Last summer the Georgia Supreme Court in Atlanta Bread Co. v. Lupton-Smith held that covenants not to work for a competitor or perform competitive acts during the course of employment were subject to strict scrutiny. In Georgia, application of a strict scrutiny review makes it considerably more difficult for an in-term covenant to be enforced by a Georgia court.
The Court stated : “Appellant contends that the clause at issue is a “loyalty provision” and not a restrictive covenant such that it is not subject to being scrutinized for its reasonableness as to time, territory and scope. We disagree. A plain reading of the clause shows that it prohibits the franchisee from engaging in a certain type of business during the term of the parties’ agreement and, thus, it is a partial restraint of trade designed to lessen competition.
Such restraints, no matter the nomenclature assigned to them, are disfavored in this state as a matter of public policy…. When such restraints are found in franchise or distributorship agreements, our jurisprudence has held time and again that these restraints are subject to strict scrutiny, receiving the same treatment as non-competition covenants found in employment contracts… “A non-competition covenant entered into in connection with a franchise or employment contract is enforceable, but only where it is strictly limited in time and territorial effect and is otherwise reasonable considering the business interest of [the party] sought to be protected and the effect on the franchisee.” [internal citation omitted]. 285 Ga. 587 (2009)
According to data supplied by FranchiseOpportunities.com and FranchiseSolutions.com Georgia ranks as the 5th most popular state for prospective franchisees. Consequently, given the importance of Georgia to the franchising world this case is particularly important for the entire franchise community and the reason why the IFA filed an amicus briefs in the case. This ruling is perhaps of even greater importance and scope to the franchise community than it might appear on its face because it would also apply to the in-term non-compete agreements that many franchisees have in place with their employees. Unless in-term provision contain precise limitations on geography and scope of activity they will be invalidated. And, since Georgia courts “blue-pencil” employment agreements, the presence of an unenforceable in-term covenant in any employment agreement in any business will invalidate any other non-compete or non-solicitation covenant contained in the agreement.
Thus the franchisee must also be cognizant of any limitations it attempts to place on its employees in its employee agreements. So what might appear at first glance to be a slam-dunk ruling in favor of the franchisees might at some later date be used franchisees by their own employees.
I handled this case for the successful franchisee. One problem that Atlanta Bread had in this case was that the word “loyalty” did not appear anywhere in the contract, much less in the purported “loyalty” clause. A bigger problem, is that “loyalty”, without objective criteria as to what is prevented or required, is vague and ambiguous, and thus void and unenforceable.
Contrary to what many pro-franchisor groups say, this case does not invalidate in-term restrictive covenants in general. All that is required, is that the restriction, whether in-term or post-term, have a reasonable time, territory and scope of restricted activity. The easiest way for an employer to protect itself during the term of employment is to require the full-time and best efforts of the employee. However, if you are willing to allow your employees or franchisees to work part-time in some jobs but not others, then you need to clearly define what is restricted, and where it is restricted. If you want to require “loyalty”, then you need to define loyalty, and specify exactly what is required and restricted to eliminate the guesswork.
Randy Edwards
15 Mar 10 at 5:42 pm