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May 28, 2015 Practice Points

Reformation Clauses No Savior in North Carolina

A recent decision has held that courts do not have the power to reform an overbroad restrictive covenant in an employment agreement, even when the agreement contains a reformation clause.

By Michael Molzberger

A recent decision has held that courts do not have the power to reform an overbroad restrictive covenant in an employment agreement, even when the agreement contains a reformation clause. The decision, Lab. Corp. of Am. Holdings v. Kearns, No. 1:14-CV-1029, 2015 WL 413788 (M.D.N.C. Jan. 30, 2015), reinforces that parties cannot rely on reformation clauses to save overbroad restrictive covenants. The better practice for drafters is to carefully research the applicable jurisdiction's reasonableness requirements regarding length, geographic area, and scope. Drafters should then craft restrictive covenants narrowly within these parameters. This practice is particularly important in the relatively few jurisdictions that, like North Carolina, follow the outmoded, strict blue-pencil rule.

In Kearns, a former employee, Kearns, started a competing business and solicited customers from his former employer, LabCorp. Kearns' employment agreement with LabCorp included non-solicitation and non-competition restrictive covenants. Kearns had also executed a separate agreement with LabCorp related to the sale of a business. LabCorp, however, did not seek to enforce the restrictive covenants contained in the sale agreement. LabCorp brought suit and moved for a preliminary injunction to enforce the employment agreement covenants.

In entering a preliminary injunction enforcing the non-solicitation covenant, the court found that the non-compete was likely overbroad and unenforceable. The court then employed a two-step process to determine whether it could modify the non-compete covenant to make it enforceable. First, it considered whether it could blue-pencil the non-compete. Some background here: jurisdictions vary widely in their willingness to blue-pencil or otherwise reform overly broad restrictive covenants. Many jurisdictions liberally allow for equitable reformation, whereas others allow only for limited revisions. North Carolina follows a common law doctrine known as the strict blue-pencil rule: "[a] court at most may choose not to enforce a distinctly separate part of a covenant in order to render the provision reasonable. It may not otherwise revise or rewrite the covenant." Id. at *8. The Kearns court held that it lacked power under the blue-pencil rule to modify the non-compete covenant to make it reasonable.

Second, the court considered whether the agreement's reformation clause empowered the court to reform the non-compete covenant despite its inability to do so under the blue-pencil rule. The clause stated that if a provision in the agreement were found unenforceable, it should be reformed and enforced to the maximum extent permitted by law. In determining whether the reformation clause would allow it to reform the non-compete, the court analyzed Beverage Sys. of the Carolinas, LLC v. Associated Beverage Repair, LLC, 762 S.E.2d 316 (N.C. Ct. App. 2014). In Beverage Systems, the trial court found that a restrictive covenant in a sale of business agreement was overbroad and thus unenforceable. The trial court refused to blue-pencil and refused to reform the agreement despite the agreement's reformation clause. The appellate court reversed. The court held that the trial court should have enforced the parties' agreement, which included giving effect to the reformation clause by reforming the overbroad restrictive covenant.

The court in Kearns, on an issue of first impression, rejected the extension of Beverage Systems' holding into the employment context. The court stated that the rationale of Beverage Systems was inapplicable to employment-related non-competes. Noting that its decision was consistent with North Carolina's general unwillingness to enforce and reform restrictive covenants, the court refused to reform the non-compete despite the reformation clause, and therefore it refused to preliminarily enjoin Kearns from competing with LabCorp.

This decision yields two takeaways. First, as discussed above, drafters should carefully research and narrowly draft restrictive covenants to ensure their enforceability, particularly in the employment context. Second, litigators should sue based on restrictive covenants contained in sales and franchise agreements, rather than employment agreements, when presented with that option. A court may be more likely to enforce and reform the former as opposed to the latter.

Keywords: intellectual property, litigation, restrictive covenant, Kearns, reformation clause

Michael Molzberger is with Schiff Hardin in Chicago, Illinois.

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Michael Molzberger – May 28, 2015