When Covenants Not to Compete and NDAs Reach Too Far
South Carolina courts are clear in their general dislike of covenants not to compete and any provisions that restrict an individual’s ability to work. They are also clear in their tendency to rule in favor of the employee rather than the employer in related cases. This was the issue at hand in a recent case decided by the South Carolina Court of Appeals.
Covenants not to compete and non-disclosure agreements (NDA) were covered on this blog previously, because it’s so important for employers to be extremely careful in their wording on non-compete and non-disclosure agreements. If they try to restrict their employees’ actions too much, an employer may discover their agreement has reached too far and is invalid.
Fay vs. Total Quality Logistics
That’s essentially what happened in the case at hand, Fay vs. Total Quality Logistics. TQL, an Ohio-based transportation and logistics company, hired Joshua Fay in late 2012. As required by the company, Fay signed TQL’s Non-Compete, Confidentiality, and Non-Solicitation Agreement before commencing work. The Agreement was signed in Ohio and was to be enforced under Ohio law.
The following summer, Fay was fired. He then founded JF Progressions, LLC, in Mount Pleasant, SC, providing logistics services to another company. TQL found out and notified Fay that TQL intended to pursue legal action if he didn’t stop what he was doing. Fay then filed suit against TQL to seek a declaratory judgment that the Agreement he had signed was invalid and not enforceable. He argued that the Court must invalidate the Agreement if it is contrary to SC public policy, even if Ohio law applied to the interpretation of the Agreement.
The case made it to the South Carolina Court of Appeals which sided with Fay and found that, though it was to be enforced under Ohio law, the Agreement offended South Carolina public policy and was therefore not enforceable. The Court of Appeals found that the lower court (the Circuit Court) erred when it ruled against Fay, stating that the Agreement was enforceable under Ohio law and did not offend SC public policy.
When non-compete and non-disclosure agreements are too broad
To understand why the South Carolina Court of Appeals ruled as it did, it’s important to understand the basics of non-compete agreements. Two important clauses in a non-compete agreement are about time and geography; agreements place limits on the length of time and the geographical area in which an employee or former employee can work. An enforceable agreement strikes a balance between protecting the employer’s interests and giving the employee or former employee the freedom to earn a living in their profession.
South Carolina has determined that these limits must be “reasonable.” In the Agreement Fay signed, the limits were not reasonable under South Carolina’s standards. The non-disclosure agreement was worded so as to effectively be a non-compete agreement, which was to be in effect “at all times.” Under the Agreement, Fay was restricted from working with “Competing Businesses,” which was defined as “any person, firm, corporation, or entity that is engaged in the Business anywhere in the Continental United States.” If TQL’s Agreement were enforced, Fay would not be able to work in the field of transportation and logistics in the Continental U.S. “for an indefinite time, if not forever,” in the Court of Appeal’s wording. South Carolina determined that these restrictions were too broad and violated the state’s public policy, as they restrict an individual’s right to exercise their trade.
The Court of Appeal’s decision cited the Stonhard case, quoting “The agreement fails to limit the covenant to a particular geographical area. To add and enforce such a term requires this [c]ourt to bind these parties to a term that does not reflect the parties’ original intention. Therefore, we hold that the covenant, despite any reformation, is void and unenforceable as a matter of public policy.”</P
In addition, the Court of Appeal’s decisions reaffirmed the fact that South Carolina does not follow the “blue pencil” rule. In non-compete cases, this rule allows courts the discretion to invalidate certain portions of an agreement while maintaining others and to create terms the court believes the parties should have agreed on in the first place.
(It’s important to note that this discussion is about the March 2017 decision of the South Carolina Court of Appeals. It’s possible that the South Carolina Supreme Court may take up this issue at a future date, at which point this decision could be reversed or affirmed.)
Lesson for employers on covenants not to compete and NDAs
The lesson here for employers is to be extremely careful in the wording on covenants not to compete, NDAs, and other contracts that have any limiting effect on your employees’ current or future ability to work. As we can see from this case, strict wording of an NDA can effectively be interpreted as a non-compete agreement, even if that wasn’t the original intention.
Employers also need to be cognizant of these issues with regards to different states’ laws. Even if your state’s courts find your contracts “reasonable,” another state’s courts may not, depending on the state’s public policy. The internet cannot provide reliable guidance on this topic, which is why it’s important to discuss it with an attorney who’s well versed in this topic.
For guidance on how to craft your company’s covenants not to compete and NDAs, or for advice on one you’ve already signed, contact Mt. Pleasant business attorney Gem McDowell. He can be reached at Gem McDowell Law Group in Mount Pleasant at (843) 284-1021 or by filling out this contact form online. Contact them today.
How South Carolina Courts View Covenants Not to Compete
On the surface, covenants not to compete look simple. One party agrees not to compete against another party – either by working for a competing company, or by starting their own competing company – for a specified amount of time and within a specified location. But as simple as they seem, covenants not to compete aren’t so straightforward.
When two parties end up disagreeing over a covenant not to compete, the matter sometimes ends up in the South Carolina Court of Appeals. That happened recently, in a matter called Palmetto Mortuary Transport, Inc. v. Knight Systems, Inc., as recorded in the May 4, 2016 Advance Sheets (pdf). This case shows how the courts of South Carolina view and enforce covenants not to compete, and why, as a business owner, it’s important to do everything you can to draw up covenants not to compete that are enforceable.
The Background: Seller’s Remorse
In 2007, Seller sold its mortuary transportation business to Buyer. Among other things, the two parties agreed that 1) Seller would not provide mortuary transportation services within 150 miles of the business for a period of ten years after the sale, and 2) Buyer would buy certain types of body bags exclusively from Seller (at discounted prices) for ten years.
The terms of the sale worked well for several years, but then two things happened.
First, in 2011, Richland County sent out an RFP (request for proposal) for mortuary services. As part of the sale, Buyer had bought an existing contract for mortuary transportation services with Richland County. The covenant not to compete would bar Seller from providing mortuary services to Richland County for 10 years from the date of sale, because it was located within the agreed upon 150-mile radius. However, Seller was interested in submitting an RFP.
Second, Seller accused Buyer of breaking their agreement by purchasing body bags from someone other than Seller. It was found that Buyer had purchased over $45,000’s worth of body bags from Seller since 2007, but had also purchased $478.50’s worth of body bags from a third party. Because Buyer was in breach of contract, Seller said, Seller was no longer bound by the rules of the covenant not to compete.
Seller ended up winning the contract with Richland County. Buyer wasn’t happy.
The case was tried in late 2013, and the judge (actually a court-appointed special referee) found in favor of Buyer. Seller appealed and the decision by the South Carolina Court of Appeals is recorded in the May 4th Advance Sheets.
The Court of Appeals’ Verdict: Throw out the Baby With the Bathwater
The Court of Appeals did not agree with the lower court.
The lower court held that the terms of the covenant not to compete were “reasonably limited” in time and geographic scope. The Court of Appeals disagreed, stating, “In our view, the 150-mile restriction was overly broad and did not protect the rights and interests of [Buyer] in a reasonable manner.”
The Court also wrote that “In South Carolina, our courts will generally uphold and enforce a covenant not to compete arising out of the sale of a business if it is (1) reasonably limited as to time and territory, (2) supported by valuable consideration, and (3) not detrimental to the public interest.”
So for a covenant not to compete to be enforceable in South Carolina, it must meet all three requirements. If it fails one of the requirements, the entire agreement becomes void. Some other states allow courts to “blue pencil,” which means a court can say something like “150 miles is too much, but 50 miles is acceptable, so the rest of the agreement remains intact except for this part.” Not South Carolina. It throws the baby out with the bathwater.
Because the covenant not to compete in question failed to satisfy requirement #1, the entire covenant is not enforceable.
What it means for the parties: Seller is free to provide mortuary services in South Carolina without the restrictions originally laid out in the terms of the sale. Buyer lost a valuable contract as well as a competitive advantage because the covenant not to compete wasn’t enforceable. What Buyer thought was a smart move – restricting business activities of Seller in the manner it did – didn’t end up working out.
Why 150 Miles Wasn’t “Reasonable”
The United States is a large country. From Washington, D.C. to San Francisco, it’s over 2,400 miles. So restricting a business within a 150-mile radius doesn’t seem like a large area. How could that be “unreasonable”?
But consider the State of South Carolina. If you buy a business in Columbia, is it reasonable to expect the seller to abstain from business within a 150-mile radius? Columbia to Hilton Head is 125 miles as the crow flies. Columbia to Myrtle Beach is also 125 miles. And it’s just shy of 100 miles to Greenville. The seller would effectively be barred from conducting business in the entire state.
Also consider that the State of South Carolina is just over 30,000 square miles. The area in a circle with a 150-mile radius (πrr) is over 70,000 square miles – more than twice the area of the State of South Carolina.
150 miles doesn’t seem quite so reasonable now.
How to Determine “Reasonable” Geographic Restriction
It would be helpful to business owners if the courts would give a firm number that’s reasonable. But it doesn’t work that way. Among other things, the nature of the individual business determines what’s reasonable.
One way to think of it is how far a customer would travel to patronize a business. Would a customer drive 20 miles to go to a convenience store? Unlikely. That’s like driving all the way from Isle of Palms to Avondale in West Ashley. The vast majority of people are not going to drive that far for a soda and a lottery ticket. So in this example, even a 20-mile radius would be too large.
Or think of it from the salesperson’s point of view. Could a company that installs pools expect to serve customers in both Summerville and Folly Beach (a distance of 35 miles)? Possibly, yes. In this example, a 20-mile radius might be perfectly reasonable.
What You Should Do
Before drawing up or signing any covenant not to compete in South Carolina, take time to see if it will satisfy the three requirements listed above. In particular, look at restrictions on time and geographic scope. Consider the nature of the business you’re selling or buying to determine what seems reasonable. Don’t be greedy; that’s often the underlying case of such disputes. Rather, be conservative. You stand a better chance of having an enforceable agreement if you do.
You should also seek out the advice of an experienced business attorney like Gem McDowell. Contact Gem at their Mount Pleasant office at (843) 284-1021 today.
How to Protect Your Interests With Enforceable Covenants Not to Compete
South Carolina is a state that values an individual’s freedom to work. Because of that, it does not look kindly on contracts that try to restrict a person from working.
This can be tricky for employers trying to protect their interests. Many employers require employees to sign covenants not to compete, which are intended to prevent them from taking trade secrets and sensitive information to a competitor and/or staring their own competing company. But if the covenant not to compete isn’t written correctly, it won’t be worth the paper it’s written on. So here’s how to write one that might hold up in South Carolina court – and a couple extra things to think about, too.
Three things to address in your covenant not to compete
The keyword is reasonable. You have to be reasonable about what, when, and where your employee can work after they leave your employ.
1) Scope
The scope of duties cannot be restricted in an unreasonable way. If one of your employees writes the company newsletter, you cannot restrict them from writing anything at all after leaving your company. The scope in that case is simply too broad.
2) Duration
A “safe,” reasonable duration is typically two years. Any longer might cross over into unreasonable territory.
3) Geographic Location
This one’s interesting. Many covenants not to compete contain seemingly innocuous clauses that say something to the effect that the employee cannot work at a similar company within a 50-mile radius. That doesn’t seem that unreasonable at first glance – surely that leaves plenty of potential customers and places to do business – but it is.
You’ll remember from high school geometry that the area of a circle is πr2, which in this case equals over 7,854 square miles (3.14159*50*50). The state of South Carolina is only 32,000 square miles. Not so reasonable now, is it? A full quarter of the state is now off-limits. Even a 10-mile radius essentially covers all of Charleston County.
There’s no hard-and-fast rule here about what is considered “reasonable.” You’ll need to use your judgment, and get the advice of a business attorney, to draft a geography clause in your covenant not to compete that’s more likely to hold up in court.
How you, the employer, can protect your interests
As stated above, South Carolina is not known for looking kindly on strict covenants not to compete. But some states are. So a company may add a “forum clause” that says if disputes arise, they’ll be settled in a court in a state like Florida, which is more favorable to employers in these cases.
Another way to protect your interests and keep sensitive information out of competitors’ hands is to focus more on non-disclosure agreements (NDAs) and confidentiality agreements than on covenants not to compete. Because NDAs and confidentiality agreements don’t tend to restrict a person’s freedom to work, the South Carolina Court doesn’t enforce them so heavily in favor of the employee as it does with covenants not to compete. That is, the Court’s decision is likely to be more favorable towards you, the employer, rather than the employee. (The 2012 case Milliken & Company v. Morin set this precedent.)
Get advice on creating your reasonable covenants not to compete
Need help with your contracts, covenants not to compete, and other business documents? Contact business attorney Gem McDowell at their Mount Pleasant office at (843) 284-1021 today.
5 Ways A Business Lawyer Helps Grow And Protect Your Business
Business law, or corporate law, is the application of law to the business world. The two are completely intertwined at all times. For that reason, as a business owner you should plan to work closely with a business attorney throughout the life of your company, right from the very start. Here are 5 common ways a business lawyer can help you and your business.
1. A business lawyer will help you create your business.
This is called “choice of entity” and it’s a crucial step every business owner must take. Should you be an LLC? A corporation? If so, what kind? Both provide shelter from creditors to your personal assets, but the two entities are very different from one another. Furthermore, there are four ways to structure limited liability companies in South Carolina, and numerous ways to structure corporations.
An experienced business attorney can advise you on which entity is right for you and can tell you the potential pitfalls that you won’t read about on LegalZoom or other DIY sites.
2. A business lawyer can draft your corporate governance documents.
Corporate governance documents describe, govern and constrain activity of the business owners. They “set the rules” and tell everyone involved how things should go and what should happen when a particular occasion arises. They are unique to each business.
You absolutely should have these documents if your company has two or more owners/shareholders/partners (these terms will be used interchangeably through the rest of this article, though they are technically different). Here are some you might consider having:
Bylaws detail how the business is structured and give information on the board of directors, the responsibilities of the owners and more.
An Operating Agreement details how much each member owns in the company, how profits and losses will be allocated, what each member’s responsibilities are, how the company should be managed and more.
A Buy-Sell Agreement is essentially a “pre-nup” for the company. This document lays out what will happen in the event that one of the owners or shareholders dies, becomes ill, simply stops working, etc.
A Capital Call Agreement spells out what happens when the company needs to raise money and what happens when one of the partners can’t come up with their part. A partner who can’t contribute equally may lose voting rights, give up shares, or forego distributions, for example.
Non disclosure agreements (NDAs) and covenants not to compete are intended to protect your company against a former owner or employee running off with your trade secrets and your best customers, thereby hurting your business.
Question: Can you DIY? Should you?
Google these documents and you’ll find plenty of examples and templates you can download and fill in yourself – but don’t do it! Those documents might have been created in a different state, or before a significant change in the law, and they may not be valid. They were certainly drafted for a different business, for different people with different needs from yours. No two businesses are alike, and no two sets of governance documents should be alike.
Question: When is the best time to get these documents?
The best time to draft these documents is at the birth of your new company, when it’s likely that you’ll come up with documents that are fair to all parties. Imagine three years down the road, when one of your partners can’t come up with the money for a capital call – do you think they will want to sign a capital call agreement penalizing non-payment with a high rate of interest? Probably not. To avoid situations like that, it’s best to do it as early as possible, when all the owners feel goodwill towards each other. However, if you’re years into your business and still don’t have them, get something drafted now. Every single company faces issues that these documents address, so it’s not a matter of if but of when something will happen.
3. A business lawyer advises you on the best course of action and helps protect you from potential problems.
A lawyer is often referred to as “attorney and counselor-at-law.” A lawyer both applies the law and provides counsel on it. During a company’s growth, a business lawyer will be most helpful providing counsel on various issues that pertain to the law in order to deal with problems as they arise or, better yet, prevent them in the first place.
Contracts are the area in which you’ll probably need the most regular help from an attorney. As a business owner, you should have a lawyer familiar with your business draft your contracts and look over contracts given to you before signing. Other issues attorneys can help with may include long-range planning (see #4 on succession planning below), drafting terms & conditions for a website, advising on letters received, and, in the case of an attorney experienced in real estate law like Gem McDowell, rezoning or buying and selling land, to name just a few.
4. A business lawyer helps you with succession planning.
Succession planning allows all partners to come to an agreement about what will happen when one of the partners retires and leaves the company. Succession planning usually happens when one partner starts thinking about retirement.
5. A business lawyer represents you in litigation.
Working with a lawyer in the four situations above should hopefully reduce the likelihood that you’ll ever be involved in a lawsuit – and that’s really the point. Litigation is costly, lengthy and stressful for all parties. By being proactive and working with a business attorney from Day 1, you can sidestep the landmines that could otherwise destroy your business.
Learn more about how a business lawyer can help your business
Contact South Carolina attorney Gem McDowell and his associatess at their Charleston office at 843-284-1021 to discuss your company and its legal needs. Whether you’re thinking of starting a new entity or you’ve been running a thriving business for decades, it’s never too late to get legal advice from lawyers with experience in corporate law.
