Under North Carolina law, a non-compete agreement entered in connection with the sale of a business is enforceable if: (1) it is reasonably necessary to protect the interest of the purchaser; (2) it is reasonable with respect to both time and territory; and (3) it does not interfere with the interest of the public. One issue that often comes up in the context of non-compete agreements is the extent – if any – to which a court may strike through or revise an otherwise overbroad restriction. A related issue is whether parties to a contract can negotiate around such rules.
Although the majority of states permit judges to revise or rewrite otherwise unenforceable non-compete agreements, North Carolina is among the strong minority that allow only the “blue-penciling” of such agreements. Under the “strict blue pencil doctrine” as adopted and applied in North Carolina, when considering an otherwise unenforceable restrictive covenant, a court may, but is not required to, enforce “divisible and reasonable” portions of a restrictive covenant, and may not otherwise take action to save the restriction. This means that a court applying North Carolina law may strike through overbroad restrictions contained in a non-compete agreement, but may not rewrite the agreement to make it enforceable.
Until recently, the extent to which parties negotiating at arm’s length in connection with the sale of a business could contract around North Carolina’s blue penciling rules was unclear. Earlier this year, the Supreme Court of North Carolina addressed this issue in Beverage Systems of the Carolina, LLC v. Associated Beverage Repair, LLC, and held, in reversing the decision of the North Carolina Court of Appeals to the contrary, that parties cannot by contract give the court power to rewrite restrictive covenants. In that case, the geographic scope of the non-compete agreement – which included all of both North Carolina and South Carolina – was determined to be overbroad. However, the parties had entered into a Non-Competition, Non-Solicitation and Confidentiality Agreement as part of an asset purchase. As relevant to this post, the parties had agreed as follows in that contract:
If … 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 that the court shall be allowed to revise the restrictions contained in [the agreement] to cover the maximum period, scope and area permitted by law.
The purchaser argued that this language gave the trial court the power to rewrite the territorial limits to make them reasonable. The Supreme Court of North Carolina rejected the argument that this language could be used to avoid North Carolina law, finding that “parties cannot contract to give a court power that it does not have” and that “[a]llowing litigants to assign to the court their drafting duties as parties to a contract would put the court in the role of scrivener, making judges postulate new terms that the court hopes the parties would have agreed to be reasonable at the time the covenant was executed or would find reasonable after the court rewrote the limitation.”
Based on this decision, it is now clear that North Carolina’s “strict blue pencil doctrine” applies to all restrictive covenants – whether those restrictions are part of an employment agreement or part of the sale of a business – and that parties cannot empower courts to rewrite such covenants in contravention of North Carolina law through contract.
This leaves contracting parties with several options. First, restrictive covenants should be drafted carefully to increase the chance that they will be found enforceable. Second, if the agreement will be governed by North Carolina law, drafters will likely want to consider using the “cascading” or “step” approach to drafting territorial restrictions. Under this approach, a series of gradually expanding territories will be included in the restrictive covenant, leaving ultimate responsibility for determining the reasonableness of any particular restriction on the court. One risk with this approach is that courts applying North Carolina law are not required to strike through unreasonable restrictions and may, instead, decline to enforce the restrictions.