Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—BankrEDTex: Non-Compete Covenant in Franchise Agreement Invalidated by Long-Since-Repealed Michigan Law, (Jan 15, 2013)

By E. Darius Sturmer, J.D.

A franchisor of one-stop marketing, print, mail, and signage businesses, Allegra Network, LLC, was not entitled to enforce a non-compete agreement signed by a bankrupt former franchisee, the federal bankruptcy court in Texarkana, Texas, has ruled (In re: Ruth, January 10, 2013, Parker, B.). The non-compete covenant in the franchise agreement was void from its inception under applicable Michigan law, the court said.

The company’s request for declaratory relief, and all related requests, were denied. However, a cause of action for a determination of the dischargeability of its claim against the former franchisee and his wife in bankruptcy court was severed into a new adversary proceeding and put aside pending the outcome of the bankrupt individuals’ Chapter 13 case.

The former franchisee and his wife operated an Insty-Print commercial printing shop in Texarkana, Texas. They became affiliated with Allegra Network when their original franchisor, Minnesota-based Insty-Prints, Inc., assigned all of its rights under the October 1984 franchise agreement and any addenda thereto to Allegra Network as part of a larger transfer of assets.

Eventually, due to the subsequent failure of the franchisee and his wife to pay past-due royalty amounts required under a 2006 renewal addendum to their franchise agreement, Allegra Network terminated the franchise relationship in November 2008.

Early in 2010, Allegra Network filed a suit alleging breach both of the franchise agreement and of the non-compete agreement that became operative after the 2008 franchise termination. That suit was stayed by the two individuals’ August 2010 filing of a voluntary petition for relief under Chapter 13 of the Bankruptcy Code.

The court noted that the controversy regarding the covenant arose solely because of the choice-of-law provision that was inserted at Allegra Network’s insistence into the 2006 renewal addendum. Without that provision, there would have been no non-bankruptcy barrier to the enforcement of the covenant because both Texas and Minnesota generally allowed the enforcement of reasonable covenants not-to-compete in 1984.

The State of Michigan, however, considered covenants not-to-compete absolutely void as a matter of public policy until 1985, when the statute banning them, §445.761, was repealed. A subsequent Michigan law allowing such covenants explicitly limited its application to those agreements entered into after March 29, 1985, the court reasoned.

Michigan law as it stood in 1984 governed the case, the court decided, because an examination of the character of the subsequent addenda to the 1984 franchise agreement revealed that the addenda constituted but revised extensions of one continuous agreement beginning in 1984 and ending with the 2008 franchise termination.

Although Michigan’s Franchise Investment Law offered no default rule, or even guidance, on whether the renewal addenda at issue amounted to an extension (a continuous contract) or a renewal (a new, distinct agreement), “language utilized in both the 1995 and 2006 renewal addenda specifically indicate[d] that an extension of the 1984 franchise agreement was, in fact, what the parties elected to do.”

Whereas the franchise agreement did contain language contemplating the promulgation of a new franchise agreement at the end of each term, that provision did not preclude the extension of the original agreement into a succeeding term of years. The formats of the 1995 and 2006 renewal addenda—each of which (1) stated that the pact was executed to “amend and revise” provisions of the 1984 franchise agreement, and (2) included an extension of the initial term and certain other additions—clearly indicated that the parties were pursuing extensions rather than new agreements.

Allegra Network neglected to raise any argument that Michigan authorized the recognition and enforcement of non-compete covenants at the time the 2006 renewal addendum—with the newly-added choice-of-law provision—took effect, the court noted.

Even if the covenant had been valid, the right of Allegra Network to enforce it constituted a “claim” against the former franchisee for purposes of bankruptcy law that was subject to discharge in bankruptcy, the court held. The claim would have fit within the scope of any discharge ultimately entered in favor of the franchisee and his wife in their bankruptcy proceeding because of the availability of monetary damages as an appropriate remedy for beach of a covenant not to compete under Michigan law, in the court’s view.

The case is No. 10-50184.

Attorneys: David Ruff II (Law Office of David Ruff) for Michael G. Ruth.

Companies: Allegra Network, LLC.

Cases: FranchisingDistribution TexasNews