Will the restrictions in my non-compete agreement be dischargeable in bankruptcy?

20 August 2016

Answer:  Maybe, it depends on the language of the agreement and the judge deciding the issue.

Initially, one needs to understand the basics, which is that rights against others are generally either equitable on the one hand, or legal (or at law) on the other.  Roughly speaking, equitable rights are those which force someone or something to either take or not take action (such as an injunction or restraining order), where legal (or at law) rights are those for money damages.  This all comes from the history of jolly old England where there were legal courts and the king’s (equitable) courts, each able to fashion a different kind of relief.  For now, we will focus on a Massachusetts bankruptcy case.

Recently in the federal case of In re Carl S. Hurvitz, the debtor learned why he was not able to discharge the restrictions in his non-complete agreement or stop his former franchisor from enforcing its injunction against him.  No. 16-11844, (Bankr. D. Mass, July 20, 2016).  In Hurvitz, the former franchisor had obtained a preliminary injunction against the debtor prior to the debtor filing for bankruptcy to stop him from working for a direct competitor after the debtor breached the franchise agreement.  It then sought to obtain relief from the automatic stay to enforce its prior injunction and proceed with the state court case.  (The automatic stay goes into place upon filing and generally stops most collection activity by operation of law.)  Massachusetts Bankruptcy Judge Melvin S. Hoffman framed the question of whether to grant stay relief to depend on whether the franchisor has a “claim” under the bankruptcy code.  Interpreting 11 U.S.C. § 105 (5)(B) he observed “the right to equitable relief constitutes a claim only if it is an alternative to a right to payment or if compliance with the equitable order will itself require the payment of money.” He analyzed the existing case law and found First Circuit precedent to be inconsistent.

Relying on the bankruptcy code and other case law, he applied the same to the language of the franchise agreement and determined in this case that breach of the agreement provided for equitable relief, and that money damages would only lie for lost profits due to early termination of the agreement, and not as an alternative to post-termination restrictions.  Since he found that the franchisor’s right to money damages was not an alternative to, but only cumulative to, its equitable rights, the judge found the restrictions not dischargeable.

The author must take notice of the agreement’s specific language and wonder whether the drafter had this issue in mind when he did not provide for money damages as an alternative to equitable relief to stop the franchisee from working for a competitor.  If so, my hat is off.

The take away here for a future debtor (consumer) is that you need to understand what you can discharge and what you cannot, or at least understand there is uncertainty, before you file bankruptcy.  In the event you are facing such a question, especially an issue involving dischargeability, feel free to give this office a call.