The answer is ‘yes’ in at least one case. The case is Allegra Network, LLC v. In re Michael G. Ruth. Michael G. Ruth and Elnoria J. Ruth, collectively the “Ruths” entered into a franchise agreement initially in 1984. The franchise agreement was renewed in 2006. The franchise agreement stated that the laws of the state of Michigan governed the franchise agreement.
In 2008, the then franchisor, Allegra Network, LLC, terminated the Ruths’ franchise agreement for failure to pay royalties. Allegra Network sued the Ruths for payment of unpaid royalties and enforcement of the post franchise agreement non-compete. The Ruths filed for bankruptcy.
This is where it gets complicated. The court goes on a tangent. Under Michigan law, if a non-compete is violated, the remedy is monetary damages. The violator of the non-compete agreement must pay money damages. Now remember we are in bankruptcy. Under Chapter 13 bankruptcy all monetary obligations are discharged or erased. So, it only follows that the money damages for violation of the non-compete are erased. A little bit of circular reasoning.
In essence, the former franchisee can compete against the franchisor.-without any liability. The obligation to pay damages for violations of the non-compete are erased by the bankruptcy. The franchisor has no remedy.
In a side note, the court makes an interesting statement. This decision is not the outcome in all jurisdictions. The court states that if the case were in Minnesota or Texas, bankruptcy would not render the non-compete unenforceable.
Business Take Away: Bankruptcy changes the typical rules and not all states have the same laws.
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