North Carolina Court of Appeals Permits Judicial Revision of Noncompete If Contract Permits It

North Carolina’s “blue pencil” rule has historically restricted North Carolina trial courts faced with a noncompete agreement that is overbroad as written. The traditional rule was that the court could only cross out any severable, unenforceable provisions and then determine if what was left after the “blue pencil” was used would still be enforceable. For instance, say the geography of the noncompete was identified alternatively as: (1) all 50 states in the United States; or (2) all the states east of the Mississippi River; or (3) North Carolina and South Carolina. Then, if the facts were that the customer relationships the covenantee was seeking protection for were only in North Carolina and South Carolina, the traditional blue-pencil rule permitted (but did not require) the trial court to cross out the overbroad geographic areas in (1) and (2) above but STILL enforce the covenant because what remained (i.e., #3) was enforceable in light of the facts presented. This historically distinguished North Carolina noncompete law from that of many other states in which trial judges are authorized, with their equity powers, to “reform” or “rewrite” the contract of the parties to insure that what they intended (e.g., some form of restriction on competition) was respected.

Yesterday, in the case of Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, Ludine Dotoli and Cheryl Dotoli (N.C. Ct. App., August 5, 2014) the North Carolina Court of Appeals appears to have contingently changed the historical “blue pencil” rule, but the majority used language to suggest that the change applies to noncompetes in the “sale of business” context only. The plaintiff/appellant in that case supplies, installs and services beverage products and beverage dispensing equipment in North Carolina. It purchased the assets of Imperial Unlimited Services, Inc. and Elegant Beverage Products, LLC in July of 2009. Included in the assets purchased were trade names, customer lists, accounts receivable, current customers and customer contracts, equipment and real property. The selling family that owned those companies is named Dotoli and there is a Thomas, a Kathleen and a Ludine Dotoli. Since they were running the companies purchased, they had to sign noncompete agreements as part of the sale documents.

The noncompete contracts had a provision somewhat common to a lot of others that went like this: “If, at the time of enforcement of Sections 1, 3 or 4 hereof, a court holds that the restrictions stated herein are unreasonable under circumstances then existing, the parties hereto agree that the maximum period, scope or geographical area that are reasonable under such circumstances shall be substituted for the stated period, scope or area, and the court shall be allowed to revise the restrictions contained in Sections 1, 3 and 4 hereof to cover the maximum period, scope and area permitted by law.” Now, friends, I’ve seen a good number of these “revise/reform to the extent permitted by law” provisions in my day. But I’ve always concluded, based on my understanding of the blue-pencil rule identified above, that these provisions were a nullity if North Carolina law applied. In other words, I always figured you can’t create a contract that grants judicial power to the court that the law has already removed from the court. What I’m telling you is that it’s a good thing I wasn’t arguing that point to the Court of Appeals because it appears I am wrong.

In a 2-1 decision, Judge Hunter explained that this “we authorize the court to fix our mistake” contract language DOES change the rules for the trial court. The majority noted that the issue (e.g., “the right of a trial court to revise the provisions of a noncompete based on the express language of the contract for the sale of a business”) was a novel one and concluded “we believe that this practice (i.e., permitting contractual authorization for judicial revision in the sale-of-business context) makes good business sense and better protects both a seller’s and purchaser’s interests in the sale of a business.” Judge Hunter went on to explain “this is especially true in North Carolina where our Supreme Court has been unwilling to adopt a more flexible approach to the the “blue pencil doctrine,” leaving the courts with few options to try and enforce noncompetes in a rapidly changing economy.” He also noted that were the blue-pencil doctrine to apply, it would render the contractual language a nullity. (Editor’s note: At least I had that part right.)

The trial court’s entry of summary judgment for the Dotolis was obviously a result that Judge Hunter did not agree with – and one can understand his frustration in the scenario. The Dotolis had sold the businesses to the Plaintiff and then hauled off and competed afterward, arguably impairing the value of some of what they’d transferred to the Plaintiff (a period of time where Plaintiff wouldn’t have the good will it purchased interfered with by the Dotolis’ competition) and defending themselves by arguing “hey, that agreement we signed is overbroad and not enforceable.” This was a result Judge Hunter wasn’t comfortable with and he was joined in this by the recently sworn in Court of Appeals Chief Judge, Judge McGee.

Judge Elmore, in a respectful manner, dissented. He noted that the blue-pencil doctrine (query: aren’t legal rules that ultimately earn the name “doctrine” normally sacrosanct?) is applicable law that does not permit judicial reformation of an agreement, no matter what the parties intended for their contract. Thus, the parties couldn’t contractually grant the reformation or rewriting power to the trial court. And that, my friends, is how I’ve always evaluated such language and other similar provisions in which contract drafters attempt to change rules that they don’t have the power to change. For instance, Rule 65© requires the trial court entering an injunction mandate the posting of “security by the applicant, in such sum that the court deems proper, for the payment of such costs and damages as may be incurred or suffered by any party who is found to have been wrongfully enjoined or restrained.” Can the parties, by contract, establish that no such security be given? I don’t think so – but I’ve read a good number of noncompete agreements that say as much. Similarly, I don’t think parties can contractually agree that any injunction order need not be set forth the reasons for its issuance or be specific in its terms – again these are rules directed at the trial court. Parties aren’t free to contractually avoid or limit the requirement that a likelihood of success on the merits of the claims be shown, are they? There are clearly some legal rules and requirements that aren’t open for a private contract to amend their mandate. On the other hand, can two parties agree to contractually waive some legal rules designed exclusively for their benefit – such as the proper venue for a dispute or the choice of law that will apply to their dispute? Depending on the circumstances, certainly.

What Judge Elmore didn’t mention, probably in a show of respect to the majority, is the majority’s reference to the North Carolina Supreme Court’s refusal to create a more “flexible” approach to the enforcement of noncompete agreements in a “rapidly changing economy.” One doesn’t have to go too far out on a limb to conclude that Judge Hunter’s real message is: “this body of law needs attention and if they won’t fix this situation, we will.” All of this said, Judge Elmore’s dissent means that this Court of Appeals decision can be appealed by the Defendants/Appellees to the North Carolina Supreme Court as a matter of right. I suspect that the defendant/appellees will do that because they’re facing a return to the trial court that just received instructions to fix the noncompete and then a determination if the fixed noncompete was breached. I don’t imagine the Dotolis will want to test those waters if there’s still a chance the Supreme Court will reject Judge Hunter’s suggested new approach. If that appeal is timely taken, the North Carolina Supreme Court will have its opportunity to adopt the reasoning utilized by Judge Elmore. We’ll see.

One suspects that attorneys in employment-based noncompete cases will try and pivot off this opinion and argue: “why shouldn’t this be the same rule in the employment context?” One clear reason sticks out, of course – the hyper-strict scrutiny applied in North Carolina law to noncompetes generating from the employer-employee relationship has never been applied to those in the sale-of-business context. At last check, in the history of reported decisions in North Carolina there has never been a reported case in which a “sale-of-business” related noncompete has been found overbroad or unenforceable by the North Carolina courts. This can not be said, of course, of employment-related noncompetes. And for good reason.