United States: Enforcing Non-Compete Provisions: A Recent Decision Raises the Risks Nationwide

A recent decision by the Eleventh Circuit Court of Appeals has significant implications for franchisors seeking to enforce their non-compete agreements. In April, that court held that a post-employment non-compete agreement declared invalid in Georgia is also invalid in all other states.

The case, Palmer & Cay, Inc. v. Marsh & McLennan Companies, Inc., involved an insurance sales executive seeking to nullify his non-compete agreement with his former employer. In 2003, the executive, James B. Meathe, left Chicago-based Marsh & McLennan (Marsh) and moved to Georgia to become president of one of Marsh’s competitors, Savannah-based Palmer & Cay. Taking this new job appeared to violate his non-compete agreements, which generally barred Meathe from soliciting clients with whom Meathe had dealt while employed by Marsh and from accepting unsolicited business from them for two years. The agreements also forbade Meathe from soliciting employees of Marsh for the purpose of competing with the company.

When Meathe became president of Palmer, he and his new employer immediately sued Marsh in the U.S. District Court for the Southern District of Georgia to obtain a declaratory judgment invalidating the non-compete agreement. The agreement lacked either a forum selection clause or a choice of law provision, allowing Meathe to avail himself of Georgia’s general reluctance towards enforcing covenants against competition by former employees. Applying Georgia law, the District Court held that Meathe’s entire agreement with Marsh violated Georgia’s public policy and so was unenforceable within the state. Marsh appealed the ruling, and Palmer cross-appealed, arguing that the court should have prevented enforcement of the agreement nationwide.

Under Georgia law, restrictive covenants related to employment are subject to strict scrutiny and are enforceable only where they are narrowly limited in time and geographic scope and reasonable in light of the interests of the employer and the impact on the employee and the public interest. This public policy has led Georgia courts to adopt a general rule preventing the enforcement of post-employment non-competition agreements that prohibit an employee from accepting unsolicited business from former clients. Moreover, Georgia law prevents courts from revising or blue-penciling employment covenants to sever unconscionable provisions. Once one covenant provision is found to be invalid, under Georgia law, the agreement is invalid in its entirety.

On appeal, the Eleventh Circuit panel found that the trial court was correct to invalidate the entire agreement as inconsistent with Georgia law. But the court also went further, holding that the agreement is also invalid in all other state and federal jurisdictions. The court held that once a post-employment non-compete agreement is declared unenforceable under one state’s law, the Full Faith and Credit clause of the U.S. Constitution and federal common law render the agreement unenforceable nationwide.

According to the court, at the state level, the Constitution’s Full Faith and Credit Clause and its federal implementing statute require that a final judgment issued by one state with proper personal and subject matter jurisdiction be given "recognition throughout the land." For preclusive purposes, in other words, "the judgment of the rendering state gains nationwide force." In fact, the court noted that the Full Faith and Credit principle "applies even if the rendering state’s judgment is based on public policy offensive to the enforcing state."

Applying these rules, the Eleventh Circuit held that the District Court’s declaratory judgment was final and effective nationwide. The court noted that Georgia does not attempt to limit the effects of its declaratory judgments, and it held that a federal court sitting in Georgia and applying Georgia law should not do so either.

Although the full impact of this decision remains to be seen, some commentators have criticized it as an open invitation to those subject to post-term covenants to avoid them simply by relocating to Georgia or the handful of other states that share its anti-covenant view. Others worry that the decision will trigger a race to the courthouse as both parties to non-compete agreements rush to obtain favorable declaratory rulings.

This decision underscores the importance to franchisors of determining the court that will decide (and the state law to be applied in deciding) the issue of the enforceability of a non-compete. Forum selection clauses and choice of law clauses are essential. However, because courts do not always enforce such clauses, it may also be necessary for a franchisor to file first in a state likely to uphold the covenant, in order to obtain a ruling before the franchisee obtains one from another state that is hostile to such covenants. As the Palmer court recognized, the doctrine of Full Faith and Credit would require a state that might otherwise not enforce a post-term covenant to enforce it as a result of a prior judgment enforcing it by another court.

If you have any questions about the decision or about the non-competition provisions in your franchise agreements, please contact us.

DLA Piper Rudnick Gray Cary was named global Franchise Law Firm of the Year 2005 in the inaugural Who’s Who Legal Awards. The International Who’s Who, published in London, England, is the result of nine years of independent research incorporating feedback from thousands of lawyers, covering over 6,000 practitioners across 25 separate practice areas and over 100 countries.

We are proud that 16 partners from our firm were included in the Franchise chapter of the International Who's Who, including David Beyer (Tampa), Michael Brennan (Chicago), Fredric Cohen (Chicago), John Dienelt (Washington, D.C.), Barry Heller (Northern Virginia), Stuart Hershman (Chicago), Ann Hurwitz (Dallas), Bret Lowell (Northern Virginia), Lee Plave (Northern Virginia), Lewis Rudnick (Chicago), Michael Santa Maria (Dallas), Joseph Sheyka (Chicago), Dennis Wieczorek (Chicago), Sandy Wong (Hong Kong), and Erik Wulff (Washington, D.C.). In addition, Philip Zeidman of our Washington office was honored with the Franchise Lawyer of the Year 2005 Award, and was described as "the dean of franchising law" by respondents, attorneys who are among the most highly regarded individuals in the global research.

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