Labor & Employment – Contract — Covenants Not to Compete – Solicitation & Confidentiality – Tort/Negligence – Unfair Trade Practices – Punitive Damages

Akzo Nobel Coatings Inc. v. Rogers (Lawyers Weekly No. 11-15-1143, 44 pp.) (James L. Gale, J.) N.C. Bus. Ct.

Holding: Although the restrictions in defendants’ Rogers’ and Taylor’s covenants not to compete are broad, since the covenants were entered into as part of a corporate buy-out, and since they are governed by Delaware law, the covenants survive defendants‘ motion for judgment on the pleadings.

The individual defendants’ motion for judgment on the pleadings is granted as to the non-competition provision in defendant Schoning’s agreement; defendant Parker’s and Caravello’s agreements; plaintiff’s claims of fraud, negligent misrepresentation, tortious interference with contract and prospective economic advantage; plaintiff’s claim of unfair and deceptive trade practices claim against defendants Rogers, Taylor, Schoning, and Caravello; plaintiff’s Trade Secrets Protection Act (TSPA) claims against defendants Rogers, Taylor, Schoning, and Caravello; and plaintiff’s punitive damages claim against defendants Rogers, Taylor, Schoning, and Caravello.

The individual defendants’ motion for judgment on the pleadings is denied as it relates to defendant Rogers’ agreement; defendant Taylor’s agreement; the non-solicitation provision in defendant Schoning’s agreement; plaintiff’s unfair and deceptive trade practices claim against defendant Parker; and plaintiff’s claim for punitive damage, to the extent that it depends on the TSPA claim against Parker.

Allegations

Plaintiff merged with the individual defendants’ former employer. As part of the merger, defendant Rogers received $9.5 million in exchange for agreements not to compete with plaintiff, not to solicit plaintiff’s customers, and not to use plaintiff’s confidential information. Also as part of the merger, defendant Taylor received $304,000 in exchange for similar agreements.

Defendants Schoning and Caravello had similar agreements with plaintiff’s predecessor.

Plaintiff contends the individual defendants have breached their agreements. In addition to plaintiff’s breach of contract claims, the complaint sets out tort claims and claims for unfair trade practices.

Choice of Law

Defendants Rogers’ and Taylor’s agreements include a choice of law provision indicating that the agreements are to be governed by Delaware law.

North Carolina’s “blue pencil” rule restricts the courts’ power to alter restrictive covenants because it is based on public policy, and Delaware allows courts to rewrite covenants in order to make them reasonable.

As a general rule, North Carolina will give effect to a contractual provision agreeing to a different jurisdiction’s substantive law. This rule has been applied in the context of covenants not to compete.

Delaware has a substantial relationship to the transactions involving Rogers and Taylor. Plaintiff is a Delaware corporation, and both the Rogers and Taylor agreements are made with plaintiff.

The choice of law provision in the Rogers and Taylor agreements were bargained for by sophisticated parties and should be honored. Doing so does not violate public policy.

Breach of Contract

The non-compete provision of the Rogers agreement seeks to prevent him from competing “directly or indirectly” with plaintiff or “any Company Entity engaged in the business of wood coatings,” but the agreement contains a carve-out which allows him to hold certain equity ownership interests.

The agreement is based on the sale of a business; therefore, it is subject to less judicial scrutiny than a simple employment contract.

The court cannot rule at this time that the prohibition against “direct or indirect” competition is overbroad under Delaware law. The inquiry may be revisited on a more fully developed record.

The Rogers agreement also prohibits Rogers’ solicitation of “any customer or client, or prospective customer or client, of any Company Entity,” except through his provision of Consulting Services.

Based on Rogers’ position as an officer and equity interest holder in plaintiff’s predecessor, Chemcraft Holdings Corporation (Chemcraft), an initial reasonable inference can be drawn that Rogers had significant opportunity to develop relationships within the overall industry, such that plaintiff’s relationships with prospective customers could be significantly affected by Rogers’ competitive efforts and that this broad restriction is both necessary and represented in the substantial consideration paid to Rogers.

Rogers also contends that agreement paragraph 8(b) is overly broad because it seeks to restrict him from soliciting “customers or clients, or prospective customer or client of any Company Entity.” Whether the affiliates at issue are part of plaintiff’s legitimate business interest is a factual question which should not be decided by the present motion.

The Rogers agreement contains a four-year restricted period. This time restriction is coupled with a client-based restriction, which is international in scope.

Though the scope of Rogers’ client-based restriction is extensive, so are his alleged job responsibilities and alleged knowledge of plaintiff’s business practices. As noted above, the court is less discerning of an agreement’s scope when the non-compete accompanies the sale of a business. These factors lead the court to conclude that the four-year time restriction, when coupled with the client-based restriction, does not necessarily fail as a matter of law.

Defendants’ motion with respect to the Rogers agreement is denied.

In addition to the same grounds asserted to invalidate the Rogers agreement, the motion highlights particular language of the Taylor agreement prohibiting him from “solicit[ing] or encourag[ing] any customer of or vendor to any Company Entity to terminate its relationship with them or, in the case of a customer, to conduct with any person any business or activity which such customer conducts or could conduct with any Employer or any of its affiliates.”

As the court reads this language, it does not prohibit the solicitation of future customers; it seeks to prohibit any present or future business activity with current customers. If plaintiff argues it extends to prospective customers, the covenant is nevertheless better reviewed at summary judgment.

The motion with respect to the Taylor agreement is denied.

The Schoning agreement is governed by N.C. law.

The Schoning non-compete provision would prevent Schoning from working for a competitor in the wood coatings industry in a position wholly outside the scope of his employment with Chemcraft and from indirect ownership of a competing firm. Thus, this provision goes farther than is necessary to protect a legitimate business interest. The motion with respect to the Schoning noncompetition provision is granted.

The Schoning agreement also prevents him from soliciting “any customer of or vendor to [Chemcraft and its affiliates] … to conduct with any person any business or activity which such customer conducts or could conduct with any Company Entity.”

Under N.C. law, whether the affiliates at issue in the Schoning agreement are part of plaintiff’s legitimate business interest is a factual question.

Defendants further argue that the language of the Schoning agreement prohibits the solicitation of prospective customers and should be dismissed under Digital Recorders, Inc. v. McFarland, 2007 NCBC 23 ¦¦ 25, 60, 71 (N.C. Super. Ct. June 29, 2007), http://www.ncbusinesscourt.net/opinions/2007%20NCBC%2023.pdf. Plaintiff contends that the clause specifically targets only current customers and vendors.

As with the Taylor agreement, the language does not appear to prohibit the solicitation of future customers but seeks to prohibit any present or future business activity with current customers.

Schoning received $50,000.00 in return for his covenants. The court does not believe the covenant supported by independent consideration fails because it was not integrated into a single employment agreement. It is nevertheless part of this employment agreement as required by United Labs., Inc. v. Kuykendall, 322 N.C. 643, 370 S.E.2d 375 (1988).

The motion as to the Schoning agreement is denied except as to the non-competition covenant.

The Parker and Caravello agreements are governed by N.C. law.

The agreements restrict Parker and Caravello’s conduct “for a period of twenty-four months following termination of employment with the Company for any reason,” and prohibit them from contacting “any of the Companies’ customers with whom the Company did business during the three (3) years preceding [their] termination for the purpose of selling, purchasing, developing, manufacturing or distributing industrial liquid coatings.”

As indicated by Farr Assocs., Inc. v. Baskin, 138 N.C. App. 276, 530 S.E.2d 878 (2000), the look-back provision must be added to the restrictive period to determine the real scope of the time limitation.

A five-year restriction on competition is disfavored and requires a showing of special circumstances. Plaintiff alleges only that Parker and Caravello were sales representatives who attempted to solicit its customers and employees in violation of their restrictive covenants. These are not special circumstances that would allow the court to determine that a five-year restriction is reasonable in this case.

The five-year duration standing alone is incurable and unreasonable as a matter of law.

Defendants’ motion with respect to the Parker and Caravello agreements is granted.

Tort Claims

The term “economic loss doctrine” has been used to denote limitations on the recovery in tort when a contract exists between the parties that defines the standard of conduct and which the courts believe should set the measure of recovery. To state a viable claim in tort for conduct that is also alleged to be a breach of contract, a plaintiff must allege a duty owed to him by the defendant separate and distinct from any duty owed under a contract. The independent tort must be identifiable, and the tortious conduct must have an aggravating element such as fraud, malice, reckless indifference, oppression, insult, or willfulness. The policy behind the independent tort exception recognizes that the open-ended nature of tort damages should not distort bargained-for contractual terms.

Plaintiff alleges in August 2009, more than two years after its acquisition of Chemcraft, plaintiff sent Rogers a letter reminding him of his obligations under the Rogers agreement. In response, Rogers affirmatively misrepresented that he was “not an employee or sales representative of the German company [Bergolin]”; “the only ‘purpose of Bergolin USA is to sell coatings to windmill blade manufacturers;’”; “Bergolin USA is not engaged in the industrial wood coatings business in the US”; he “did not retain any confidential documents upon [his] resignation from Chemcraft in July 2007”; and that he had “no intention of violating the agreement.”

Notably, plaintiff does not contend that Rogers’ alleged misrepresentations induced its execution of the Rogers agreement. Rather, plaintiff asserts that it relied on the alleged misrepresentations in forbearing an action against Rogers in contract.

Although the complaint alleges, with specificity, several material misrepresentations made by Rogers once he was confronted about his relationship with Bergolin, plaintiff has failed to allege the existence of a duty, owed to it by Rogers, separate and distinct from the duty owed under the Rogers agreement. Under the Rogers agreement, Rogers owed a contractual duty to refrain from competing with plaintiff and to refrain from soliciting its customers. The breach of that contractual duty cannot provide the basis for an independent claim of fraud or negligent misrepresentation.

Absent allegations of a separate and distinct legal duty, plaintiff has failed to state a claim against Rogers for fraud or negligent misrepresentation upon which relief can be granted.

Plaintiff relies upon the individual defendants’ solicitation of its customers and employees to support its claims for tortious interference with a contract and prospective economic advantage.

When viewed in tandem with the primary breach of contract allegations, the complaint lacks tort allegations that can be considered “distinct from” the alleged primary breach of the non-compete and non-solicitation agreements.

Moreover, the complaint fails to allege the existence of a duty “separate and distinct” from the individual defendants’ obligation under their respective agreements.

The legal duty that precludes the individual defendants from soliciting customers and employees of plaintiff is imposed by express contractual agreement between plaintiff and the individual defendants. The purpose of the non-compete and non-solicitation agreements at issue was to ensure that the individual defendants would not compete with plaintiff and solicit its customers. Any breach of that contractual duty is properly actionable in contract, without the potential for an open-ended tort damage award.

The individual defendants’ motion with respect to plaintiff’s claims for tortious interference with a contract and prospective advantage is granted.

Unfair Trade Practices

With respect to Taylor, Parker, Caravello, and Schoning, the complaint contains generic allegations that do little more than recite the prima facie elements of an unfair and deceptive trade practices claim. Plaintiff has failed to plead the existence of substantial aggravating circumstances capable of sustaining a claim for unfair and deceptive trade practices that is identifiable and distinct from the individual defendants’ primary breach of contract.

With respect to Rogers, plaintiff has pled that Rogers made affirmative misrepresentations about his involvement with Bergolin USA. Accepting these allegations as true, plaintiff might be found to have pled an unfair and deceptive trade practice by Rogers, separate and distinct from the underlying breach of contract, in or affecting commerce, but plaintiff has not pled the requisite harm resulting from the wrongful act.

The only specific allegation of damages related to the alleged August 2009 misrepresentations of Rogers provides that plaintiff relied on the misrepresentations in not taking legal action against Rogers in August

2009. The temporary forbearance of legal action is not, however, sufficient to establish the actual injury requirement of G.S. Chapter 75.

The motion concedes that the TSPA claim survives a Rule 12(b)(6) dismissal at least against Parker. Under G.S. § 66-146, a violation of the TSPA necessarily constitutes an unfair act or practice under G.S. 75-1.1. Accordingly, the Chapter 75 claim against Parker must survive.

With the exception of Parker, the individual defendants’ motion with respect to plaintiff’s claims for unfair and deceptive trade practices is granted.

Trade Secrets Protection Act

In support of its TSPA claim, plaintiff alleges, “Shortly before leaving his employment with [plaintiff], Parker … obtained technical materials for [plaintiff’s] products wholly unrelated to his work for the company, including his removal from [plaintiff’s] premises formulas and technical information concerning [plaintiff’s] fiberglass door coating products.” The complaint alleges that the formulas meet the statutory definition of trade secrets under G.S. § 66-152(3) in that they “derive independent actual or potential commercial value form not being generally known or readily ascertainable through independent development or lawful reverse engineering” and that plaintiff “made reasonable efforts under the circumstances to maintain the secrecy of its trade secrets.”

While the individual defendants acknowledge that the complaint states a TSPA claim against Parker, they challenge the sufficiency of the pleadings as they relate to the other individual defendants, specifically contending that the TSPA claim “fails to identify with specificity the trade secrets allegedly misappropriated by Rogers, Schoning, Caravello, or Taylor.”

Plaintiff’s identification of the trade secrets allegedly misappropriated is broad and vague and does not identify with sufficient specificity either the trade secrets defendants allegedly misappropriated or the acts by which the alleged misappropriations were accomplished. As a result of plaintiff’s failure to identify the trade secrets allegedly misappropriated, the individual defendants’ motion is granted with respect plaintiff’s claims for violation of the TSPA other than the TPSA claim against Parker.

Punitive Damages

Punitive damages cannot be awarded solely for breach of contract.

The court is not persuaded that plaintiff can maintain any independent tort claims because the alleged breach of contract was not accompanied by an identifiable tortious act and some element of aggravation. As a result of this deficiency, plaintiff’s punitive damages claims against Rogers, Taylor, Schoning, and Caravello should be dismissed.

The court cannot dismiss the punitive damages claim against Parker because a claim for punitive damages necessarily follows an allegation of willful and malicious misappropriation of trade secrets.

Motion granted in part and denied in part.