From time time DDIFO is pleased to present Guest Commentary from valued contributors. The following is an Analysis of Recent Franchise Non-Compete Decisions written and submitted by Eric Karp and David J. Meretta of Witmer, Karp, Warner & Ryan LLP
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Over the years, countless numbers of current and prospective franchisees have asked us a variation of the same question: will the non-competition covenant in my franchise agreement be enforced? This question most frequently arises at or near the end of the franchise relationship, or when the franchisee is deeply dissatisfied with the value proposition behind the franchise relationship, and as a consequence is considering whether or not to remain in the system or “go independent”.
As set forth in three recent franchise non-compete decisions, the answer to this question generally is highly dependent on two factors: (i) whether there is an actual protectable interest of the franchisor at stake, and, if so, (ii) the degree to which the non-competition covenant is narrowly tailored to protect precisely that protectable interest of the franchisor.
In Atlanta Bread Co. v. Lupton-Smith, 285 Ga. 587, 679 S.E.2d 722 (2009), the Georgia Supreme Court found the in-term non-compete covenant contained in the parties’ franchise agreements to be unenforceable, because its terms were not adequately defined as to the territory and the nature of the business. In particular, the covenant contained no territorial limitation, it prevented the franchisee from engaging in any capacity within the bakery/deli business, and failed to specify the restricted activities with sufficient particularity.
The in-term covenant in Atlanta Bread prohibited the franchisee from directly or indirectly engaging in, or acquiring “any financial or beneficial interest in (including any interest in corporations, partnerships, trusts, unincorporated associations or joint ventures), advise, help, guarantee loans or make loans to, any bakery/deli business whose method of operation is similar to that employed by store units within the System”.
Applying strict scrutiny to assess the reasonableness of the in-term covenant, the court found the covenant to be unenforceable, because its terms were not defined as to the territory and the nature of the business. As observed by the Court of Appeals of Georgia:
[The in-term covenant] does more than prevent Smith from operating a bakery/deli, as argued by Atlanta Bread Company. The provision contains no territorial limitation, prevents Smith from engaging in any capacity within the bakery/deli business, and fails to specify the restricted activities with sufficient particularity. “Bakery/deli business” is not defined in the franchise agreement. Under Atlanta Bread Company’s definition, any business operation that bakes or sells baked goods or sells cooked meats and prepared salads would be prohibited. In addition, the restrictive covenants prohibit Smith from acquiring any interest, advising, or engaging in any bakery/deli business whose method of operation “is similar” to that of the “System.” If Smith were to own an interest in a coffee shop that sold baked goods purchased from an unrelated supplier, in an area where Atlanta Bread Company did not compete, Smith would still be in violation of [the in-term covenant]. Likewise, if Smith were to take a position of janitor in a deli, he also would be in violation of [the in-term covenant].
Here, because [the in-term covenant] fails to specify with any particularity the nature and kind of business which is or will be competitive with Atlanta Bread Company and because the Restriction fails to specify with particularity the nature of the business activities in which Smith is forbidden to engage, the covenant is unreasonable. It imposes a greater limitation on a franchisee than is necessary for the protection of the franchisor. In addition, “[r]egardless of the level of scrutiny we apply, the lack of a territorial restriction renders [the covenant at issue here] unenforceable.” We find the covenant in restraint of trade in this case, when read in its entirety, to be vague and overly broad.
The Court of Appeals of Georgia further found that the post-term non-compete agreement in Atlanta Bread was also unenforceable. The post-term covenant restricted the franchisee from directly or indirectly engaging in, or acquiring any financial or beneficial interest in (including any interest in corporations, partnerships, trusts, unincorporated associations or joint ventures), advising, helping, guaranteeing loans or making loans to, any bakery/deli business whose method of operation is similar to that employed by bakery/deli stores within the System which is located within a twenty (20) mile radius of any store unit within the System, for one (1) year following the termination of the Agreement. The court found in pertinent part as follows:
[The post-term covenant] is unreasonable as a matter of law because it contains “shifting and expanding” territorial restrictions. “[A] territorial restriction which cannot be determined until the date of the [franchisee’s] termination is too indefinite to be enforced…. [The franchisee must be] able to forecast with certainty the territorial extent of the duty owing.” If the covenant’s language allows territories to be added during the course of the agreement, the covenant is unenforceable. Here, the covenant at issue restricts the franchisee from certain actions “within the System which is located within a twenty (20) mile radius of any store unit within the System.” This language allows the 20-mile radius of prohibited territory to shift and/or expand during the course of the agreement as new stores are potentially added to the System. The covenant falls squarely within the holding of Koger Properties and its progeny invalidating territorial restrictions that change or expand during the course of the agreement.
The Atlanta Bread decisions further held that the in-term and post-term covenants could not be severed from one another, because a noncompetition agreement entered into in connection with a franchise contract cannot be “blue-penciled” by the courts, so if one provision of a covenant not to compete is found to be unenforceable, the entire covenant will be struck down.
We observe that the extent to which the Atlanta Bread decision reflects that Georgia may now be “franchisor unfriendly” has been somewhat overstated among industry organizations. Non-compete agreements have long been disfavored in Georgia; the Atlanta Bread decision merely applied this doctrine to the franchise relationship.
More recently, in Anytime Fitness, Inc. v. Family Fitness of Royal, LLC, 2010 WL 145259, Bus. Franchise Guide (CCH) ¶14,303 (D.Minn.,2010), the U.S. District Court for the District of Minnesota denied the franchisor’s motion for a temporary restraining order to enforce the in-term non-compete clause in the parties’ franchise agreement. The court’s decision turned on the finding that the franchisor had failed to establish irreparable harm, because the harm alleged by the franchisor – that the franchisee would be able to utilize information regarding the franchisor’s upcoming promotions and sales strategies to steal customers – was speculative rather than certain and imminent. In this regard, the court noted that the Anytime Fitness location nearest the alleged infringing location was owned by the defendant franchisee itself, and thus the defendant would primarily be competing with his own business. The franchisee had converted one of its four Anytime Fitness locations to an independent fitness center upon the expiration of the franchise agreement for that location, while continuing to operate the other three Anytime Fitness locations.
Conversely, in Domino’s Pizza Franchising, LLC et al v. Yeager, 2010 WL 374116, Bus. Franchise Guide (CCH) ¶14,312 (E.D.Mich.,2010), the U.S. District Court for the Eastern District of Michigan recently granted a preliminary injunction enjoining a former Domino’s Pizza franchisee from operating a pizza business within ten miles of the former franchise location for one year, pursuant to the terms of the non-compete clause in the franchise agreement.
It bears noting that the Yeager franchisee was neither represented by counsel, nor responded to Domino’s application for a temporary restraining order, nor appeared for the preliminary injunction hearing. The only action taken by the Yeager franchisee to oppose the motion for a preliminary injunction was to submit a two-page affidavit. Accordingly, under these circumstances, that the court ruled in Domino’s favor should not have come as a surprise.
Franchisors undoubtedly will argue that the precedential impact of Atlanta Bread and Anytime Fitness is limited by (i) the fact that Atlanta Bread is a Georgia state case, and (ii) the unique factual circumstances presented in Anytime Fitness. In the bigger picture, however, these cases demonstrate that judicial enforcement of non-compete covenants is hardly a sure bet. Moreover, the real lesson of these three cases is precisely what we have been telling franchisee clients for years:
1. If you plan to test the enforceability of a non-competition covenant, you must first do your homework, which means you must:
a. Determine whether there is an actual protectable interest of the franchisor at stake. If, for example, the franchisor has no other locations within a 50-mile radius surrounding the franchisee’s store, the franchisor would be hard pressed to demonstrate that it is a protectable interest in preventing the franchisee from continuing a similar business in the same location after fully de-identifying from the franchisor’s system. This is precisely what drove the Anytime Fitnessdecision; the Anytime Fitness location nearest the alleged infringing location was owned by the defendant franchisee itself, and thus the defendant would primarily be competing with his own business.
b. If there is an actual protectable interest of the franchisor at stake, determine whether its non-competition covenant is narrowly tailored to protect precisely that protectable interest. As evidenced by the Atlanta Bread decision, a broadly crafted non-compete agreement that contains shifting or expanding territorial restrictions, or imposes a greater limitation on a franchisee than is necessary for the protection of the franchisor, may well be unenforceable.
c. Carefully consult applicable state statutes and case law, both
for the state whose law is specified in the franchise agreement, as well as the state in which your franchise is located. Although Georgia is a difficult state in which to enforce a non-competition agreement, it is far from the only state that disfavors such restrictions.
2. Be prepared to refrain from the use of the franchisor trademark, trade dress and other proprietary assets.
3. Be fully prepared to engage in a battle with the franchisor. The franchisee in Yeager clearly did not anticipate that Domino’s would seek to enforce its non-competition covenant, and the franchisee paid the price.