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Partial Award Regarding Validity and Enforceability of Non-Competition Agreement and Non-Solicitation Agreement

I, THE UNDERSIGNED ARBITRATOR, having been designated in accordance with the arbitration agreement entered into between the above-named parties and dated October 7, 2011 (the "Stipulation"), which provides in pertinent part as follows:

"[T]he parties agree to ask the Arbitrator to resolve, expeditiously, the following legal issues...: Whether, or to what extent, the non-competition agreement...and the non-solicitation agreement...between Kaba and Gravelle are valid and enforceable under North Carolina law." (Stipulation,¶ 8)

And having been duly sworn, and having duly heard the proofs and allegations of the Parties, do hereby, AWARD, as follows:

Claimant, Gordon Gravelle o/a CodePro Manufacturing ("Gravelle") is represented in this matter by Barry Leon and Owen Bourns. Respondents, Kaba Ilco Corp. ("Kaba") and Chuck Murray ("Murray"), are represented by Mark Vasco and Peggy Kane. The parties have submitted affidavits, briefs and other materials in support of their respective positions on these issues, and the Arbitrator has conducted a brief telephone hearing on the issues as well. This matter is now ripe for decision.

Findings of Fact

Claimant Gravelle, a resident of Ontario, Canada, is engaged in the key cutting machine business as a sole proprietor doing business under the name of CodePro Manufacturing ("CodePro").
Respondent Kaba Ilco Corp. ("Kaba") is a North Carolina corporation headquartered in Rocky Mount, North Carolina, and is engaged in the business of developing, distributing and selling key cutting machines, key blanks, locks, lock replacement cylinders and locksmith supplies. Respondent Murray is and since 2002 has been employed as Kaba’s General Manager.
In 1997, Gravelle designed and programmed a single-sided key cutting machine named the CodePro 4500 ("CP4500"). During the period from 1998 until late 2006, Gravelle sold 78 units of the CP4500 machine, primarily in the United States and Canada.
On November 14, 2006, Gravelle and Kaba entered into a written Software Purchase and Sale Agreement (the "Purchase Agreement") under which Gravelle agreed to sell and assign to Kaba, and Kaba agreed to purchase, certain software (the "Software") and technology (the "Technology") that Gravelle had developed for the CP4500 machine.
The Purchase Agreement provided that "Kaba is purchasing the Technology in order to develop a commercially viable code type key machine system which will accommodate a two-sided vise jaw and cut single and double-sided keys....Seller [Gravelle] warrants that the Technology and Software delivered shall be modified by Seller in accordance with Buyer’s [Kaba’s] specific requirements and shall perform to accommodate a two-sided vise jaw, incorporate "on-board" indirect code capabilities, and cut single and double-sided keys...." (Purchase Agreement, ¶ 4.7)
The Purchase Agreement further provided that Gravelle would assist Kaba in its efforts to develop the Software and Technology that Gravelle sold to Kaba to perform in Kaba’s EZ-Code key cutting machine with a two-sided vise jaw. (Purchase Agreement, ¶ 6.3)
In the Purchase Agreement, Kaba agreed to pay Gravelle $20,000.00 for the Software and Technology, plus $100 per unit over the first three years and $50 per unit for the next five years, for each "stand alone" key cutting machine sold by Kaba that utilized the Software. (Purchase Agreement, ¶ 3 and Exhibit 2 thereto)
Paragraph 8.2 of the Purchase Agreement contained the following non-solicitation covenant from Gravelle in favor of Kaba (the "Non-Solicitation Agreement"):

"8.2, Non-Solicitation. For a period of ten (10) years from Closing, Seller shall not, directly or indirectly, solicit or induce or attempt to solicit or induce any employee or customer having a relation with the business of Buyer to leave or cease doing business with Buyer or in any way interfere with the relationship between any such employee or customer and the business."

The Purchase Agreement also contained a stand-alone covenant not to compete (the "Non-Competition Agreement"). (Purchase Agreement, Exhibit 3 thereto) The Non- competition Agreement essentially provides that, for a period of eight (8) years from and after the date of the Purchase Agreement, Gravelle will not directly or indirectly engage in "Competing Business", which is defined as follows:

"Competing Business shall mean the development, manufacture, distribution, sale, marketing, or providing of products and/or services that are the same as, substantially similar to, or otherwise competitive with the Buyer’s code type key cutting machine that the Buyer is purchasing the Software and Technology from the Seller to develop and which is based on or derived from the Software and the Technology.

The Non-Competition Agreement also provided as follows:

"Furthermore, Seller may continue to develop, market and sell its key machine featuring a key blank hopper and auto-feed mechanism, designed only to cut single keys by bitting code, stamp, deburr and rerack them, provided, however, that it does not and shall not contain the Software and Technology in any form or version, including any part or derivative thereof, as acquired pursuant to the terms of their Agreement.

The "Restricted Territory" set forth in the Non-Competition Agreement is world-wide.
On or about April 22, 2008, Gravelle and Kaba entered into an agreement entitled "Addendum to an Agreement Dated November 10th, 2008" (the "Addendum"). The Addendum recited that certain disputes had arisen between Kaba and Gravelle, and that in order to resolve those disputes the parties’ Purchase Agreement and Non-Competition Agreement would be amended in pertinent part as follows:

(a) Gravelle reconfirmed that all of his right, title and interest in and to the Technology have been transferred to Kaba.

(b) Kaba agreed to pay Gravelle $60,000 in advance payment of the royalties called for in Exhibit 2 of the Purchase Agreement, and, in exchange for the advance royalty payment, the parties agreed that Gravelle’s right to receive royalties for each "stand alone" machine sold by Kaba would not commence until after Kaba had sold 625 machines.

(c) Kaba agreed to pay Gravelle an additional $9,000 for his development work done and to be completed under the Purchase Agreement, thereby increasing the total amount to be paid to Gravelle for such work from $20,000 to $29,000.

(d) Kaba agreed to modify and clarify the terms and conditions of Gravelle’s Non-competition Agreement, as follows:

"Kaba agrees that Gravelle can build a high security code cutting machine [and a "commercial machine" that sells for at least $5,000 USD] that does not use any of the proprietary code, patented electronic touch off feature, nor electronic taper connection feature. Gravelle can use non-proprietary hardware parts that may be similar to those used in the EZ Code (switches, connectors, motors, etc.).

Gravelle can use generic source code commonly used, but shall not use any Technology." (Addendum,¶¶ 5, 8)

Conclusions of Law

The undersigned Arbitrator has jurisdiction to determine whether the Non-competition Agreement and the Non-Solicitation Agreement are valid and enforceable under North Carolina law. See Stipulation, ¶ 8.

A. Non-Competition Agreement

In North Carolina, a covenant not to compete is valid and enforceable if it is (a) in writing, (b) based upon valuable consideration, (c) reasonably necessary for the protection of legitimate business interests, (d) reasonable as to time and territory, and (e) not otherwise against public policy. A.E.P. Industries, Inc. v. McClure, 302 S.E. 2d 754 (N.C. 1983); Rauch Industries. Inc. v. Radko, 2007 WL 3124647 (W.D.N.C. October 25, 2007).
In this case, the Non-Competition Agreement is in writing, is supported by valuable consideration, and does not appear to be offensive to public policy. So the real question becomes whether the Non-Competition Agreement is (i) reasonably necessary for the protection of Kaba’s business and (ii) reasonable as to time and territory.
Restrictive covenants in employment agreements are strictly scrutinized in North Carolina, while covenants given in connection with the sale of a business are given greater latitude. Seaboard Industries, Inc. v. Blair, 178 S.E.2d 781, 787 (N.C.App. 1971). That said, however, the criteria for enforceability of restrictive covenants remain the same regardless of the context in which they arise, the only difference being that employment-related covenants not to compete are more carefully scrutinized than sale of business covenants. Radko, supra.
Here, we have neither an employment relationship nor a sale of a business. Rather, the restrictive covenant in this case arises in the hybrid context of a sale of technology and software to be used in the development of certain key cutting machines.
Sale of business restrictive covenants receive somewhat more relaxed treatment under North Carolina law because in a sale of business context, one of the main things the purchaser is buying is goodwill, or freedom from competition from the seller. But this is not a sale of business case. Kaba purchased Gravelle’s intellectual property- the Software and the Technology - not Gravelle’s entire business. In the Purchase Agreement, Gravelle transferred, conveyed and assigned to Kaba all of his right, title and interest in and to the Software and the Technology. In so doing, Gravelle surrendered his right to use the Software and the Technology for any purpose, including but not limited to competing with Kaba’s business or its products that utilize or are derived from the Software and/or the Technology. Given the protections afforded to Kaba under the Purchase Agreement, it is difficult to see why the Non-Competition Agreement is reasonably necessary for the protection of Kaba’s business.
In any event, the Non-Competition Agreement is not reasonable as to time and territory. Kaba has not offered any persuasive evidence to show why it must be protected from competition by Gravelle on a world-wide basis. The evidence is clear that, with few exceptions, Gravelle’s sales of CP4500 machines have been in the United States and Canada. Kaba’s only evidence regarding the sales of its EZ-Code machine is the statement that Kaba sells the product "internationally." Such limited evidence cannot justify the imposition of a world-wide restrictive covenant against Gravelle.
For these reasons, the Arbitrator concludes that the Non-Competition Agreement is not valid and enforceable under North Carolina Law.

B. Non-Solicitation Agreement

The requirements for enforceability of the Non-Solicitation Agreement are the same as those for covenants not to compete. See Paragraph 2 above. Again, the touchstone is that such agreements must be shown to be reasonably necessary for the protection of Kaba’s business. Farr Associates. Inc. v. Baskin, 530 SE.2d 878 (N.C. App. 2000); Hartman v. W.H. Odell & Associates, Inc., 450 S.E.2d 912 (N.C. App. 1994).
The Non-Solicitation Agreement purports to prohibit Gravelle from (i) "directly or indirectly" soliciting or inducing any of Kaba’s employees to leave Kaba’s employ, or (ii) "directly or indirectly" soliciting or inducing any customer "having a relation with the business of Buyer" to cease doing business with Buyer. This covenant extends for a period of ten years from and after the closing of the Purchase Agreement.
Kaba urges that the Non-Solicitation Agreement is necessary for the protection of Kaba’s business because Gravelle assisted Kaba in modifying the Software and Technology to develop the EZ-Code machine, but Kaba fails to provide any substantial evidence to show how Gravelle’s assistance to Kaba in modifying the Software and the Technology has made Gravelle such a competitive threat to Kaba that he must be barred contractually from interfering with Kaba’s employee and customer relations for a period of ten years. Kaba does not allege or show that Gravelle has had any contacts with Kaba’s customers as a result of his work for Kaba, nor does Kaba’s evidence show how Gravelle’s work has given him a potentially unfair competitive advantage with regard to Kaba’s relations with its employees.
Additionally, the Non-Solicitation Agreement is worded too imprecisely to be fairly enforceable. How does one determine whether a person’s conduct constitutes "direct or indirect" solicitation or inducement of a customer or employee to leave Kaba? How does one define a "customer having a relation with the business of Buyer [Kaba]"? Does that wording include only actual customers or does it include prospective customers as well? To be enforceable, a non-solicitation covenant should provide clear guidance as to exactly what conduct is prohibited, and the Non-Solicitation Agreement fails to provide that necessary guidance.
For these reasons, the Arbitrator finds and concludes that the Non-Solicitation Agreement is not valid and enforceable under North Carolina law.
I hereby certify that, for the purposes of Article 1 of the New York Convention of 1958, on the Recognition and Enforcement of Foreign Arbitral Awards, this Partial Award was made in Charlotte, NC.
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