Two years ago, we wrote about a noncompete decision in which a special referee found a business seller had breached a sales agreement by violating both a noncompete covenant and an exclusive sales provision contained in the agreement (see "Body bag dispute offers lessons on noncompetes in South Carolina" on page 1 of the June 2016 issue). The seller appealed, and the South Carolina Court of Appeals reversed and remanded the case (i.e., sent it back to the lower court), holding the noncompete's 150-mile territorial restriction was unreasonable and unenforceable. The South Carolina Supreme Court reviewed the appeals court's decision and has now issued its own ruling. Read on to see what the supreme court did.
10-year exclusivity provision at center of dispute
In the 1980s, Robert Knight began operating a mortuary transport business, Knight Systems, Inc. (KSI), which eventually expanded to include the manufacturing and sale of body bags. In 2006, he decided to sell the mortuary transport portion of the business and approached a broker for assistance. In October 2006, Donald and Ellen Lintal, the CEO and CFO, respectively, of Palmetto Mortuary Transport, Inc., met with a broker to discuss the purchase of Knight's mortuary transport business. From November 2006 to January 5, 2007, the parties and their agents-including brokers, accountants, and attorneys-negotiated the terms of an asset purchase agreement. During the negotiations, Knight expressed to Mr. Lintal his desire to get out of the mortuary transport business.
On January 5, 2007, Knight and Palmetto signed the agreement. Under its terms, Knight sold various tangible assets, goodwill, and customer accounts-including body removal service contracts with Richland County, Lexington County, and the University of South Carolina-to the buyer for $590,000. The agreement included an exclusivity provision requiring (1) Palmetto to purchase body bags from Knight for 10 years and (2) Knight to sell body bags to Palmetto for 10 years. The provision became a central issue in the dispute between the parties.
A 10-year, 150-mile noncompete covenant also was signed and included as an exhibit to the agreement. Although the noncompete restricted Knight from providing mortuary transport services within a 150-mile radius of Lexington County, it placed no limits on KSI's ability to continue its body bag manufacturing business. The noncompete covenant also provided that Palmetto's breach of the agreement or other ancillary sale documents would release Knight from any and all of their restrictions.
During the trial, Donald Lintal testified the 150-mile territorial restriction around Lexington County was included to ensure Knight would not compete with Palmetto in South Carolina for 10 years. Lintal acknowledged that at the time Palmetto purchased the transport business, KSI provided services primarily in Richland and Lexington counties. Lintal added: "We didn't know where the business was actually going to-what we were going to-if we were going to try to expand it at different locations. We wanted to keep our options open if it was doable."
In 2011, Palmetto still held the mortuary transport services contract with Richland County. Since the original five-year term between the two parties was expiring, the county issued a request for proposal (RFP) seeking mortuary transport services for the next five years. Palmetto submitted a timely response to the RFP.
As noted above, the exclusivity provision required Palmetto to purchase body bags from KSI for 10 years. From 2007 through 2011, Palmetto bought more than $45,000 worth of body bags from the company. Palmetto also purchased body bags from other manufacturers costing $884.97. The amount included 31 infant bags ($192.75), four extra-large body bags ($213.72), six heavy-duty body bags ($208.50), and six water retrieval bags ($270). When Knight became aware of the infant-bag purchases in 2009 or 2010, he immediately considered them to be a breach of the agreement but didn't confront Palmetto for almost two years. Knight testified he didn't become aware of the other purchases until discovery (the pretrial exchange of information) during litigation.
Palmetto didn't believe the exclusivity provision required it to buy infant or extra-large bags from KSI. Palmetto agreed it had breached the exclusivity provision by purchasing heavy-duty and water retrieval bags from other manufacturers but argued the breach wasn't significant. Instead of canceling the agreement, Palmetto argued it should be allowed to pay damages totaling $478.50-the sum it had given the other manufacturers for the heavy-duty and water retrieval bags. Knight, on the other hand, argued the exclusivity provision required Palmetto to purchase all of its body bags from KSI and claimed the breach was significant and nullified all terms and conditions of the agreement, including the noncompete covenant.
Business seller 'didn't want to be left out in the cold'
On June 16, 2011, a day before the deadline to respond to the RFP, Knight recorded a conversation with Lintal. During the talk, Knight accused Palmetto of buying infant body bags from other manufacturers. Lintal replied he didn't believe the purchase was "significant" or that "it was anything to break [the agreement]." As noted above, before the confrontation, Knight had been aware of Palmetto's supposedly illicit purchase of infant body bags for almost two years.
Afterwards, Lintal suspected KSI was going to bid against Palmetto for the Richland County contract. His suspicion was correct-Knight submitted his own RFP the very next day. Even though Knight had received $590,000 for selling the business and an extra $45,000 in body bag purchases from Palmetto, he testified, "I didn't want to get back in the business. I was forced to. . . . I felt like if I didn't take action at that time, I was going to be left out in the cold."
After the RFP deadline passed, Knight contacted the Richland County Procurement Office and told an official that KSI should be awarded the contract because it was the sole provider of odor-proof body bags-an RFP requisite. Although Palmetto's response to the RFP contained the lowest price for services and received the highest number of points from the procurement office, the county awarded the contract to KSI.
Palmetto sued Knight for breach of the agreement, alleging he violated (1) the noncompete covenant prohibiting KSI from providing mortuary transport services within the 150-mile limit for 10 years and (2) the exclusivity provision, based on his refusal to supply Palmetto with body bags. Knight counterclaimed, alleging the noncompete covenant was unenforceable because it contained an unreasonable territorial restraint and time restriction and wasn't supported by adequate consideration (or something of value given in return for signing it). Knight also alleged that any breach of the noncompete covenant was excused because Palmetto violated the exclusivity provision first by buying body bags from other manufacturers.
The case was tried before a special referee who found the noncompete covenant was reasonably limited in time and territorial scope and supported by valuable consideration. The special referee found Knight breached the agreement by violating the noncompete covenant and refusing to sell body bags to Palmetto. On the other hand, Palmetto's purchase of the heavy-duty and water retrieval body bags from other manufacturers, although a breach, wasn't significant enough to excuse Knight from performing his contractual obligations.
The special referee ordered Knight to pay attorneys' fees and damages of $373,264.54 in lost profits resulting from the wrongful competition with Palmetto. The referee issued a permanent injunction requiring Knight to comply with the noncompete covenant for a period of five years and seven months after the date of his order but allowing KSI to complete its performance of the 2011 mortuary transport services contract with Richland County. Finally, the referee awarded $478.50 in damages to Knight for Palmetto's breach of the agreement.
Knight appealed the ruling to the court of appeals, arguing the special referee erred in finding (1) the noncompete's territorial limits were reasonable and enforceable, (2) the restriction was supported by independent and valuable consideration, (3) the noncompete covenant wasn't void for being against public policy, and (4) it wasn't nullified by Palmetto's breach of the exclusivity provision. The court found the 150-mile limit unreasonable and unenforceable and sent the case back to the referee.
Because South Carolina doesn't follow the "blue-pencil rule" (i.e., rewriting an agreement for the parties) and the noncompete didn't include a "step-down provision (language eliminating grammatically unreasonable provisions, but not adding or rewriting provisions)," the court of appeals found it couldn't redraw the arrangement to include a smaller territorial restriction. The supreme court granted Palmetto's petition to review the court of appeals' decision.
South Carolina Supreme Court's decision
Palmetto's argument was that the court of appeals erred when it found the noncompete's territorial restriction to be unreasonable. The supreme court first pointed out that noncompetes are enforceable if they are not detrimental to the public interest, are ancillary to the sale of a business or profession, are reasonably limited in terms of time and territory, and are supported by valuable consideration. The court further stated that the reason why such covenants are held to be unenforceable is that unless they meet certain criteria, they constitute a restraint on trade, which is against public policy. With that backdrop, the court then looked at the facts and previous law in the noncompete area.
Relying on a 1942 decision, the court wrote that in determining whether a contract in partial restraint of trade is reasonable, it will look at (1) the contract's "whole subject matter," (2) the kind and character of the business, (3) location, (4) the purpose to be accomplished by the restriction, and (5) all circumstances that show the parties' intention must have entered into the making of the contract.
Contract's subject matter. The noncompete covenant between Knight and Palmetto arose out of a business sale between two sophisticated parties. Noncompetes signed during a business sale should be scrutinized at a more relaxed level than those that are tied to employment contracts. The latter are generally disfavored and strictly construed against an employer because of the unequal bargaining power that may exist between the two parties. The risk is significantly lower when the restriction arises during a business sale between two sophisticated parties. Also, signing a noncompete covenant in connection with the business sale allows the seller to capitalize on the disposition of the enterprise's goodwill and bargain for a higher price.
Looking back at the pertinent facts, the court noted the agreement involved the somewhat complex sale of Knight's mortuary transport services business to Palmetto for $590,000. Both parties were sophisticated and represented by legal counsel throughout the negotiations. Knight had to consider the restrictions in the noncompete before deciding to enter into the agreement. The noncompete was integral to Palmetto's decision to sign it. Lintal testified about Knight's "strong reputation" in the business and stated, "[The noncompete covenant] was very important to us because without [it], we wouldn't have bought the business." Further, the covenant provided, "[Knight] has agreed to provide such covenants as set forth herein as a material inducement to [Palmetto] to enter into and close the Purchase Agreement" (emphasis added). It's clear the noncompete was a centerpiece of the agreement and that both Palmetto and Knight bargained for and intended to benefit from its terms.
While the noncompete caused a partial restraint of trade by limiting Knight's ability to provide mortuary transport services, it was offset by KSI's continuation of its body bag manufacturing business and the exclusivity provision requiring Palmetto to buy bags from it throughout the covenant's term. Indeed, Palmetto purchased approximately $45,000 worth of bags from KSI before the current controversy arose. The agreement didn't prohibit KSI from continuing to sell bags to other customers. It's clear that both sides carefully considered and calibrated their options and best interests before striking the deal.
Kind and character of the business, and its location. Knight's territorial restriction consisted of a 150-mile radius around Lexington County. When Palmetto bought the business, it mainly served Richland and Lexington counties. Focusing only on the existing territory, however, and Palmetto's lack of concrete plans for geographical expansion ignores the "kind and character" of the business.
Because a mortuary transport business necessarily involves the mobility of services, an expansion into other areas of South Carolina was certainly foreseeable. This isn't a brick-and-mortar local retail business of the 1950s. Palmetto, a sophisticated buyer, saw the opportunity to expand outside KSI's existing business area and thus negotiated the agreement with Knight, a sophisticated seller, to protect its interests by implementing the 150-mile restriction. At his deposition, Lintal testified that since the agreement went into effect, Palmetto has added new customers and "on occasion" provides services for people outside of the Columbia and Lexington areas.
After considering the agreement as a whole and giving the noncompete the more relaxed scrutiny it requires, the court found the 150-mile radius didn't exceed what was essential to reasonably protect the rights Palmetto purchased.
Other concerns. In looking at any potential invalidity of the agreement on public policy grounds, the court admitted there may be times when a restriction against competition between potential competitors for public contracts will be voided for being against public policy, but KSI's case didn't rise to that level. Based on all of the facts including Knight's desire to get out of the mortuary transport services business, the court declined to create a blanket rule that would find such agreements to be against public policy.
Agreeing with the special referee, the supreme court held that while Palmetto breached the exclusivity provision by buying $478.50 worth of body bags from other manufacturers, the breach wasn't significant and didn't nullify Knight's obligation to honor the noncompete. The court reversed the court of appeals and reinstated the referee's order.
Lessons for SC employers
First, you've just witnessed the rigorous application of the requirements for successful noncompete covenants in South Carolina. Imposing limited restrictions on time and place and providing adequate consideration will still be the norm. The courts will likely strike down any workplace noncompetes that are overly broad.
Second, the standards won't be as vigorous in the business context. As we've explained, the courts will look at the whole subject matter of the contract, the kind and character of the business, the location, the purpose to be accomplished by the restriction, and all circumstances showing the parties' intent. Be careful not to conflate the standards for the sale of a business with situations involving a single employer/former employee noncompete issue.
For more information on the BLR, click here. For more information on the South Carolina Employment Law Letter, click here.