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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.