United States: Federal Court's Practical Approach To Enforcement Of A Restrictive Covenant Provides Business-Friendly Decision

On April 11th, a North Carolina federal court granted an insurance business's motion for preliminary injunction against six of its former independent insurance agents and enjoined further violations of a restrictive covenant.  In Superior Performers, Inc. v. Meaike, 2014 U.S. Dist. LEXIS 50302 (M.D.N.C. Apr. 11, 2014), the court took on a number of discreet legal issues related to the drafting of employee restrictive covenants in North Carolina and, in a refreshingly practical manner that prioritized substance over form, reached several employer-friendly conclusions. 

The Case

The plaintiff, National Agents Alliance (the trade name for Superior Performers, Inc.) ("NAA"), is a marketing organization for various life insurance companies.  NAA sells "leads" (contact information of potential policy buyers) to independent insurance agents and earns a portion of the agents' commissions from the issuing insurance companies.  NAA's agents also recruit new agents and earn an extra commission on any agents they recruit (called "Downline Agents").  Both the recruiting agents and Downline Agents are independent contractors and are required to sign NAA's "Agent Agreement."  The Agent Agreements contain restrictive covenants prohibiting the agents' soliciting of NAA's employees and independent contractors.

The defendants were each independent contractors with NAA.  Upon being hired, each signed Agent Agreements and, during the course of their agency, were ordered to electronically sign subsequent Agent Agreements before accessing the website where they retrieved their leads. 

The legal dispute arose when the defendants terminated their independent contractor relationship with NAA and joined Family First Life ("FFL"), an insurance company formed by one of the defendants.  NAA alleged that of its 186 agents, 121 began working for FFL.  This, NAA alleged, was a violation of their employee/independent contractor non-solicitation restrictive covenant. 

NAA filed suit.  The court first granted NAA's motion for a temporary restraining order, and then its motion for a preliminary injunction.  In so doing, the court rejected the defendants' arguments and set forth an opinion laced with valuable precedent for employers on a number of issues:

1.  Providing Contact Information for Potential Customers Constituted Sufficient Consideration for the Restrictive Covenant

Each agent executed an Agent Agreement at the inception of their employment, and when they accessed their leads, they also "clicked through" new agreements.  Defendants argued that each time they did so, the agreement they entered was a replacement, or "novation" to the original agreement, requiring new consideration.  NAA countered that the electronic agreements were identical to the original agreements the defendants entered when they began working as independent contractors, so they did not qualify as superseding contracts.  Alternatively, they argued that even if the subsequent agreements were novations, access to the leads constituted new consideration.

With insufficient proof to confirm NAA's first argument about the original agreements, the court assumed that the contracts were novations but found that access to the leads was sufficient consideration.  Importantly, the court was persuaded by the fact that access to the NAA's Lead Program was not required for the defendants to maintain their independent contractor relationship, thus suggesting that if the leads were a necessity to perform the work, they would not constitute sufficient consideration. 

2.  The Court Rejected an Illogical Approach to the Look-Back Rule Adopted by the North Carolina Court of Appeals In Prof. Liab. Consultants, Inc. v. Todd      

NAA Agents were forbidden from soliciting NAA employees and independent contractors during their tenure with NAA and for two years after.  Defendants argued that the language constituted a "look-back period" which, under North Carolina precedent, extended the restricted period to an unreasonable length.

The "look-back" principle originates from the Supreme Court of North Carolina's per curiam opinion in Prof. Liab. Consultants, Inc. v. Todd.  In Todd, the court held that a five-year restriction against soliciting any of the employer's customers from the three years prior to the defendant employee's resignation "transform[ed] what purports to be a five-year covenant into an eight-year restriction.  345 N.C. 176, 478 S.E.2d 201 (1996) (per curiam), adopting 122 N.C. App. 212, 468 S.E.2d 578 (1996) (Smith, J. dissenting)).  Citing Todd, North Carolina courts addressing the reasonableness of non-solicitation clauses added the years of the post-termination restriction to any years for which the drafter "looks back" into the employment period to define the restriction's scope, often ignoring the legitimate common sense business interests behind the covenant during an employee's tenure.  See Farr Assocs., Inc. v. Baskin, 138 N.C. App. 276, 280 (2000); Hejl v. Hood, Hargett & Assocs., 196 N.C. App. 299, 306 (N.C. Ct. App. 2009).    

The Agent Agreement did not define the restricted customers as those within a specific time period preceding an agent's resignation, but simply forbade solicitations during an agent's period of service to NAA and for two years following termination.  The agents apparently construed this to mean that the restricted period comprised the two year post-termination restriction plus the length of their employment.  But the court rejected the agents' argument, determining that the Agent Agreement did not apply to any former employees of NAA, unlike agreements in cases cited by the agents.  The court found that the restriction therefore lasted for just two years, a reasonable period under North Carolina law.1

3.  The Court "Blue-Penciled" Words, Mid-sentence, to Render the Restriction Enforceable

Along with assailing the consideration exchanged for and the temporal period of the restrictive covenant, the defendants further argued that the prohibited activity was overbroad in that it prohibited them from soliciting the employees and independent contractors of NAA "or its Affiliates," which the agreement defined as including two companies that were "deemed to be third-party beneficiaries" to the terms of  the agreement.  The agents argued that extending such restrictions to sister corporations may impermissibly broaden a restriction.  See Med. Staffing Network, Inc. v. Ridgway, 194 N.C. App. 649, 657 (2009).  NAA responded that it had no ambitions to enforce the "and its affiliates" language, but the court rejected this, stating that "North Carolina courts do not simply ignore an unreasonable part of a restrictive covenant that a plaintiff is not trying to enforce – rather, they still apply the blue pencil approach in those cases." 

The question then became whether the court could apply the "blue-pencil" rule to save the restrictive covenant from being overbroad.  In North Carolina, when a covenant is overbroad, a court may choose not to enforce a distinctly separable part of the covenant in order to render the provision reasonable, but it may not otherwise revise or rewrite the covenant.  See Technology Prater, Inc. v. Hart, 298, 243 (4th Cir. 2008).  Use of blue-penciling typically occurs in situations where the restrictive covenant has several separately numbered sections or subsections. See, e.g., Philips Elects. N. Am. Corp. v. Hope, 631 F. Supp. 2d 705, 715 (M.D.N.C. 2009) (reasoning that the court may use its 'blue pencil' to excise separately numbered subsections where the overbroad provision was separated by the term "or").  In evaluating the Agent Agreement, the court had to decide whether to strike the problematic words from the middle of a sentence.  In determining the covenant was subject to being blue-penciled, the court reasoned  "[a]lthough ['or its affiliates'] is not separated off by number or in a different clause, the language can readily be struck through and the rest of the restrictive covenant still makes sense and stands on its own."  

Drafters should, however, bear in mind that simply striking words will still be considered an impermissible re-writing if it fundamentally alters what the drafter intended.  In a recent case in which a restrictive covenant impermissibly prevented an employee from working for a competitor "in any manner," the Court of Appeals of North Carolina refused to strike the words "in any manner" because doing so "would amount to an effort to rewrite the noncompetition agreement rather than a refusal to enforce a severable provision.  See CopyPro, Inc. v. Musgrove, 754 S.E.2d 188, 193 n. 3 (N.C. Ct. App. 2014).

4.  The Court Considered the Scope of the Defendants' New Restrictive Covenants in its "Balance of the Equities"

Finally, in finding that the "balance of the equities" favored the plaintiffs in its preliminary injunction inquiry, the court cited as support that the FFL contracts contained a very similar restrictive covenant to the one found in NAA's contracts.  The holding serves as a reminder to companies that use restrictive covenants to be mindful of their potential hire's restrictive covenant with his or her last employer.  Similar provisions would make it more difficult for the hiring employer to argue that the agreement is not enforceable in a litigation scenario.     

Take-Aways from the Decision

The Superior Performers decision is a helpful addition to the arsenal of cases for companies seeking to enforce contracts against covenantee employees or independent contractors.  The number of defenses raised by the agents, however, only highlights the attention that must be paid to the myriad nuances of North Carolina law when drafting restrictive covenants.

Footnote

1 The court could have more simply held that the defendants misapplied the look-back rule:  the Agent Agreement did not "look-back" into the agents' tenure with NAA to define the scope of the restriction, but simply forbade solicitations during the period the agents worked for NAA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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