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North Carolina Business Court Addresses Consideration Requirement for Covenant Not to Compete

September 20, 2017

In American Air Filter Co., Inc. v.  Price, No. 16 CvS 13610, 2017 WL 2797794 (N.C. Super. Ct. June 26, 2017), the plaintiff’s former employee signed an employment agreement that renewed automatically each year. The agreement contained a non-compete covenant. The plaintiff alleged that its former employee received consideration for each renewing year in the form of base salary, commissions and bonuses. Significantly, however, the complaint did not allege that the former employee’s salary or bonus was increased in conjunction with the alleged annual renewals.  Id., 2017 WL 2797794, at *2.  Therefore, in deciding the plaintiff’s claim seeking to enforce the employment agreement’s covenant not to complete against the former employee, the Business Court concluded that there was no consideration to support the agreement at the time of the employee’s resignation in 2016 and therefore, it dismissed the claim. Id., 2017 WL 2797794, at *7-8.

The employment agreement at issue became effective on November 13, 2006 for a term of one year, and thereafter it was to renew automatically for successive one-year terms unless it was terminated. Id., 2017 WL 2797794, at *2. While still employed by the former employer, the employee accepted employment with a competitor, and upon moving to the competitor’s business, he performed substantially similar duties as he did at his prior job.  Id., 2017 WL 2797794, at *3.  While at the new job, he allegedly contacted customers of his former employer who he had previously serviced.  As a result, the former employer brought suit on multiple claims against its former employee and his new employer, which included a claim under the non-compete provision for breach of the employment agreement. Id.

The agreement contained a Kentucky choice of law provision, and the parties debated whether North Carolina or Kentucky law would apply. Finding that Kentucky had a substantial relationship to the parties and the transaction and that Kentucky law did not violate North Carolina public policy, the Court decided that Kentucky law would apply to the plaintiff's claim for breach of the employment agreement. Id., 2017 WL 2797794, at *6.  The Court determined that Kentucky law requires that an enforceable non-compete covenant must be supported by consideration other than continued employment of the employee.  Id., 2017 WL 2797794, at *6 (citations omitted). Similarly, under North Carolina law, continued employment is not sufficient consideration to support a covenant not to complete. Id. (citing Cox v. Dine-A-Mate, Inc., 129 N.C. App. 773, 778, 501 S.E. 2d 353, 356 (1998)). Under North Carolina law, "keeping one's existing job is insufficient consideration for the signing of a covenant not to compete." Cox, 129 N.C. App. at 778, 501 S.E.2d at 356 (citing Henley Paper Co. v. McAllister, 253 N.C. 529, 117 S.E.2d 431 (1960)).

Applying Kentucky law, the court concluded that at the time of the former employee's resignation in 2016, the employment agreement was not supported by consideration. It also did not contain a geographic or territorial restriction.  Therefore, the agreement could not be enforced.  American Air Filter, Co., Inc., 2017 WL 2797794, at *7.  While the complaint alleged facts showing that the employment agreement was supported by consideration for its initial one year term from 2006-07, the complaint did not sufficiently allege that the former employee was provided consideration for the yearly renewals of the agreement from 2007 through the end of his employment.  Id., 2017 WL 2797794, at *7-8. 

In dismissing the claim for breach of contract, the Business Court stated:  "Any failure to provide consideration for a given year's renewal would break the 'chain' and render the 2006 Agreement unenforceable as to subsequent years.  [Plaintiff’s] allegations in the [complaint] do not support the notion that [Plaintiff] provided consideration, or that [the former employee’s] employment relationship with [Plaintiff] changed, in exchange for his agreement to renew the non-compete covenant each year after 2006.”  Id., 2017 WL 2797794, at *8. 

After American Air Filter, parties in non-compete litigation will want to consider whether the agreement in question provided for annual renewals and, if so, whether the agreement was supported by new consideration for each year that the agreement renewed.

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