Learn more about the Labor and Employment Group at Schiff Hardin. Attorneys In This Practice Eric L. Barnum Howard R. Barron Wendi J. Berkowitz Max G. Brittain Jr. Lisa Carey-Davis William J. Carroll Ashley G. Eddy Nicole Finitzo Larry B. Garrett Stephen M. Hankins Victoria Hartanto Valarie Hays Charlene Q. Kalebic Paula M. Ketcham Matthew D. Lahey Neil Lloyd Catherine M. Masters Ralph A. Morris Marc L. Silverman Henry W. Sledz Jr. Patricia Costello Slovak Drahcir M. Smith Julie Furer Stahr Kathleen A. Stimeling Catherine H. Thompson Richard L. Verkler Nora Kersten Walsh Tamera M. Woodard Schiff Hardin Offices One Atlantic Center, Suite 2300 1201 West Peachtree Atlanta, GA 30309 225 Franklin Street, Suite 2600  Boston, MA 02110  233 S Wacker Drive Suite 6600 Chicago, IL 60606 One Westminster Place Suite 200 Lake Forest, IL 60045 900 Third Avenue New York, NY 10022 One Market, Spear Tower 32nd Floor San Francisco, CA 94105 1666 K Street, NW Suite 300 Washington, DC 20006 - - - - - - - - - Join our mailing list. Forward this alert to a friend or colleague.

Schiff Hardin Labor and Employment Alert

Georgia Supreme Court Extends Strict Scrutiny To
"In-Term" Loyalty Covenants In Franchise Agreements

By Tamera M. Woodard

In Georgia, contracts in restraint of trade are void as against public policy. Restrictive (or non-competition) covenants are considered to be partial restraints of trade. While non-competition covenants are not void, Georgia courts have repeatedly held that those contracts are subject to the strict scrutiny standard of review, and must be reasonable as to time, territory and scope to be enforceable. The cases analyzing restrictive covenants reflect an intent by the courts to encourage competition, prevent monopolies, and ensure that the public has access to the broadest range of services, skills and products. Recently, in Atlanta Bread Company International, Inc. v. Lupton-Smith, S08G1815 (June 29, 2009), the Georgia Supreme Court extended strict scrutiny review to a new category of covenants: in-term loyalty covenants contained in franchise agreements.

In Atlanta Bread, the franchisee signed a franchise agreement that prohibited the franchisee from competing with the franchisor during the term of the agreement. Specifically, the agreement contained a "loyalty provision," which prohibited the franchisee from "directly or indirectly engag[ing] in or acquir[ing] a financial or beneficial interest in...advis[ing], help[ing] or mak[ing] loans to any bakery/deli business whose method of operation is similar to that employed by store units" within the franchise system.

After the franchisee opened a coffee lounge in Atlanta, Georgia, the franchisor attempted to terminate the franchise agreement, based on the loyalty provision. The franchisor argued that the loyalty provision was not a restrictive covenant and, therefore, not subject to strict scrutiny. The Supreme Court disagreed. First, the court rejected the franchisor's argument that the nomenclature assigned to the provision was controlling. Instead, the court reiterated its commitment to looking at the effect of the restraint. Second, the court rejected the franchisor's argument that a lesser level of scrutiny should be employed because the loyalty provision was operative only during the term of the franchise agreement. The court declined to make a distinction as to the level of scrutiny to be applied to a non-competition clause based on its status as being active during the term of the agreement.

Ultimately, the court rendered the loyalty provision unenforceable because it lacked a territorial limitation. Extending longstanding Georgia jurisprudence even further, the court declined to "blue-pencil" the loyalty provision and insert a territorial limitation to render it enforceable.

This decision not only makes it more difficult for franchisors to enforce loyalty covenants, but also, given the court's unwillingness to "blue-pencil" the loyalty provision, raises the risk that an in-term loyalty provision could invalidate an otherwise enforceable covenant contained in the same agreement.

Although the loyalty provision at issue was contained in a franchise agreement, it is likely the court's decision will extend to loyalty provisions contained in other documents including, but not limited to, employment agreements, employee handbooks, conflict-of-interest policies, severance agreements or non-solicitation agreements. Employers should review the loyalty provisions contained in these policies to ensure that any restrictions are appropriately limited in scope. While there is no bright-line rule to determine whether such provisions are enforceable, Georgia courts have found territorial restrictions of up to 100 miles and temporal restrictions of two years or less to be reasonable, provided that the other restrictions are not overarching.

Schiff Hardin's Labor and Employment Practice Group has particular expertise in advising our clients on non-compete agreements, restrictive covenants and their application in various jurisdictions across the country. If you have questions about loyalty provisions contained in any of your documents, please contact any attorney in Schiff Hardin's Labor and Employment Group.

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