VOLUME I Chapter 2 Covenants Not to Compete and Other Restrictive Covenants

• Jurisdiction: South Carolina

Chapter 2 Covenants Not to Compete and Other Restrictive CovenantsCherie W. BlackburnNexsen Pruet, LLC

Under the early common law of England, an agreement in restraint of a person's right to exercise his trade was void as against public policy.¹ The reason lies in the fact that one could not lawfully exercise a trade unless he had been fully apprenticed and, once apprenticed, one was obligated by statute to follow and exercise that trade.² Thus, to enforce a restrictive covenant was not only to deny a person the right to earn a living but also to require him to violate an express provision of the law. Over the years, the law has changed and today, a restrictive covenant ancillary to a lawful contract will be enforced where it is reasonable and consistent with the interests of the public.³

I. Covenants Not to Compete in the Employment Context

A. The Reasonableness Test

In analyzing the enforceability of covenants not to compete, South Carolina courts have consistently stated that such covenants in employment contracts are generally disfavored and will be strictly construed against the employer.⁴ The restriction must be narrowly drawn to protect the legitimate interests of the employer.⁵ If the covenant does not fall within the boundaries of certain reasonableness criteria, it will fail, regardless of the employer's willingness to accept an interpretation which would render the covenant reasonable in scope.⁶

Under the "reasonableness test" applied by the courts, a covenant not to compete will be enforced if it can be shown that the covenant (1) is necessary for the protection of the legitimate interests of the employer, (2) is reasonably limited with respect to time and place, (3) is not unduly harsh and oppressive in curtailing the legitimate efforts of the employee to earn a livelihood, (4) is reasonable from the standpoint of sound public policy, and (5) is supported by valuable consideration.⁷ Each case that addresses the enforceability of a covenant not to compete must be decided on its own facts.⁸

1. Valuable Consideration

A covenant not to compete must be supported by "valuable consideration."⁹ The hiring of an employee is sufficient consideration for the promises set forth in a restrictive covenant, even when the employment is at-will.¹⁰ Consideration to an existing employee may take the form of a promotion or other benefit to the employee.¹¹ In addition to offering employment or giving a promotion, the forbearance on the part of an employer to enforce a prior covenant not to compete may be valuable consideration for a restrictive covenant.¹²

In Poole v. Incentives Unlimited, Inc. d/b/a Dunlap Motivation and Travel, et al, the Supreme Court held that continued at-will employment alone is not sufficient consideration to support a covenant not to compete.¹³ The court found that since the employee's duties, position and salary were left unchanged when she signed the covenant not to compete at issue in the case, the covenant was unenforceable for lack of consideration.¹⁴

2. Reasonable as to Time and Place

a. Time Restriction

A restrictive covenant must be reasonably limited with respect to the time period it covers.¹⁵ There is not an established time period which is deemed reasonable per se, and the courts consider each case separately to determine if the time period is reasonable. It is clear, however, that an open-ended covenant, without any time limitation, is not enforceable. In Sermons v. Caine & Estes Insurance Agency, Inc., the South Carolina Supreme Court stated, "[w]hile conceding that a limitation of two or even three years may not be obnoxious, the limitation 'at any time' cannot be justified."¹⁶

The Supreme Court has upheld covenants of up to two and three years. In Rental Uniform Service of Florence v. Dudley, the court upheld a three-year covenant not to compete, reasoning that it was only a year longer than the two-year restraint described as reasonable in Delmar Studios of the Carolinas v. Kinsey.¹⁷

b. Territorial Restriction

The South Carolina Supreme Court has shown particular concern that the geographical limitations of a covenant not to compete be reasonable in breadth and fair to the employee. If the territorial scope of the covenant is unreasonable, no inquiry needs to be made as to the other requirements.¹⁸

In one of the first state appellate cases addressing a covenant not to compete in an employment agreement, the Supreme Court struck down the covenant on the grounds that its territorial restraint was "broader than reasonably necessary for the protection of [the employer's] business."¹⁹ In Delmar Studios, Delmar Studios sought to enforce a two-year covenant not to compete against its salesman. Delmar Studios was in the business of taking photographs of students and selling school yearbooks. The company operated in parts of North Carolina and Georgia, as well as the entire state of South Carolina. Kinsey was a salesman who solicited contracts and took pictures within a territory comprising ten counties in South Carolina and six in Georgia. The covenant not to compete which Kinsey signed prohibited him from competing with Delmar Studios for a period of two years following the termination of his employment within a "territory" which covered "about three-fourths of the State of North Carolina, all of South Carolina, and eleven counties in Georgia."²⁰ In writing for the court, Justice Oxner set forth what became the rule in South Carolina with regard to the scope of a territorial restriction: "It must not restrain his activities into a territory into which his former work has not taken him or given him the opportunity to enjoy undue advantages in later competition with his employer."²¹ Since the territorial restriction in Kinsey's contract was much broader than the actual area in which Kinsey worked, it was "broader than reasonably necessary for the protection of Delmar's business" and "must be declared invalid."²²

In the case of Standard Register Company v. Kerrigan, the South Carolina Supreme Court clearly defined the rule that "a restraint as to territory, in order to be reasonable, must be necessary in its full extent for the protection of some legitimate interest of the employer."²³ Stated differently, the territorial scope renders the restraint unreasonable if it covers an area broader than necessary to protect the legitimate interest of the employer."²⁴Focusing on the employer-customer relationship, the court went on to say, "the territorial restraint in a covenant not to compete will, generally speaking, be considered reasonable if the area covered by the restraint is limited to the territory in which the employee was able, during the term of his employment, to establish contact with his employer's customers."²⁵

The South Carolina appellate courts have consistently considered the criteria that a covenant's territorial limitation be reasonable in conjunction with the criteria that the covenant as a whole be necessary for the legitimate interests of the employer. In Somerset v. Reyner, the South Carolina Supreme Court reviewed a covenant not to compete in a sale of business context, stating:

We shall first determine whether the covenant under consideration is necessary in its full extent for the protection of the covenantee's business or goodwill. If not, the territorial scope of the restraint is unreasonable and no inquiry need be made as to the presence or absence of other necessary requirements.²⁶

This case not only helped delineate the rule of reasonableness with regard to territorial restrictions but also established that if the territorial limitation of the covenant is unreasonable, the covenant is invalid and the court need not consider the remaining criteria.

In the case of Sermons v. Caine & Estes Insurance Agency, Inc.,²⁷ the employee sold insurance within a 50-mile radius of Greenville. However, the covenant not to compete that he signed prohibited him from competing within the entire State of South Carolina. The South Carolina Supreme Court stated simply "[t]here is no good reason for limiting the activity of the employee throughout the entire state of South Carolina."²⁸

The South Carolina Court of Appeals has strictly applied the requirement that the covenant not cover an area broader than is necessary to protect the employer's legitimate interest. In Stringer v. Herron, the court found that a territorial restriction of a 15-mile radius surrounding each of three veterinary practices, contained within a veterinarian's covenant not to compete, was overly broad where the overwhelming majority of the practice's clients lived much closer than 15 miles from at least one of the practice locations.²⁹ Herron, a veterinarian, entered into a contract with Stringer that contained a covenant not to compete which prohibited Herron from engaging in any veterinary practice for a period of three years from the termination of his employment within 15 miles of any veterinary practice operated by Stringer. Herron voluntarily terminated his contract with Stringer, who at that time operated three animal hospitals in Anderson County. Herron began a mobile veterinary practice in and around Anderson County. He vaccinated at least 249 animals formerly on Stringer's active customer list.

The Court of Appeals focused on one criteria of the reasonableness test: "whether, as a matter of law, the covenant in issue is reasonably limited in its operation with respect to place."³⁰ Citing Somerset v. Reyner, the court reiterated the rule that if the territorial scope of the covenant is unreasonable, no inquiry need be made as to the presence or absence of other necessary requirements.³¹ In analyzing the evidence presented at trial, the court emphasized that although 96% of Stringer's clients lived within 15 miles of at least one of the three locations, 55% of them lived within 5 miles and 84% lived within 10 miles of at least one of these locations. Considering the fact that an "overwhelming majority"...