The Franchise Memorandum

In Atlanta Bread Company Int’l, Inc. v. Lupton-Smith, 2009 WL1834215 (Ga. June 29, 2009), the Georgia Supreme Court held that in-term and post-term covenants against competition in franchise agreements are subject to a strict scrutiny standard of review, rendering them more difficult to enforce in Georgia. In this case, the franchise agreements between Atlanta Bread Company International, Inc. (“ABCI”) and the franchisee prohibited the franchisee from owning or engaging in any “bakery/deli business whose method of operation is similar to that employed by store units within the System.” The post-term covenant prohibited the franchisee from engaging in a competing business within 20 miles of any Atlanta Bread Company store for one year. During the term of the franchise agreements, the franchisee opened a PJ’s Coffee & Lounge in the same city as four of his ABCI franchises. Soon after, ABCI terminated the franchise agreements, alleging that the operation of PJ’s Coffee & Lounge was a breach of the in-term non-compete covenant.

The Georgia Supreme Court affirmed the court of appeals’ ruling that the in-term covenant was not enforceable because it was not limited to a specific territory.  The high court disagreed with ABCI’s argument that the covenant was a loyalty covenant rather than a covenant against competition, stating that “[a] plain reading of the clause shows that it prohibits 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.” The court held that restrictive covenants in franchise or distributorship agreements are subject to the same level of strict scrutiny applied to restrictive non-competition covenants found in employment agreements. This level of strict scrutiny is to be applied to restrictive covenants in franchise agreements, the court held, regardless of when they are in effect. The court further held that because in-term covenants against competition are subject to strict scrutiny, they cannot be blue-penciled under Georgia law, meaning that the court could not insert a territorial restriction to render the covenant enforceable.

In light of this case, franchisors who have franchises governed by Georgia law will need to make sure they carefully set a territory covered by any non-competition covenants.