Michigan Bankruptcy Court Upholds Non-Compete and Confidentiality Clauses in Franchise Agreement Rejection

Michigan Bankruptcy Court Upholds Non-Compete and Confidentiality Clauses in Franchise Agreement Rejection

In a recent ruling, the Michigan Bankruptcy Court granted Empower Central Michigan Inc.’s (Empower) motion to reject a franchise agreement as an executory contract while maintaining the enforceability of the included non-compete clause and confidentiality agreement. The decision declared on April 26, 2024, has significant implications for the treatment of franchise agreements and associated restrictive covenants in bankruptcy proceedings. In re: Empower Cent. Michigan, Inc., 2024 WL 1848504 (Bankr. E.D. Mich. Apr. 26, 2024)

In August 2023, Empower initiated Chapter 11 bankruptcy proceedings with the initial plan of reaffirming its franchise agreement with Auto-Lab Franchising, LLC to run an Auto Lab Complete Car Care Center. However, Empower later opted to undergo a rebranding process at the same location, catering to the same customer base but under a new identity. As a strategic move, Empower sought court approval to nullify the franchise agreement, citing the excessive monthly franchise fees as its primary financial burden and asserting that the agreement no longer yielded tangible advantages.

After a thorough perusal of Empower’s petition under Section 365(a) of the Bankruptcy Code, the court permitted the rejection of executory contracts. Both parties agreed that the franchise agreement was an executory contract and thus subject to rejection, allowing Empower to cease its obligations under the franchise agreement. Also, the court diverged from Empower’s position regarding the non-compete clause and the confidentiality agreement within the franchise contract. Auto Lab contended that these clauses were crucial for protecting its business interests, including its trademarks, proprietary information, and customer goodwill built over nearly two decades at the Fenton, Michigan location.

In siding with Auto Lab, the court determined that these restrictive covenants were not executory contracts under Section 365(a) and therefore could not be rejected. The court emphasized that the equitable remedies provided by these clauses were designed to safeguard Auto Lab’s intellectual property and customer relationships, which are fundamental to its business operations. These remedies were not reducible to monetary claims and were essential for maintaining the integrity of Auto Lab’s franchise system.

The court’s ruling allows Auto Lab to seek injunctive relief against Empower for any violations of the non-compete and confidentiality agreements, despite Empower’s bankruptcy status. This outcome highlights the balance courts seek to achieve between providing debtors with financial relief and upholding contractual rights that protect business operations.