Thursday, July 22, 2010

Failure to Separate Covenants Invalidates Non-Solicitation Agreement (MJM Investigations v. Sjostedt)

If you're drafting non-compete agreements in a blue-pencil state like North Carolina, you have to be careful.

Proving once again that the consequences for improper drafting can be severe, the Court of Appeals in North Carolina invalidated a client non-solicitation clause due in part to overbreadth but also due to the strict application of the state's blue-pencil law.

As regular followers of this blog know, there is a sharp distinction between states which will modify covenants to make them reasonable and states which adhere to a mechanical blue-pencil approach. North Carolina falls in the latter category. (It is this scribe's humble opinion that the more equitable approach - favored in states like Illinois and Ohio - leads to less litigation and incents employees to comply with at least some restriction that an objective person would deem reasonable. That is not to say this approach does not have a chilling or deterrent effect, which it clearly does.)

This means that a court may not add or change terms of a covenant, but instead only can sever or strike out offending provisions. The covenant at issue concerned an employee's agreement not to compete and not solicit clients in a specialized, niche field related to insurance coverage. Specifically, the plaintiff assisted insurance carriers in evaluating claims made related to services provided by contractors of the federal government for work overseas.

The defendant, a consultant, terminated his agreement with the plaintiff and apparently began competing directly in the same claims processing field with the plaintiff's clients. He argued that the restrictive covenants were invalid and lost in the trial court as to the less cumbersome client non-solicitation obligation. The court struck the two-year non-compete as invalid on the grounds it was overbroad.

On appeal, the defendant obtained further relief as he successfully convinced the Court of Appeals that the client non-solicitation also could not be enforced. He won on a couple of grounds:

(1) The two-year time limit was contained only in the non-compete restriction, and since it was struck as overbroad, the non-solicitation clause had no time limit whatsoever. This is a perfect illustration of the rigidity of the blue-pencil rule, because a court in an equitable modification state could easily apply the two-year time limit to the non-solicitation clause in its discretion.

(2) The definition of "client" and "prospect client" was not defined in the agreement. In North Carolina, as in many states, a client limitation cannot extend beyond relationships the employee made while employed with his former firm. In this case, the court had ample precedent to hold the terms "client" and particularly "prospect client" were too vague to be enforced. This ruling provides a lesson for practitioners: if you're going to use defined terms in a non-compete agreement, use them to define which clients are off-limits so that an employee cannot argue vagueness. That argument often wins.


Court: Court of Appeals of North Carolina
Opinion Date: 7/20/10
Cite: MJM Investigations, Inc. v. Sjostedt, 2010 N.C. App. LEXIS 1280 (N.C. Ct. App. July 20, 2010)
Favors: Employee
Law: North Carolina

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