The Franchise Memorandum

A federal bankruptcy court in Illinois has held that a franchisor’s rights under a franchise agreement’s covenant not to compete was a “claim” within the meaning of the Bankruptcy Code and would thus not be enforced via injunctive relief. In re Roberts, 2019 WL 5079247 (Bankr. N.D. Ill. Oct. 10, 2019). Aire Serv, the franchisor of an HVAC-repair system, and JSR Heating and Cooling were parties to a franchise agreement. After the relationship deteriorated, Aire Serv terminated the franchise agreement and JSR declared bankruptcy. Aire Serv commenced an adversary proceeding and moved for a preliminary injunction to prohibit JSR from operating the formerly franchised business in violation of a covenant not to compete. JSR conceded that the franchise agreement’s covenant not to compete was valid and enforceable under applicable nonbankruptcy law, and that its conduct likely violated the provision. However, JSR argued that Aire Serv’s request for injunctive relief constituted a “claim” within the meaning of the Bankruptcy Code and that Aire Serv could not enforce the covenant through injunctive relief in an adversary proceeding. Instead, Aire Serv must raise such claim by filing a proof of claim for money damages in the underlying bankruptcy case.

Under applicable bankruptcy law, the right to an equitable remedy to enforce a covenant not to compete constitutes a “claim” under the Bankruptcy Code when the obligation to perform under such covenant can be satisfied by the payment of money damages in lieu of injunctive relief or when any such right to damages exists purely as an alternative remedy to, and is not cumulative with, any such right to equitable relief. Applying that standard, the court observed that the covenant not to compete in Aire Serv’s franchise agreement expressly provided for liquidated damages as an alternative remedy to injunctive relief, and thus the court held that Aire Serv’s right to injunctive relief constituted a “claim” under the Bankruptcy Code.