Even though a franchise agreement was rejected as an executory contract, Bankruptcy Judge Joel D. Applebaum of Flint, Mich., explained why noncompetition and confidentiality agreements remained enforceable.

The debtor purchased an auto repair shop that had been operating for 15 years under a franchise agreement with a franchisor of similar businesses in the region. The debtor and its owner each signed a franchise agreement containing a noncompetition agreement. The debtor and the owner also signed a separate confidentiality agreement.

In Subchapter V of chapter 11, the debtor filed a motion to reject the franchise agreement, the noncompetition agreement and the confidentiality agreement. The franchisor conceded that the franchise agreement was an executory contract subject to rejection but took the position that the confidentiality and noncompetition agreements could not be rejected.

The franchisor won in an opinion by Judge Applebaum on April 26.

On the merits, Judge Applebaum began by analyzing whether the three agreements were executory contracts. He cited the Supreme Court for the idea that contracts are executory if performance remains on both sides. See NLRB v. Bildisco & Bildisco, 465 U.S. 513, 522, n.6 (1984).

Because rejection of an executory contract is a “breach of contract” under Section 365(g)(1) “immediately before the date of filing of the petition,” Judge Applebaum said he was required to “determine the nature of any damages arising from the breach.”

Next, Judge Applebaum cited the Sixth Circuit for the notion that equitable relief is not a “claim” if it’s “an alternative to a right to payment.” Kennedy v. Medicap Pharmacies, Inc., 267 F.3d 493, 497 (6th Cir. 200). He quoted the Collier treatise: “‘Most courts have concluded that a covenant not to compete, or at least the portion of such a contract giving a right to injunctive relief, is not a claim.’”

Judge Applebaum also cited a case from the Sixth Circuit where the debtor was subject to a covenant not to compete that was part of a franchise agreement. The bankruptcy court had modified the automatic stay, allowing the franchisor to pursue injunctive relief in state court.

The Sixth Circuit affirmed, holding that the right to injunctive relief was not a claim “because compliance with the injunction required only that the debtors cease violating the terms of the non-compete agreement going forward.” Kennedy v. Medicap Pharmacies, Inc., 267 F.3d 493, 497 (6th Cir. 2001).

Admitting that the franchise agreement was an executory contract subject to rejection, the franchisor contended that the noncompetition and confidentiality agreements were not executory because equitable relief was the remedy.

Judge Applebaum focused on the damages provisions in the three contracts. The franchise agreement called for monetary damages calculated by formula, making the franchise agreement a rejectable executory contract.

In the event of breach, the confidentiality agreement called for injunctive relief because, it said, damages would be “incalculable.” Thus, the confidentiality agreement could not be rejected. Likewise, Judge Applebaum said that “the equitable remedies contained in the [noncompetition agreement] and the Confidentiality Agreement cannot be reduced to a monetary claim and remain enforceable by [franchisor].”

“While a monetary claim based upon the liquidated damages formula may compensate for lost royalty payments, this provision does not (nor was it intended to) protect [the franchisor’s] trademarks, confidential intellectual property and customer goodwill,” Judge Applebaum said. “Accordingly,” he held that “the equitable relief at issue in this case is not simply an alternative to a right of payment and, therefore, cannot be reduced to a monetary claim under 11 U.S.C. § 101(5)(B).”

Judge Applebaum allowed rejection of the franchise agreement. As to the other two agreements, he held:

The non-compete clause in the Franchise Agreement remains enforceable post-rejection. Moreover, the separate Confidentiality Agreement is not an executory contract subject to rejection and, therefore, that agreement also remains enforceable.