Post-Termination Covenants Not To Compete

Franchise and dealership agreements often contain clauses that
prohibit competition with the franchisor or supplier after the contract
ends. These covenants usually provide that the franchisee will not
compete with the franchisor, or with other franchised outlets, for some
period following expiration or termination of the franchise agreement.
Sometimes there are similar covenants providing that principal
employees may not work for competitors. The enforceability of such
covenants varies substantially state by state and even case by case.
A. Protection of Goodwill Versus Free Competition
Because post-termination covenants not to compete impose
restrictions after the conclusion of a relationship, they pose more
problematic questions for courts than in-term covenants. Franchisors and
suppliers assert that post-termination covenants protect their interest in
the goodwill built up at a particular location or in a particular
community. The franchisee or dealer, however, may contend that he will
have no means of livelihood if the covenant is enforced. This argument
may be compelling where the business relationship was long term or if
the circumstances of the termination were inequitable. Moreover, the
franchisor’s or supplier’s interests in enforcement may not appear as
urgent or as tangible as in the case of in-term covenants.
Post-term covenants not to compete generally have been viewed as
restraints of trade. Most states permit their enforcement to the extent
they are “reasonable,”1 although a few states have enacted statutes
1. See, e.g., Certified Restoration Dry Cleaning Network v. Tenke Corp., 511
F.3d 535 (6th Cir. 2007); Curves Int’l v. Mosbarger, 525 F. Supp. 2d
1310, 1313 (M.D. Ala. 2007); O.V. Mktg. Assocs. v. Carter, 766 F. Supp.
960, 964 (D. Kan. 1991); Carvel Corp. v. Eisenberg, 692 F. Supp. 182,
185-86 (S.D.N.Y. 1988); Kutka v. Temporaries, Inc., 568 F. Supp. 1527
Franchise and Dealership Termination Handbook
prohibiting restrictive covenants of this type.2 Whether a covenant’s
restrictions are reasonable is usually a question of law.3
Historically, covenants not to compete outside of the franchise
context have fallen into two broad categories: (1) covenants in
employment contracts, under which the employee agrees not to compete
with his employer for a period of time following termination of
employment; and (2) covenants in contracts for the sale of a business
under which the seller agrees not to compete with the buyer.4 It is
generally recognized that the test of reasonableness for a covenant not to
compete within an employment contract is stricter than that for
enforcement in the context of contracts for the sale of a business.5 Such a
distinction is also important because in some jurisdictions the availability
of “blue penciling,” as discussed in detail below, depends on whether the
covenant is contained in an agreement that is more similar to an
employment contract, or to a sale of a business.6
A covenant incident to a franchise agreement has elements of both an
employment contract and a sale of a business; for that reason, courts
initially struggled to determine which category is appropriate for a
franchise relationship. In an early case, McDonald’s System v. Sandy’s,7
the Illinois Court of Appeals recognized that the franchisor had a
legitimate interest in the franchise itself that justified enforcement of the
covenant.8 However, the Fifth Circuit, in Budget Rent-A-Car Corp. v.
Fein,9 reviewed the law in both areas and, applying the sale-of-business
(S.D. Tex. 1983); Allen v. Hub Cap Heaven, 484 S.E.2d 259, 264 (Ga. Ct.
App. 1997).
2. See, e.g., ALA. CODE § 8-1-1 (2008); CAL. BUS. & PROF. CODE § 16600
(2008); COLO. REV. STAT. ANN. § 8-2-113 (2007); IND. CODE ANN. § 24-
1-1-1 (2008); MONT. CODE ANN. § 28-2-703 (2007); OKLA. STAT. ANN.
tit. 15, § 217 (2008).
3. See, e.g., Product Action Int’l v. Mero, 277 F. Supp. 2d 919, 925 (S.D.
Ind. 2003); Licocci v. Cardinal Assocs., 445 N.E.2d 556, 561 (Ind. 1983).
4. See Budget Rent-A-Car Corp. v. Fein, 342 F.2d 509, 515 (5th Cir. 1965).
5. Id.; see also, e.g., Keller Corp. v. Kelley, 187 P.3d 1133, 1138-39 (Colo.
Ct. App. 2008).
6. See, e.g., Gandolfo’s Deli Boys, LLC v. Holman, 490 F. Supp. 2d 1353,
1357 (N.D. Ga. 2007) (“Georgia law ‘considers franchise agreements to be
analogous to employment contracts, and covenants in such agreements
receive strict scrutiny and are not blue-penciled.’”) (citation omitted).
7. 195 N.E.2d 22 (Ill. App. Ct. 1963).
8. Id. at 27-28.
9. 342 F.2d 509 (5th Cir. 1965).

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