Georgia Law Regarding Non-competes Is Revised

Most franchisors have non-compete, non-solicitation, and non-disclosure provisions in their franchise agreements. These restrictive covenants protect both the franchisor and the other franchisees in the system against the franchisee who uses trade secrets and confidential information, either during the term of the franchise agreement or after the termination of the franchise agreement, to its unfair advantage in competing with the franchisor and its other franchisees. In some industries, the problem includes the diversion of clients or employees.

Restrictive covenants may also be found in other agreements, such as employment, sale-of-business, distribution, dealership, lease, license, broker, and representative/agent agreements.

Enforceability of restrictive covenants has always been an “iffy” proposition in Georgia. The question was governed by case law only. Among other issues, an error in drafting could void the entire restrictive covenant, including non-compete, non-solicitation, and non-disclosure covenants, because the courts did not have authority to “blue pencil” (i.e., edit the restrictive covenant to make it enforceable), as is the case in many other states. Thus, attempted enforcement often led to no protection at all. (See Atlanta Bread Company International, Inc. v. Lupton-Smith et al., 285 Ga. 587 (2009), throwing out in-term restrictive covenants.)

During the election held on Nov. 2, 2010, Georgia's electorate voted to amend the state constitution of Georgia in a way that made effective on the next day legislation relating to non-competition covenants, namely HB 173 (the “Act”). The Act had passed in the 2009 legislative session and had been signed by the governor that year. As described in more detail below, subsequent discussion about a wording issue in the amendment and the Act would suggest that the effective date may actually be Jan. 1, 2011, or maybe later if it is determined that a legislative fix of the effective date wording is required.

HB 173

In any event, restrictive covenants must still be reasonable, but the Act, when it becomes effective, will permit courts to blue-pencil restrictive covenants and provide certain safe harbors in covenant drafting. The heart of the Act is found in Sections 1, 3, 4, and 5; note that Section 2 is the repeal of an older piece of legislation and, except for technical review, may be skipped. The full text of the Act can be found at: www.legis.ga.gov/legis/2009_10/fulltext/hb173.htm.

Some of the salient provisions, in general terms, are as follows:

• In-term covenants are subject to easier standards for the franchisor to meet for enforcement.
• Post-term covenants in the franchise context (and certain other non-employment/non-sale-of-business contexts, including dealerships, distributorships, and leases, among others) up to three years in duration are presumed reasonable (technically, subject to a “rebuttable” presumption ' meaning a court can consider evidence that the covenant is “unreasonable”).
• Post-term covenants in the employment context up to two years in duration are presumed reasonable (technically, subject again to a “rebuttable” presumption).
• Post-term covenants in the sale-of-business context up to five years in duration (or the length of a purchase loan) are presumed reasonable (technically, subject again to a “rebuttable” presumption).
• Courts cannot refuse to enforce on the ground that the person seeking to enforce is a third-party beneficiary or assignee.
• Courts may consider an “economic hardship” defense made by employees (but not franchisees).

The Act applies only to agreements signed on or after its effective date, and there is now considerable discussion in Georgia's legal community and legislature as to what that effective date is. Most hold that the intent of the legislature was to make the Act effective on Nov. 3, 2010 ' the day after the constitutional amendment was passed by the voters. However, the amendment did not state when it would take effect. There is a growing consensus that the amendment will not become effective until Jan. 1, 2011, and that the Act is unconstitutional until the amendment takes effect. Some have expressed concern that, because of that gap, the Act is invalid and will require a fix by the legislature when the session begins in January. Opponents of the Act may argue that this defect cannot be resolved. As a result, lawyers have been advising clients to wait at least until Jan. 1, 2011 to make any changes to their restrictive covenants or, if it is determined that a legislative fix is needed, until the legislature passes the fix and it is signed by Georgia's governor. The expectation is that any needed fix will be passed and signed relatively quickly. However, legislative opponents are already considering how they can derail the Act entirely. A lively debate is expected during the legislative session that begins on Jan. 10, 2011. Regardless, there will likely be battles in the courts down the road over the general effectiveness of the legislation and its interpretation.

It is a matter of opinion as to the Act's ultimate effect, of course, but it was intended to improve the certainty of enforceability of reasonable in-term and post-term restrictive covenants.

Les Wharton is senior counsel at Epstein Becker & Green, P.C., in Atlanta. He can be contacted at 404-869-5347 or [email protected]. This article is not intended as legal advice. Franchisors should consult their attorneys as to whether to revise their franchise agreements as a result of the changes effected by the Act.

Most franchisors have non-compete, non-solicitation, and non-disclosure provisions in their franchise agreements. These restrictive covenants protect both the franchisor and the other franchisees in the system against the franchisee who uses trade secrets and confidential information, either during the term of the franchise agreement or after the termination of the franchise agreement, to its unfair advantage in competing with the franchisor and its other franchisees. In some industries, the problem includes the diversion of clients or employees.

Restrictive covenants may also be found in other agreements, such as employment, sale-of-business, distribution, dealership, lease, license, broker, and representative/agent agreements.

Enforceability of restrictive covenants has always been an “iffy” proposition in Georgia. The question was governed by case law only. Among other issues, an error in drafting could void the entire restrictive covenant, including non-compete, non-solicitation, and non-disclosure covenants, because the courts did not have authority to “blue pencil” (i.e., edit the restrictive covenant to make it enforceable), as is the case in many other states. Thus, attempted enforcement often led to no protection at all. (See Atlanta Bread Company International, Inc. v. Lupton-Smith et al., 285 Ga. 587 (2009), throwing out in-term restrictive covenants.)

During the election held on Nov. 2, 2010, Georgia's electorate voted to amend the state constitution of Georgia in a way that made effective on the next day legislation relating to non-competition covenants, namely HB 173 (the “Act”). The Act had passed in the 2009 legislative session and had been signed by the governor that year. As described in more detail below, subsequent discussion about a wording issue in the amendment and the Act would suggest that the effective date may actually be Jan. 1, 2011, or maybe later if it is determined that a legislative fix of the effective date wording is required.

HB 173

In any event, restrictive covenants must still be reasonable, but the Act, when it becomes effective, will permit courts to blue-pencil restrictive covenants and provide certain safe harbors in covenant drafting. The heart of the Act is found in Sections 1, 3, 4, and 5; note that Section 2 is the repeal of an older piece of legislation and, except for technical review, may be skipped. The full text of the Act can be found at: www.legis.ga.gov/legis/2009_10/fulltext/hb173.htm.

Some of the salient provisions, in general terms, are as follows:

• In-term covenants are subject to easier standards for the franchisor to meet for enforcement.
• Post-term covenants in the franchise context (and certain other non-employment/non-sale-of-business contexts, including dealerships, distributorships, and leases, among others) up to three years in duration are presumed reasonable (technically, subject to a “rebuttable” presumption ' meaning a court can consider evidence that the covenant is “unreasonable”).
• Post-term covenants in the employment context up to two years in duration are presumed reasonable (technically, subject again to a “rebuttable” presumption).
• Post-term covenants in the sale-of-business context up to five years in duration (or the length of a purchase loan) are presumed reasonable (technically, subject again to a “rebuttable” presumption).
• Courts cannot refuse to enforce on the ground that the person seeking to enforce is a third-party beneficiary or assignee.
• Courts may consider an “economic hardship” defense made by employees (but not franchisees).

The Act applies only to agreements signed on or after its effective date, and there is now considerable discussion in Georgia's legal community and legislature as to what that effective date is. Most hold that the intent of the legislature was to make the Act effective on Nov. 3, 2010 ' the day after the constitutional amendment was passed by the voters. However, the amendment did not state when it would take effect. There is a growing consensus that the amendment will not become effective until Jan. 1, 2011, and that the Act is unconstitutional until the amendment takes effect. Some have expressed concern that, because of that gap, the Act is invalid and will require a fix by the legislature when the session begins in January. Opponents of the Act may argue that this defect cannot be resolved. As a result, lawyers have been advising clients to wait at least until Jan. 1, 2011 to make any changes to their restrictive covenants or, if it is determined that a legislative fix is needed, until the legislature passes the fix and it is signed by Georgia's governor. The expectation is that any needed fix will be passed and signed relatively quickly. However, legislative opponents are already considering how they can derail the Act entirely. A lively debate is expected during the legislative session that begins on Jan. 10, 2011. Regardless, there will likely be battles in the courts down the road over the general effectiveness of the legislation and its interpretation.

It is a matter of opinion as to the Act's ultimate effect, of course, but it was intended to improve the certainty of enforceability of reasonable in-term and post-term restrictive covenants.

Les Wharton is senior counsel at Epstein Becker & Green, P.C., in Atlanta. He can be contacted at 404-869-5347 or [email protected]. This article is not intended as legal advice. Franchisors should consult their attorneys as to whether to revise their franchise agreements as a result of the changes effected by the Act.