Georgia Supreme Court Limits "In-Term" Restrictive Covenants

In Atlanta Bread Company International, Inc., v. Lupton-Smith, 285 Ga. 587 (Ga. 2009), the Georgia Supreme Court held that covenants restricting a franchisee’s business activities during the life of the franchise agreement (“in-term” restrictive covenants) are unenforceable if not reasonably limited in time, territorial region, and scope. An “in-term” restrictive covenant is one that limits the employee’s (or franchisee’s) ability to compete during the term of the employment/franchise relationship. The Court also stated that the presence of an invalid “in-term” restrictive covenant in a franchise agreement will have the effect of invalidating any post-term restrictive covenants and noncompetition clauses contained in the agreement.

The restrictive covenant at issue in the Atlanta Bread Co. case stated that during the term of the agreement, the Franchisee could not: “directly or indirectly engage in, or acquire any financial or beneficial interest in, … advise, help, guarantee loans or make loans to, any bakery/deli business whose method of operation is similar to that employed by store units… .” Seeing no meaningful legal distinction between in-term and post-term restrictive covenants, the Court applied the same level of “strict scrutiny” as it does for post-term covenants included within franchise and employment agreements. As such, the Court held that franchisors and employers must include reasonable parameters associated with scope, time and territory even if the restrictive covenant at issue limits unfair competition only during the term of the employment or franchise relationship.

The Court also rejected Atlanta Bread’s attempt to categorize the above clause as a “loyalty provision” rather than a restrictive covenant because, according to the Court, a plain reading of the clause prohibits the franchisee from pursuing business activities without the limitation as to time, territory, and scope. Georgia common law related to the employee’s fiduciary duty and/or duty of loyalty to his/her employer protects the employer from unfair, in-term competition without limit to scope, territory or time even absent a contract between the parties at issue. As such, many Georgia employers may have historically believed that in-term contractual covenants would also not be subject to such restrictions. However, in the wake of the Atlanta Bread decision, franchisors and employers alike should be aware that such “in-term” provisions will be declared invalid by Georgia Courts in the future. Furthermore, because Georgia Courts do not “blue pencil” or modify restrictive covenants if they are otherwise invalid, the presence of an “in-term” provision which is not properly limited in scope, time and territory will automatically forfeit other restrictive covenants such as “post-term” noncompete and customer non-solicitation covenants regardless of the fact that such covenants may otherwise be valid under Georgia law.