Noncompete News: Georgia Courts Apply Strict Scrutiny to Restrictive Covenants in Franchise Agreements

A recent Georgia Court of Appeals decision reminds Georgia employers of the intricacies and bright line rules that make up Georgia's body of law on restrictive covenants. Unbeknownst to many, Georgia courts apply different levels of "scrutiny" to restrictive covenant agreements. As this article discusses, the highest level of scrutiny is applied not only to covenants incident to an employment relationship, but also to those that are found within franchise agreements. The Court's analysis also highlights some of the oft-overlooked points of Georgia law upon which a restrictive covenant in a franchise or employment agreement may rise or fall.

In a case recently decided by the Georgia Court of Appeals, Atlanta Bread Company International, Inc. v. Lupton-Smith, a franchisor terminated a franchisee's contract because the franchisee engaged in a competitive business that he allegedly based on the franchisor's business model. The dispute entered litigation, and the trial court was called to rule upon the scope and enforceability of the restrictive covenants found in the franchise agreement.

The trial court concluded that the restrictions contained in the franchise agreements were invalid as a matter of law, and the franchisor appealed that decision.

First, the franchisor argued that "strict scrutiny" should not be applied to the case, as the parties were sophisticated and the agreement was part of a complex franchise agreement. Instead, the franchisor argued that a lower level of scrutiny should apply, as it does in the context of the sale of a business. In the sale of business context, Georgia courts rely on less stringent standards to enforce covenants, and will "blue pencil" the covenants, meaning that if there is particular language making a covenant unenforceable, the court will cross out or sever the offending language, and enforce the acceptable portion of the covenant. The court rejected this argument, reminding the parties that all restrictive covenants contained within a franchise agreement are subject to strict scrutiny, meaning that the courts will analyze such covenants using the same standard as they would if they were contained in an individual's employment agreement.

Two restrictive covenants were at issue in the case. The first prevented the franchisee from entering into any business whose method of operation is similar to that employed by the franchisor during the term of the franchise agreement. The second covenant contained the same restriction, but applied it to a one year period following termination of the franchise agreement, and it was limited to the geographic area within a "twenty mile radius of any store unit" of the franchisor.

The Court of Appeals determined that the first covenant was unenforceable for two reasons: first, it was impermissibly vague and overbroad, and second, it lacked a geographic limitation, which rendered it unenforceable as a matter of law. Although the first covenant only prohibited entering into a competing business during the term of the franchise agreement, such a restraint is in partial restraint of trade, and, as Georgia courts have consistently held, a restrictive covenant against competition within a franchise agreement must be strictly limited in duration and territory. The Court held that the covenant was unenforceable as it did not specify with particularity the business activities in which the franchisee was forbidden to engage, and for the additional reason that it had no geographic limitation.

The Court held that the post-termination covenant (the covenant restricting post-franchise competition) was unenforceable as well. First, Georgia does not allow the blue-pencil doctrine of severability. Unlike a non-competition agreement entered into in connection with the sale of a business, one entered into in connection with a franchise contract cannot be "blue-penciled" by the courts to enforce valid terms if some terms of the covenant are invalid. Therefore, if one provision of a covenant not to compete is found to be unenforceable, the entire non-compete covenant will be struck down. Accordingly, because the pre-termination covenant was unenforceable, the post-termination covenant was automatically unenforceable as well.

Second, the Court held that the post termination covenant was unenforceable for the additional reason that it contained "shifting and expanding" territorial restrictions. Under Georgia law, a territorial restriction which cannot be determined until the date of the franchisee's termination is too indefinite to be enforced, as the franchisee must be able to forecast with certainty the territorial extent of the restriction. As in the employment context, 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 restricted the franchisee from competing in the geographic area "located within a twenty (20) mile radius of any store unit…" This language allowed the 20-mile radius to shift and/or expand during the course of the agreement as new stores are potentially added by the franchisor.

This case serves as a reminder to employers and franchisors alike of the complexity of Georgia law with regard to restrictive covenants. There are four important lessons to be learned from this case:

(1) Georgia courts will not "sever" an unenforceable covenant from an agreement while enforcing otherwise valid language. Additionally, non-competition and non-solicitation of customers clauses within the same agreement rise and fall together. In other words, if any of the non-compete or non-solicitation of customers language in an agreement does not meet the strict standards for enforceability under Georgia law, all other non-competition and non-solicitation of customers language within the agreement fails as a matter of law, no matter how well drafted it might be.

(2) Covenants entered into pursuant to a franchise agreement are treated with the same strict scrutiny that courts apply to covenants incident to employment.

(3) Even a restrictive covenant that applies only to the period of time during which a franchise agreement is in effect must contain a reasonable territorial restriction in order to be enforced.

(4) In a non-competition covenant, employers and franchisors must specify a restricted territory that is ascertainable and concrete at the time the parties enter into the agreement. A territory that is defined based upon a variable, even if that variable has not changed at the time the covenant is sought to be enforced, will render the covenant unenforceable.

If you have any questions regarding this decision or other issues relating to the enforceability of restrictive covenants or noncompetition agreements, please contact the Ford & Harrison attorney with whom you usually work or the authors of this newsletter, Jeff Mokotoff,, 404-888-3804 or Joey Costyn,, 404-888-3811.