine” which, as Judge Elmore wrote, “drastically restricts a court’s authority to modify” an unlawful restriction.