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When Is a Breach of a Covenant Not to Compete Also Unfair or Deceptive?

Ellis Winters

Ellis & Winters

Next Monday, August 31, the North Carolina Supreme Court will hear arguments in an important business-versus-business case.

Beverage Systems of the Carolinas v. Associated Beverage Repair (No. 316A14) includes two unsettled issues under N.C. Gen. Stat. § 75-1.1:

  1. Is tortious interference a per se (that is, automatic) violation of section 75-1.1?
  1. When does a breach of a covenant not to compete violate section 75-1.1?

The briefs in Beverage Systems might lead one to overlook the 75-1.1 issues in the case. That would be a significant oversight.

The Beverage Systems Dispute

Beverage Systems involves the sale of a business. The contract of sale included a covenant that barred the sellers from pursuing similar business activities in the Carolinas for five years.

During that period, however, the sellers started a similar company in the Carolinas. The new company solicited business from the buyer’s current and prospective clients. Those events fueled a multi-count complaint:

  • First, the buyer claimed that the sellers breached their agreement not to compete.
  • Second, the buyer alleged that the sellers tortiously interfered with the buyer’s contracts with current customers and wrongfully courted the buyer’s prospective clients.
  • Finally, the buyer argued that all of its claims—breach of contract, tortious interference with contract, and tortious interference with prospective economic advantage—showed a 75-1.1 violation as well.

The Road to the Supreme Court

The trial court held that the linchpin of the buyer’s claims—the covenant not to compete—was unenforceable. The covenant included language that purported to allow courts to narrow the covenant as needed to make it enforceable. On cross-motions for summary judgment, however, the trial court held that it could not rewrite the covenant in this way.

The North Carolina Court of Appeals, on the other hand, reversed the trial court’s decision and remanded the case, directing the trial court to narrow and reapply the covenant not to compete.

The decision of the Court of Appeals generated a dissenting opinion from Judge Elmore. He argued that the trial court was right not to revise the covenant at issue. In addition, the dissent questioned whether any of the buyer’s claims amounted to a 75-1.1 violation.

The dissenting opinion gave the buyer a right to appeal to the North Carolina Supreme Court. The buyer exercised that right. The case is now poised for oral argument.

Will the Supreme Court address Judge Elmore’s point that the buyer’s claims, as a matter of law, fall short of 75-1.1 violations? If so, the court will encounter two perplexing questions in the law under section 75-1.1.

Tortious Interference and Section 75-1.1

The first perplexing question is this: is tortious interference a per se violation of section 75-1.1?

A per se violation occurs when a violation of a source of law outside section 75-1.1—a different statute, a regulation, or a tort doctrine—automatically generates liability under section 75-1.1. Some statutes explicitly say that violating them violates section 75-1.1 as well. Courts, however, have also used other statutes and non-statutory sources of law to generate per se 75-1.1 violations. Those courts have usually reasoned, explicitly or implicitly, that the goals of the other sources of law overlap with the goals of section 75-1.1.

So is tortious interference one of those sources of law? Many business litigators would probably answer yes—but good luck finding an opinion that says so.

Consider, for example, Roane-Barker v. Southeastern Hospital Supply Corp., a case cited by the buyer in its briefing before the Court of Appeals. The Court of Appeals held in Roane-Barker that tortious interference supported a 75-1.1 claim. To back up that holding, the court wrote that United Laboratories, Inc. v. Kuykendall “specifically held that tortious interference . . . by a competitor stated a claim for unfair and deceptive trade practices under 75-1.1.”

Note well: these phrases fall short of defining a per se violation—of saying that every instance of tortious interference triggers liability under section 75-1.1. For example, the United Labs defendant had argued that tortious interference could never be a 75-1.1 violation; the court in United Labs simply rejected that argument. United Labs did not hold, in contrast, that tortious interference automatically establishes a 75-1.1 claim.

In sum, the case law to date makes tortious interference a near relative of a per se 75-1.1 violation: it makes a 75-1.1 violation more likely, but the degree to which it promotes a violation is uncertain. My 2014 article discusses these “near relative” relationships and the confusion they create.

Let’s hope that the Supreme Court uses Beverage Systems to clarify the relationship between tortious-interference claims and section 75-1.1.

When Does a Breach of a Covenant Not to Compete Rise to the Level of a 75-1.1 Violation?

Here’s the second perplexing question that comes up in Beverage Systems: what additional facts will turn a breach of a covenant not to compete into a 75-1.1 violation?

North Carolina courts have held repeatedly that a breach of contract alone, no matter how intentional the breach is, isn’t a 75-1.1 violation. Instead, a breach of contract becomes a 75-1.1 violation only if the breach involves enough “aggravating circumstances.”

The briefs in Beverage Systems do not discuss whether a breach of the covenant not to compete in that case would rise to the level of a 75-1.1 violation. This silence is notable—especially in view of a recent decision that held that a 75-1.1 claim based on a breach of a covenant not to compete “is generally not recognized.”

If the buyer in Beverage Systems means to pursue an aggravated-breach theory, it might fail in that effort. In the Court of Appeals, the buyer argued only that the sellers had “willfully” violated the covenant not to compete when they pursued former customers “actively” and “intentionally.” These adverbs allege only an intentional breach—a breach that, by itself, does not violate section 75-1.1. Despite these shortcomings of the claim, however, the majority in the Court of Appeals held that the buyer’s 75-1.1 claim should survive.

In Beverage Systems, the Supreme Court will have the chance to clarify the relationship between covenants not to compete and section 75-1.1—including whether words like “actively” are enough of a showing of aggravating circumstances.

Looking Ahead

The argument and decision in Beverage Systems should offer insight into the Supreme Court’s thinking on section 75-1.1, one of North Carolina’s most important business-litigation statutes. We hope for a discursive opinion from one or more of the Justices.

Anna Johns, a summer associate at Ellis & Winters, contributed significantly to this post.

Author: Matt Sawchak

August 25, 2015
Posted in  Per Se Violations Substantial Aggravating Circumstances