GSB Vol. 10, No. 2 - #2. Considering the Consideration Approach to Classifying Georgia Contracts In Partial Restraint of Trade.

AuthorBy John K. Larkins Jr.

Georgia Bar Journal

Volume 10.

GSB Vol. 10, No. 2 - #2.

Considering the Consideration Approach to Classifying Georgia Contracts In Partial Restraint of Trade

Georgia State Bar JournalVol. 10, No. 2, October 2004"Considering the Consideration Approach to Classifying Georgia Contracts In Partial Restraint of Trade"By John K. Larkins Jr. In Rakestraw v. Lanier,1 decided in 1898, the Georgia Supreme Court complained about the law governing contracts made in restraint of trade:

We cannot, within reasonable limits, undertake to reconcile conflicting opinions in treating of contracts in restraint of trade, nor cite the authorities which bear upon the different constituent elements which render such contracts valid, or the want of which make them void, for the reason that the first are irreconcilable, and the latter inharmonious.2 If only they could see us now. Over a century later, Georgia law governing covenants in partial restraint of trade (including non-competition, non-disclosure, non-solicitation, and non-piracy covenants-collectively referred to herein as "Covenants")3 is an ever-changing labyrinth from which few agreements escape.4 Even a sophisticated commercial agreement, negotiated at arm's length by parties represented by counsel, may be deemed by a court to be "analogous" to an employment contract and thereby subjected to the strictest of scrutiny. But the stage has perhaps been set for a modest but important change. Two recent decisions of the Georgia Court of Appeals have discarded the traditional "type of contract" method of categorizing Covenants for review, relying instead on an analysis based on the relative bargaining power of the parties and the existence of consideration for the Covenant. This article suggests that the "consideration" prong of this new test should be jettisoned, and that "bargaining power" should be the sole criterion for determining which level of scrutiny a court uses to analyze a Covenant.


Under current Georgia law, the threshold task for a court considering the enforceability of a Covenant is to examine the nature of the agreement containing the Covenant. Based on the type of contract, the court then determines whether the Covenant receives strict, mid-level or low-level judicial scrutiny.5 Traditionally, Covenants ancillary to employment contracts receive strict scrutiny, those ancillary to professional partnership agreements receive mid-level scrutiny, and those ancillary to the sale of a business receive lower scrutiny.6 Significant distinctions exist among the levels of scrutiny that dramatically affect the survival of the Covenant at issue. Although Covenants of all types are theoretically evaluated under a "rule of reason,"7 a Covenant subject to strict review is subject to numerous sub-rules defining reasonableness, and the violation of any one of these sub-rules will toll the death knell for the Covenant (and possibly others associated with it). Perhaps most importantly, a Covenant receiving strict review cannot be "blue-penciled" and will fail for even the most minor transgression, whereas a Covenant receiving low-level review can be judicially modified to make it enforceable, if necessary.8 Although strict scrutiny is typically and nominally associated with employment contracts, as a practical matter it is the default category; if the contract is not a professional partnership agreement or a contract for the sale of a business, it will be deemed "analogous" to an employment contract and thus subject to strict scrutiny.9 Indeed, Richard P. Rita Personnel Services International, Inc. v. Kot10-the case in which the Georgia Supreme Court adopted the "no blue-pencil" rule on the basis of the "in terrorem effect on employees - and on competitors who fear legal complications if they employ a covenantor"-involved a franchise agreement, not an employment contract. Consequently, even commercial transactions between sophisticated parties bargaining at arm's length have been deemed to be analogous to employment contracts and have fallen prey to the strict scrutiny rules. For example, in Amstell, Inc. v. Bunge Corp., 11 a non-competition covenant contained within an agreement between two corporations regarding the distribution of a product was considered under strict scrutiny/no blue-pencil principles, because the covenant was "ancillary to an independent contractor manufacturing and distributorship, which is treated as an employment rather than a sales contract."12 In some cases, the court has even engaged in a two-step analogy to arrive at strict scrutiny, holding that an agreement was like a franchise agreement and therefore like an employment agreement.13


There are indications that the Georgia Court of Appeals is seeking a new paradigm. Decided in 2001, Swartz Investments, LLC v. Vion Pharmaceuticals, Inc.14 involved an agreement by Swartz to raise financing for Vion. Vion agreed to a "noncircumvention provision" prohibiting it for a period of five years from contacting or negotiating with named investors regarding an investment in Vion or another company without Swartz's permission. The covenant called for the payment of a commission to Swartz if investments were obtained in violation of the covenant.15 Finding that the provision was a covenant in partial restraint of trade, the Swartz court proceeded to determine the proper category of scrutiny. After identifying the traditional categories, the court made an extraordinary statement:

Of course, not every contract falls directly into one of these three categories. Nor do we believe that the type of contract should automatically determine the applicable level of scrutiny.16

Examining the purposes underlying the varying levels of scrutiny, the court then found that the analysis is governed by the "relative bargaining power of the parties" and "whether there is independent consideration for the restrictive covenant itself."17 The court ruled that the two corporations had equal bargaining power (the parties were sophisticated corporations and advised by counsel), but that there was "no consideration for the covenant at issue," and therefore applied strict scrutiny.18 Thus, the absence of independent consideration for the covenant was sufficient to trigger strict scrutiny, despite the parties' equal bargaining power.19 In 2003, the Court of...

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