Employer and Employee--non-compete agreement--client-based--unreasonable
The trial court correctly granted defendant's motion for a dismissal under N.C.G.S. § 1A-
1, Rule 12(b)(6) of an action arising form a non-compete agreement where the client-based
territorial restriction and the five-year time limitation in the agreement were unreasonable.
Although a five-year time restriction may be upheld, it must be considered with its geographical
scope. Here, the physical scope of the territorial restriction is irrelevant, but the substitution of
the client base is unreasonable because it prevents defendant from working for all of plaintiff's
current or recent clients, regardless of location, so that he is precluded from working with a
number of businesses in a large number of cities throughout the world. Considering the relatively
small number of plaintiff's clients with whom defendant worked, the scope is extreme.
Furthermore, the restriction is unduly vague.
Constangy, Brooks & Smith, LLC, by W.R. Loftis, Jr. and
Virginia A. Piekarski, for plaintiff-appellant.
Puryear and Lingle, P.L.L.C., by David B. Puryear, Jr. and
Robert J. Lingle, for defendant-appellee.
WYNN, Judge.
In July 1996, David S. Baskin started working for Farr
Associates, a behavioral science consulting firm based in High
Point, North Carolina. Through about 461 client offices, Farr
provides behavioral consulting services to individual clients, and
conducts leadership and self-awareness seminars that are open to
the public. Its largest client base is in North Carolina, but it
also has offices in 41 other states and four foreign countries.
Its clients are generally large businesses, often having multipleoffices within a given state, province or country.
Farr provides its services through its employees called
Consultants. Their work generally consists of providing behavioral
science consulting to individual Farr clients and conducting
leadership seminars developed by Farr that are open to the public
at large. Consultants are usually trained by Farr, using a
training system developed by Farr. However, Farr did not provide
consulting training to Mr. Baskin because he had over 20 years of
experience in the field, but he did receive some training as to the
administration of Farr's leadership program.
When a Farr Consultant is assigned to work with a client, the
Consultant works very closely with that client, gaining a full
understanding of the client's business needs and cultivating close
personal relationships with the client's principle representatives.
Consultants achieve such a rapport with the client companies
through their employment with Farr.
As part of his employment contract with Farr, Mr. Baskin
signed a non-compete agreement, which provided the following:
For the valuable consideration being provided
to the Employee under this Agreement, the
Employee covenants and agrees that during the
term of this Agreement and for a period of
three (3) years from the date the Employee's
employment with the Company is terminated,
regardless of whether such termination is with
or without cause, or is by mutual agreement,
or is involuntary as to one of the parties
hereto, the Employee will not directly or
indirectly render to any current client or
customer of the Company or to any client orcustomer who was a client or customer of the
Company during the two (2) year period
immediately preceding the termination date of
the Employee's employment with the Company,
services of any kind similar to the services
previously or presently rendered for such
client or customer.
Mr. Baskin worked for Farr for about two years, providingbehavioral science consulting to eight clients. On 2 Octo
ber 1998,
Mr. Baskin gave written notice of his resignation to Farr, to be
effective in two week's time. Upon leaving Farr, Mr. Baskin
started the Baskin Group, Inc., which offers behavioral consulting
services to interested businesses. He immediately began providing
consulting services to J. A. Jones Construction Company, a client
of Farr's since 1988 that had worked directly with Mr. Baskin while
he worked for Farr. A few other Farr clients have also been in
contact with Mr. Baskin, although the parties disagree as to
whether Mr. Baskin solicited their business.
On 12 March 1999, Farr brought an action seeking to enforce
the non-compete agreement against Mr. Baskin and also asserting a
claim that Mr. Baskin breached his employment contract by not
providing sufficient advance notice of his resignation. On 19
March 1999, Farr moved for injunctive relief to stop Mr. Baskin
from violating the terms of the non-compete agreement. Mr. Baskin
moved to dismiss Farr's complaint on the ground that it did not
state a claim upon which relief could be granted. He also filed
affidavits in opposition to Farr's motion for a preliminary
injunction.
Superior Court Judge Judson D. DeRamus denied Farr's motion
for injunctive relief, finding that Farr had failed to demonstrate
a likelihood of success on the merits of the claim. Thereafter,
Superior Court Judge Peter M. McHugh granted Mr. Baskin's motion to
dismiss regarding the claim based on the non-compete agreement, but
denied Mr. Baskin's motion with respect to the claim based on hisfailure to give adequate notice of his resignation. Farr appealed
both orders to this Court. We consolidated the two appeals.
We first address Farr's argument that the trial court
erroneously dismissed this action, since the dismissal of an action
is subject to more stringent rules than the grant of an injunction.
Farr argues that the trial court committed reversible error in
partially granting Mr. Baskin's motion to dismiss because Farr's
complaint states on its face a claim for breach of an enforceable
non-compete agreement.
A motion to dismiss under Rule 12(b)(6) tests the legal
sufficiency of the complaint by presenting the question whether, as
a matter of law, the allegations of the complaint are sufficient to
state a claim upon which relief can be granted under some legal
theory. See Hobbs v. N.C. Dep't Human Resources, __ N.C. App. __,
520 S.E.2d 595, 599 (1999). A motion to dismiss under Rule
12(b)(6) should not be granted " 'unless it appears to a certainty
that plaintiff is entitled to no relief under any state of facts
which could be proved in support of the claim.' " Id. (citing
Isenhour v. Hutto, 350 N.C. 601, 604-05, 517 S.E.2d 121, 124
(1999)). As our Supreme Court has held, the “function of a motion
to dismiss is to test the law of the claim, not the facts which
support it.” White v. White, 296 N.C. 661, 667, 252 S.E.2d 698,
702 (1979).
In the case at bar, the question is whether the non-compete
agreement is enforceable as a matter of law. If not, then the
trial court properly granted Mr. Baskin's motion to dismiss theclaim.
Covenants not to compete between an employer and employee are
“not viewed favorably in modern law.” Hartman v. W. H. Odell and
Assocs., Inc., 117 N.C. App. 307, 311, 450 S.E.2d 912, 916 (1994),
review denied, 339 N.C. 612, 454 S.E.2d 251 (1995). To be
enforceable, a covenant must meet five requirements--it must be (1)
in writing; (2) made a part of the employment contract; (3) based
on valuable consideration; (4) reasonable as to time and territory;
and (5) designed to protect a legitimate business interest of the
employer. Id. at 311, 450 S.E.2d at 916. The reasonableness of a
non-compete agreement is a matter of law for the court to decide.
See id.
The record on appeal shows that the non-compete agreement
meets two of the above requirements--it is in writing and is part
of the employment contract. It also meets the third requirement
because the promise of new employment is valuable consideration in
support of a covenant not to compete. See Milner Airco, Inc. v.
Morris, 111 N.C. App. 866, 869, 433 S.E.2d 811, 813 (1993). Our
inquiry focuses on the last two requirements--whether the covenant
is reasonable as to time and place, and whether it is designed to
protect a legitimate business interest of the employer.
First we observe that the non-compete agreement in this case
meets the requirement of being designed to protect Farr's
legitimate business interests. The protection of customer
relations against misappropriation by a departing employee is well
recognized as a legitimate interest of an employer. See UnitedLaboratories Inc. v. Kuykenall, 322 N.C. 643, 651, 370 S.E.2d 375,
381 (1988). Farr's work requires that its Consultants develop an
intimate relationship with its clients. Because the clients grow
to trust individual Farr employees, the clients may naturally want
to continue that relationship even if the Consultant leaves Farr.
However, should the Consultant maintain the relationship, Farr
risks losing a customer. The danger of a departing employee
“misappropriating” a client is indeed very real, since Farr's
Consultants develop not only close relationships with Farr's
clients, but gain knowledge of Farr's business practices too.
Following Kuykendall, we hold that Farr's desire to keep its client
base intact when its employees depart is a legitimate business
interest.
However, we hold that the fourth part of the test from
Hartman--the time and territory restriction--is unreasonable on its
face and the non-compete agreement is therefore unenforceable.
In evaluating reasonableness as to time and territory
restrictions, we must consider each element in tandem--the two
requirements are not independent and unrelated. See Hartman, 117
N.C. App. at 311-12, 450 S.E.2d at 916. Although either the time
or the territory restriction, standing alone, may be reasonable,
the combined effect of the two may be unreasonable. A longer
period of time is acceptable where the geographic restriction is
relatively small, and vice versa. See Jewel Box Stores v. Morrow,
272 N.C. 659, 158 S.E.2d 840 (1968).
We have previously held that time restrictions of a certainlength are presumed unreasonable absent a showing of spe
cial
circumstances. A five-year time restriction is the outer boundary
which our courts have considered reasonable, and even so, five-year
restrictions are not favored. See, e.g., Welcome Wagon Int'l, Inc.
v. Pender, 255 N.C. 244, 120 S.E.2d 739 (1961) (holding a five-year
restriction limited to one city was reasonable); Hartman, 117 N.C.
App. at 315, 450 S.E.2d at 918 (holding that “only extreme
conditions” will support a five-year non-compete agreement.)
Accord Engineering Assoc., Inc. v. Pankow, 268 N.C. 137, 139, 150
S.E.2d 56, 58 (1966). Further, when a non-compete agreement
reaches back to include clients of the employer during some period
in the past, that look-back period must be added to the restrictive
period to determine the real scope of the time limitation. See
Prof. Liab. Consultants, Inc. v. Todd, 345 N.C. 176, 478 S.E.2d 201
(1996) (adopting dissenting opinion of Smith, J., in 122 N.C. App.
212, 468 S.E.2d 578 (1996)), reh'ing denied, 345 N.C. 355, 483
S.E.2d 175 (1997)).
In the case at bar, the covenant restricts Mr. Baskin from
providing services to Farr's clients for a period of three years
after leaving Farr. The restricted clients include those using
Farr's services at the date of termination and any client served by
Farr within the two years preceding termination. The real time
restriction of the non-compete agreement is therefore five years--
three years after the date of termination plus the two-year look-
back period. Although a five-year time restriction may be upheld,
we must consider the length of the restriction with itsgeographical scope in order to determine its reasonableness.
To prove that a geographic restriction in a non-compete
provision is reasonable, an employer must first show where its
customers are located and that the geographic scope of the covenant
is necessary to maintain those customer relationships. See Todd,
122 N.C. App. at 218, 468 S.E.2d at 582. The employer must show
that the territory embraced by the covenant is no more than
necessary to secure the protection of its business or good will.
See A.E.P. Industries, Inc. v. McClure, 308 N.C. 393, 404, 302
S.E.2d 753, 761 (1983). In addition, our Supreme Court has
recognized the validity of geographic restrictions that are limited
not by area, but by a client-based restriction. See, e.g.,
Kuykendall, supra.
Both parties present arguments as to why the physical scope of
the territorial restriction is or is not reasonable. However, the
physical scope of the restriction is irrelevant since Mr. Baskin is
not prevented from working in any particular locale. Specifically,
we reject Mr. Baskin's argument that the non-compete agreement is
overly broad because it has no defined physical territorial limit
at all. However, Farr's use of its client base as a substitute
for a physical limitation works to achieve an unreasonable effect
in its own way.
In Hartman, supra, we set forth a six-part test to determine
whether the geographic scope of a covenant not to compete is
reasonable. The six factors are: (1) the area or scope of the
restriction; (2) the area assigned to the employee; (3) the areawhere the employee actually worked; (4) the area in which the
employer operated; (5) the nature of the business involved; and (6)
the nature of the employee's duty and his knowledge of the
employer's business operation. See Hartman, 117 N.C. App. at 312,
450 S.E.2d at 917. Although we do not apply this test to the
physical scope of the covenant, since it is not an issue, we do
adapt the test as being applicable to assess the client-based
restriction.
Farr has approximately 461 offices in 41 states and four
foreign countries--Canada, Mexico, Israel, and The Netherlands.
Many of Farr's clients have multiple offices within a given state,
province or country. The covenant in question prevents Mr. Baskin
from working for all of Farr's current or recent clients,
regardless of where the client is located, whether he had any
contact with them, or whether he even knew about them. Although
Mr. Baskin is not prevented from working in any particular locale,
he is precluded from working with a number of businesses in a large
number of cities throughout the world. The scope of the covenant
is extreme, considering that Mr. Baskin only worked with a
relatively small number of Farr's clients.
We further note that the client-based restriction is unduly
vague. The covenant does not define whether the term “client or
customer” includes one-time attendees of a Farr workshop. And the
covenant may extend to clients' offices that never contacted Farr.
If Farr worked for a client in one city, but that client has
offices in other cities, the non-compete agreement ostensiblyprevents Mr. Baskin from working for that client in any of its
offices, not merely the office with which Farr once worked. Both
of these factors work to expand the reach of the covenant.
Although Mr. Baskin knows Farr's business practices, Farr's
main concern is that the Consultant makes business contacts with
Farr's clients--clients that may be lost when the Consultant
leaves. Although Farr had a legitimate reason for wanting to
prevent departing employees from misappropriating clients, the
number of clients embraced by the covenant, as compared to the
number of clients serviced by Mr. Baskin, is unreasonable.
We compare this case to Hartman, which held that where the
primary concern is the employee's knowledge of the customers, “the
territory should only be limited to areas in which the employee
made contacts during the period of his employment.” Hartman, 117
N.C. App. at 313, 450 S.E.2d at 917 (citation omitted). The
geographic limitation of that case is analogous to the client-based
limitation in the case at bar. The rule set forth in Hartman
should apply with equal force here: a client-based limitation
cannot extend beyond contacts made during the period of the
employee's employment.
Farr relies on three cases in which our Supreme Court held
that a client-based geographical restriction was reasonable. In
two of those cases, the Supreme Court upheld client-based
restrictions which included clients the employee had not personally
serviced; however, we find that the scope of the restriction in the
case at bar is much broader than the restrictions contemplated inthose cases. In Triangle Leasing Co., Inc. v. McMahon, 327 N.C.
224, 393 S.E.2d 854 (1990), the Supreme Court upheld a non-compete
agreement forbidding a former employee from soliciting its clients
anywhere within North Carolina, despite the fact that the
employee's contacts were limited to Wilmington. The sheer scope of
the covenant in the case at bar makes it distinguishable from
Triangle Leasing. In Kuykendall, supra, the Supreme Court upheld
a client-based restriction limited to clients that the former
employee either directly serviced, or those clients who were
serviced by the employees working under the defendant. The scope
of the prohibition was much smaller than in the case at bar, and
was limited to clients that the former employee had intimate
knowledge of. Finally in the third case, Whittaker Gen. Med. Corp.
v. Daniel, 324 N.C. 523, 379 S.E.2d 824 (1989), the Supreme Court
upheld a client-based restriction limited to clients that the
former employee had personally worked with. Again, the client-
based restriction in that case is much more limited than in the
case at bar.
(See footnote 1)
We hold that the scope of the client-based territorial
restriction in the case at bar is unreasonable, thereby rendering
the non-compete agreement unenforceable. In addition, since time
and territory restrictions are two parts to one inquiry, we find
that the five-year time limitation lends further support to ourholding that this non-compete agreement is unreasonably broad and
therefore unenforceable. The trial court properly dismissed Farr's
claim that Mr. Baskin breached an enforceable non-compete
agreement.
Having found for Mr. Baskin on the merits of Farr's non-
compete claim, we further uphold the trial court's denial of Farr's
motion for preliminary injunction.
Affirmed.
Judges HORTON and SMITH concur.
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