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.
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.
