A bankruptcy discharge is a way for the honest but unfortunate individual to wipe the slate clean and get a fresh start. (With a slightly diminished credit rating, of course.) The question is: How clean can the slate be wiped and how fresh of a start does a debtor get? There are always issues about which debts can be discharged (generally, credit cards) and which debts can’t be discharged (generally, student loans). However, an even more interesting issue is: Can a bankruptcy discharge wipe away an otherwise valid and enforceable non-compete clause in a franchise agreement?
Simple answer, no. According to a recent case decided by the Bankruptcy Court in the Northern District of California, two federal appellate courts have addressed this issue and both have held that “the non-competition agreement, to the extent enforceable under state law, is enforceable notwithstanding the bankruptcy discharge.” (Quattrin v. Total Car Franchising Corp. (In re Quattrin), 2011 WL 2112415 (Bankr. N.D. Cal. 2011).)
The logic behind the decision was explained in Kennedy v. Medicap Pharmacies, Inc., 267 F.3d 493 (6th Cir. 2001). The general rule is that, except for certain specific debts, a bankruptcy discharge discharges all “debts” that arose before the filing of the bankruptcy petition. Under the bankruptcy code, a “debt” is the liability on a “claim.” And a “claim” is either [1] a right to payment or [2] the right to an equitable remedy for breach of performance if such breach gives rise to a right to payment. So a bankruptcy discharge wipes the debtor’s slate clean of all “claims.”
According to the courts, the remedy for a breach of a non-compete clause is generally money damages and an injunction which prevents the competition. The money damages count as a claim and would be discharged. But the injunction generally does not give rise to a right to payment, so it would not be a claim and, therefore, would not be discharged in bankruptcy.
Obviously, each situation is different, and there are bankruptcy courts that have found that non-compete clauses can be discharged in bankruptcy. But there is case law to support the position that non-compete clauses survive a bankruptcy discharge.
