Hunton Employment & Labor Perspectives

Franchisors with operations in the State of Georgia are confronting a new challenge in their effort to enforce non-competition rights against franchisees.  In Atlanta Bread Co. v. Lupton-Smith (6/29/09), the Supreme Court of Georgia held that an “in-term” non-competition clause within a franchise agreement is held to the same strict scrutiny standard applicable to post-term and employment contract non-competition clauses.

Historically, while there was no explicit precedent on the matter, Georgia franchisors have acted under the assumption that in-term restraints would enjoy a more relaxed standard given the fiduciary and good-will dynamics at issue in an active franchise relationship.  Indeed, many Georgia franchisors have crafted in-term non-compete clauses that rely upon a more relaxed standard.  In Georgia, where the requirements for non-compete enforcement are more rigorous than those in most states, and blue-pencil revising currently is not authorized, many franchisors are left with likely unenforceable in-term non-compete provisions in current operating agreements.

One of the troubling aspects of the decision is the Court’s failure to distinguish between a garden-variety employment relationship and an ongoing franchise relationship.  The latter is undertaken by a business owner who is bargaining for the right to borrow the valuable assets -- good will, marks, products, processes, and the like -- of the franchisor, in furtherance of his own private enterprise.  Most business owners and lawmakers would agree that the franchisee is not in need of (or entitled to) the same level of protection against unfair restraint of trade as is the average citizen employee.  It is this right to bargain for enhanced restrictions that encourages franchisors to offer more franchise opportunities, which stimulates enhanced economic activity.

The legislature in Georgia has taken steps to bring enforceability to non-competition agreements.  In its Spring 2009 session, the Georgia General Assembly passed House Bill 173, which would dramatically change Georgia’s traditional hostility to covenants not to compete or solicit customers in favor of more consistent enforcement of such agreements.  However, because Georgia’s Constitution prohibits contracts “in restraint of trade,” the statute will not become effective unless the Constitution is amended in the general election in November 2010.

In the meantime, franchisors with operations in Georgia should consider revisiting any in-term non-competition clauses contained in their operating agreements, and revising them to bring them into compliance with the strict scrutiny standard applied in Georgia.