In a recent decision of interest, the Bankruptcy Court for the Eastern District of Michigan held that a non-compete clause within a franchise agreement as well as confidentiality agreement could not be rejected as an executory contract. See In re Empower Central Michigan, Inc. (Case No. 23-31281) (April 26, 2024).
In this case, Empower Central Michigan, Inc. (“Debtor”) bought an auto repair shop operating pursuant to a franchise agreement with creditor Auto Lab Franchising LLC (“Auto Lab”), which contained a non-compete clause. The parties also entered into a separate confidentiality agreement.
The Debtor subsequently commenced a chapter 11 case and sought to reject the franchise agreement and confidentiality agreement. Although Auto Lab agreed that the franchise agreement constituted an executory contract, it argued that the confidentiality agreement and non-competition clause within the franchise agreement could not be rejected.
On April 26, 2024, Judge Joel D. Applebaum, U.S.B.J., issued a decision partially granting and partially rejecting Debtor’s motion to reject the contracts. Citing the seminal Bildisco Supreme Court case, the Court noted that a contract is executory and may be rejected pursuant to section 365 of the Bankruptcy Code only if performance remains due to some extent on both sides. See NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984). In addition, the Court noted that it must “determine the nature of any damages arising from the breach,” as rejection of an executory contract is a breach of contract “immediately before the date of filing of the petition,” pursuant to section 365(g)(1) of the Bankruptcy Code.
The Court first explained that a breach of contract giving rise to money damages creates a claim in a Debtor’s bankruptcy. 11 U.S.C. § 101(5)(A). “A breach giving rise to equitable relief … may or may not be a claim, depending on whether the right to equitable relief is ‘an alternative to a right to payment or if compliance with the equitable order will itself require the payment of money.’” Judge Applebaum also stated that most other courts have determined that a non-compete clause is not a claim.
Judge Applebaum next reviewed the damages provisions contained in each of the contracts. The franchise agreement called for monetary damages calculated by formula. Thus, the franchise agreement was a rejectable executory contract. On the other hand, the confidentiality agreement mandated injunctive relief, as damages would be “incalculable” if there was a breach. Thus, the Court concluded that the confidentiality agreement could not be rejected as an executory contract. Similarly, Judge Applebaum found that the equitable remedies contained in the non-compete provision of the franchise agreement could not be reduced to a monetary claim. Thus, Judge Applebaum allowed rejection of the franchise agreement but held the non-compete clause remained enforceable after rejection. Lastly, the Court held that the confidentiality agreement was not an executory contract that could be rejected by Debtor.
Although this opinion was issued in a Bankruptcy Court in Michigan and is not binding precedent here in New York, it is important contract counterparties be aware of evolving case law in order to understand how courts characterize certain contracts and whether they may be rejected in bankruptcy. Falcon Rappaport & Berkman will continue to provide updates to its clients and colleagues on this issue.
