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It is well established in North Carolina, like it is in many other states, that covenants not to compete are disfavored and must be narrowly drafted to protect an employer’s legitimate business interests (such as the protection of confidential information). North Carolina and other states hold that if the noncompete agreement is drafted too broadly and tends to stifle normal competition, the agreement will be unenforceable. A recent opinion from the North Carolina Court of Appeals, Phelps Staffing LLC, v. C.T Phelps, Inc., drives this point home.

The factual background is long and tortured and is described in an earlier part of the litigation. The short version is that the parties, Phelps Staffing, LLC (“Phelps”) and C.T. Phelps, Inc. (“CTP”), are both in the business of providing temporary workers to clients. In December 2008, CTP began competing directly with Phelps [and since Phelps believed such competition violated the terms of an asset purchase agreement, the first litigation was born].

CTP was able to convince some of Phelps’ clients to switch their business to CTP, and in order to meet the clients’ needs, CTP then recruited Phelps’ temporary workers to become CTP employees. CTP even allowed them to keep their same positions with the client companies. This process is allegedly known as “flipping” employees.

In an effort to prevent further flipping, Phelps began requiring its workers to sign covenants not to compete that prevented them from working with the same client companies either as a result of working directly for them or being placed there by a competing staffing company. The noncompetes did not contain any geographic limitations on their restrictions [though they were, arguably, customer based]. The time restriction in these covenants was twelve months.

The noncompete agreements did not stop CTP’s efforts to win business from Phelps’ customers, and in October 2010, CTP again flipped a number of Phelps employees. The client companies went along and paid CTP rather than Phelps for the labor being provided.

Phelps filed suit against CTP, claiming that CTP improperly interfered with the covenants not to compete and induced the temporary workers to break them. Phelps also claimed that CTP back dated some of the workers’ job applications to make it appear the workers had changed employers earlier than they actually had, meaning CTP could improperly bill and collect an extra week’s worth of fees for each employee that should have instead been paid to Phelps. Phelps alleged all of this conduct amounted to an unfair trade practice. The trial court, however, dismissed all of Phelps’ claims.

In deciding whether to affirm or reverse that dismissal, the North Carolina Court of Appeals first looked at the tortious interference with contract claim. In order to decide whether one party improperly interfered with another’s contractual rights [in this case, the rights belonging to Phelps by virtue of its noncompete agreements with its employees], the contract must have indeed been valid. In other words, if the noncompetes that were supposedly broken were not enforceable to begin with, CTP could not have improperly interfered with them.

This is where the law of covenants not compete becomes so important. Citing previous cases, the North Carolina Court of Appeals set out the rule:

whether a noncompetition agreement offends public policy requires us to consider the right of the employer to protect, by reasonable contract with its employee, the unique assets of its business, a knowledge of which is acquired during the employment and by reason of it. We have recognized such unique assets to include customer contacts and confidential information. However, when such proprietary interests of the employer are absent and the effect of a contract is merely to stifle normal competition, it is offensive to public policy in promoting monopoly at the public expense and is bad.

For the underlying covenants not to compete to be valid, the court had to determine what, if any, unique assets Phelps had that were worthy of protection.

Unfortunately for Phelps, it admitted in the lawsuit that the primary purpose in requiring its employees to sign the noncompete agreements was to prevent competition from competitors like CTP. Phelps also admitted that its temporary workers did not have access to trade secrets or proprietary information as a result of their employment with Phelps. Phelps attributed no special skills to its employees that they learned while working for Phelps, describing them instead as “general laborers.”

It’s not hard to guess which way the case would turn based on that testimony [and it is reminiscent of the testimony featured in our recent post about 3-D printers]. Nonetheless, the court cited other flaws in the noncompete agreements. For instance:

the agreement does not contain any terms restricting its scope to only the specific location where that employee was placed for work. Thus, a former employee would be prohibited from working for a client, such as Hoover, whether the client had a second location in the same city or in a different state. Moreover, as the agreement provides that its terms apply after termination of the employee “for any reason whatsoever,” if Phelps Staffing were to decide to no longer provide staffing to a client and terminated its contract with the client, plaintiff’s noncompetition agreement would prevent the former employees from accepting employment from plaintiff’s former client for a period of twelve months.

Given all these flaws, the Court of Appeals determined the underlying covenants not to compete would have been unenforceable, and therefore CTP could not have improperly caused the temporary workers to break them. As for Phelps’ claim that CTP committed an unfair trade practice, Phelps failed to allege any egregious or aggravating conduct by CTP, which is required to support such a claim. The Court held that simply alleging a billing error was not enough to support the claim, and affirmed the grant of summary judgment to CTP.

The Phelps case is an important reminder of the need to narrowly tailor noncompete agreements to cover no more than is necessary to protect a company’s legitimate business interests. North Carolina courts, and indeed courts in many other states, will not hesitate to strike down agreements that interfere with normal competition. Covenants with no geographic restrictions that purport to keep employees (who have no knowledge of propriety or confidential information) from working for a competitor will not be enforceable. Moreover, any covenant that is admittedly designed to prevent ordinary competition, like the Phelps covenants, will be invalid as a matter of law.

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