Tuesday, October 15, 2013

North Carolina Court Adopts Hybrid Level of Judicial Review of Non-Compete Provisions in Franchise Agreements

In Outdoor Lighting Perspectives Franchising, Inc. v. Harders, 747 S.E.2d 256 (N.C. App. 2013), the franchisor sought to enforce a provision in its franchise agreement that would have prohibited a former franchisee from involvement in a "competing business" for two years following the termination of the franchise agreement.  The agreement defined a "competing business as any business "operating in competition with an outdoor lighting business" or "any business similar to" the franchisee's business.  The North Carolina Court of Appeals, with Judge Ervin, writing for a unanimous Court, created a "hybrid" level of scrutiny of non-compete provisions in franchise agreements.  In so holding, the court noted other sorts of agreements which, in its view, might be appropriate for resolution under this “hybrid” level of scrutiny, including the dissolution of a professional partnership (citing Beam v. Ruthledge, 9 S.E.2d 476 (N.C. 1940)), a venture capitalist’s purchase of a franchise (citing Keith v. Day, 343 S.E.2d 562 (N.C. App. 1986)), and restrictive covenants in independent contractor agreements (citing Starkings Ct. Reporting Servs., Inc. v. Collins, 313 S.E.2d 614 (N.C. App. 1984)). 

In the lower court, the franchisee had successfully argued that the non-compete provision was overly broad.  In so holding, the trial court had relied, in part, on cases employing the scrutiny standard used in employment cases.  On appeal, the franchisor argued that the sale-of-business standard of review of non-competes should have been used by the trial court, and sought reversal on that basis.  

The Court of Appeals found that the franchisor-franchisee relationship did not fit squarely into either a sale-of-business or an employment-relationship setting.  The Court explained that "practical differences between the typical employer-employee arrangement and the typical buyer-seller arrangement preclude us from concluding that the rules that typically govern either arrangement should be applied with unbending rigidity in this situation."  Those differences included, on the one hand, the fact that, unlike in typical sale-of-business cases, a portion of the good will generated by a franchisee would naturally accrue to the franchisor as well.  Likewise, the specific “job description” of the franchisee, while less relevant than in the employment context, retained some relevance to evaluating the reasonableness of a non-compete in a franchise agreement.

Instead of committing itself to one rigid standard for the enforceability of non-competes, the Court adopted a "hybrid" standard.  The Court found that the standard should insure that such non-compete arrangements are no more restrictive than is necessary to protect the franchisor's legitimate interests.  In articulating this "hybrid" standard, the Court drew from both the employment and sale of business standards.  The resulting standard included consideration of the reasonableness of the restriction's duration, the reasonableness of the restriction's geographic scope, and the extent to which the restriction is otherwise necessary to protect the legitimate interests of the franchisor. 

In applying the new "hybrid" standard to the case at hand, the Court held the agreement was overly broad in geographic scope, as it prohibited the franchisee from doing business in geographic areas related to the franchisor's affiliates that were not competitive in the outdoor lighting market.  In addition, the Court held that the agreement restricted more activities than reasonably necessary to protect the franchisor's legitimate business interests, specifically criticizing the language that prevented the franchisee from involvement in “any business similar to the [plaintiff’s business]”. 

As North Carolina does not blue pencil a non-compete agreement, the Court of Appeals concluded that the agreement was unenforceable and affirmed the trial court. 

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