In Atlanta Bread Co. Int’l, Inc. v. Lupton-Smith, S08G1815, 2009 WL 1834215 (Ga. Jun. 29, 2009), the Georgia Supreme Court held that a non-compete provision that covers a franchisee during the term of a franchise agreement (an “in-term non-compete”) is subject to the same strict scrutiny as a non-compete provision that applies after the end of the relationship (a “post-term non-compete”). In so ruling, the Supreme Court held that franchise agreements are held to the same strict standards as employment agreements. More importantly, the Supreme Court has given franchisees the right to compete with their franchisors during the term of the franchise relationship unless their in-term non-competes are properly limited by geography and scope of activity. (This ruling is similar to a recent Ninth Circuit decision in Comedy Club, Inc. v. Improv West Associates. Please see our Management Alert for more information on that case.)

The question presented in Atlanta Bread Company was whether the in-term non-compete in a franchise agreement between Atlanta Bread Company (“ABC”) and a franchisee was enforceable under Georgia law. The covenant at issue stated that the franchisee could not engage in any bakery/deli business whose method of operation was similar to that employed by Atlanta Bread Company.

The Supreme Court held that the provision was unenforceable. It rejected ABC’s argument that the provision was not a non-compete provision, highlighting that the paragraph stopped 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.” Thus, ABC could not prevent its franchisee from competing against it during the term of their relationship.

What does this mean for your company?

If your company has basic in-term non-competes in its franchise agreements, then those provisions are now unenforceable in Georgia unless they meet the rigid standards for employee post-term non-competes. In addition, the unenforceable in-term non-compete will invalidate any other non-compete or customer non-solicitation provisions, including post-term covenants.

Georgia places a number of restrictions upon non-compete provisions. For instance, a post-term non-compete cannot restrict a franchisee from assisting a competitor “in any capacity.” The restriction must be limited to preventing the performance of tasks similar to those that the franchisee performed under the agreement. Additionally, the geographic area covered by a post-term non-compete must be determinable at the time that the agreement is signed. A provision such as “franchisee will not compete within 10 miles of any of the stores that franchisee operates” would be unenforceable because the number or location of the stores (and thus, the restricted territory) could change over the life of the agreement.

Georgia law forbids blue-penciling or modification of unenforceable covenants in the employment and franchise areas, so any flaw in a non-compete provision will be fatal. Georgia law also treats all non-compete and non-solicitation covenants in an agreement as being linked, so if any one provision is unenforceable, then all provisions in those categories will be unenforceable.

By applying the strict post-term non-compete standards to in-term non-competes, the Georgia Supreme Court has created a potential problem for franchisors. Take for example a hypothetical agreement with a franchisee. The agreement contains a general loyalty provision to the effect of “franchisee will not engage in a competing business during the term of the agreement.” The agreement also contains limited non-compete and non-solicitation of customers provisions that apply after the agreement terminates. Because of the existing case law regarding post-term non-competes, the in-term non-compete becomes unenforceable for a variety of reasons, such as the fact that it does not contain a geographic limitation and it is not limited to the tasks that the franchisee will perform under to the agreement. The non-compete and non-solicitation covenants are thus also unenforceable, regardless of how limited their scope may be.

Companies that have franchisees located in Georgia should examine their franchise agreements to determine whether the Atlanta Bread Company case has rendered their in-term and post-term non-competes invalid.