Many franchise agreements contain post-termination covenants not to compete, in which franchisees agree not to operate or have an interest in a business similar to the franchise within certain temporal and spatial limits after the franchise agreement expires or is terminated.
The United States does not have a federal law that governs the enforcement of such covenants; rather, enforcement is governed by state law.
Restrictive covenants are generally disfavored because they act as restraints on trade and may interfere with the franchisee's employment prospects. Some states have enacted statutes that govern restrictive covenants, while many others analyze the validity of restrictive covenants under the common law. In either situation, recent events indicate that states are increasingly willing to enforce covenants not to compete in franchise agreements.
For example, Georgia used to be one of the most difficult states in which to enforce a restrictive covenant. But in November 2010, Georgians voted to amend the state constitution to allow for the enforcement of covenants not to compete. Now, post-termination covenants that last for two years or less will enjoy a presumption of reasonableness. See Ga. Code Ann. § 13-8-50, et seq. In addition, a Colorado appellate court recently decided that a covenant not to compete contained in a franchise agreement fell within a sale of business exception to a statutory prohibition on covenants that restrict the right of a person to work. Keller Corp. v. Kelley, 187 P.3d 1133, 1139 (Colo. Ct. App. 2008).
While the law of each state differs, most states that analyze restrictive covenants under the common law require that the covenant be necessary to protect a legitimate business interest or not be offensive to public policy, and be reasonable in geographic and temporal scope. When a franchise agreement contains a covenant not to compete, many state courts liken it to a covenant contained in either a contract for the sale of a business or an employment agreement. Traditionally, covenants not to compete in employment agreements are analyzed with stricter scrutiny than covenants in agreements for the sale of a business.
Recently, more state courts have decided to analyze covenants contained in franchise agreements as covenants in the sale of a business. This means the state courts use less scrutiny when determining whether the covenant is enforceable. For example, in Boulanger v. Dunkin' Donuts, Inc., 815 N.E.2d 572, 577 (Mass. 2004), the court decided that the restrictive covenant contained in the franchise agreement was akin to a restrictive covenant in a sale of business contract because the franchisee was not an employee of the franchisor, and received confidential information and the right to use the franchisor's trademark. Similarly, a New Jersey court in Athlete's Foot Mktg. Assocs., LLC v. FL Consulting Inc., No. 06-3035 (SRC), 2007 U.S. Dist. LEXIS 32995, at *5-6 (D.N.J. May 2, 2007) also decided to analyze a restrictive covenant in a franchise agreements like a covenant in a contract for the sale of a business. As more states move in this direction, courts will analyze restrictive covenants in franchise agreements less strictly, and it will be easier for franchisors to enforce the covenants contained in their agreements.
Carl E. Zwisler, IDI franchising Country Expert for U.S.A. and Maisa Jean Frank, Gray Plant Mooty.