Did You Want To Read Something About Radius Restrictions?

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At this moment, when we are about to set pen to paper (so to speak), it is our intention to raise a single topic; get in; and, get out. That hasn’t worked well for Ruminations in the past, but that’s no reason to stop trying.

On its face, today’s posting will deal with “radius restrictions.” Actually, we are going to write about judicial interpretation (again), restraints against alienation, and “blue penciling.” All that will be in the context of a 2014 decision by the Court of Appeals of Georgia in Fab’Rik Boutique, Inc. v. Shops Around Lenox, Inc. Readers can see that decision by clicking: HERE.

The facts are pretty simple and were undisputed. The clothing store had a three-year lease. Either in the lease, or by a later agreement, the tenant had a renewal option. When the tenant tried to exercise the renewal option, the landlord refused to accept the exercise and asserted the tenant had defaulted under the lease, specifically because the following radius restriction had been violated:

Tenant agrees not to open or operate another store (other than a store owned by Tenant as of the Commencement Date [of the Lease] [)] within 5 miles of the premises without Landlord’s prior written consent which may be withheld by Landlord in Landlord’s sole, absolute, and unfettered discretion and in the even[t] Tenant breaches this provision, Tenant shall be in immediate default under this Lease.

According to the landlord, its tenant was in violation of this lease provision “because two stores had been opened within the restricted radius during the Lease term.” It was willing to renew the lease, but only at a higher rent. The tenant was unwilling to pay the higher rent and sued its landlord for an order requiring the landlord to honor the lower rent renewal terms within the lease.

The storeowner asserted that one of the locations was actually owned by a separate (apparently related) franchisee and therefore its existence did not violate the radius restriction. As to the second store, the tenant’s owner admitted that, upon its opening, the named tenant was the same as the named tenant in this case, but “in an attempt to cure the radius violation, the owner transferred ownership of [that location] to a sister corporation.”

Though neither the reasoning of the lower court nor of the appellate court explained their respective findings, it is clear that each court ignored the technical niceties of the use of separate entities to hold the leases for the two radius-violating stores. Their focus was on use of the same trade name and the commonality of ownership between this particular tenant’s store and that of the other two stores.

The factual findings are not the most interesting aspect of the issues raised in this radius restriction dispute. So, Ruminations is going to accept those findings and move on to some generally applicable observations about the enforceability of radius restrictions and how leases might be better written.

The Georgia courts likened the enforceability of a radius restriction to the enforcement of restrictive covenants in non-competition agreements and employment agreements. As with all types of restrictive covenants, judicial policy is to interpret them narrowly because of the public policy disfavoring “restraints against alienation” and similar restraints on the “freedom” of people to conduct lawful activities. Although stated in terms of Georgia law, the following statement by the appellate court pretty much sums up the law’s approach to restrictive covenants, and therefore to radius restrictions:

“Whether a restrictive covenant violates Georgia law depends upon whether the covenant can be considered a ‘reasonable’ restraint on competition, given the circumstances of a particular lease. Specifically, the restraint imposed must be reasonably limited and must be reasonably necessary to protect the interest of the party in whose favor it is imposed.”

That same court continued with another principle, generally applicable throughout all jurisdictions:

“The level of scrutiny with which the court applies the test for reasonableness varies depending on the nature of the contract containing the restrictive covenant.”

Although the tenant in this dispute argued that the court should have applied the “strictest level of scrutiny,” being the one most often applied to employment contracts, the Georgia court rejected that argument. Had the tenant prevailed, the test would have been that the radius restriction would have to be reasonable, supported by valuable consideration, reasonably necessary to protect the landlord, and without prejudice to the public interest. Instead, the Georgia court, as Ruminations expected, used a “three-element test of duration, territorial coverage, and scope of activity [,] utilizing it, not as an arbitrary rule but as a helpful tool in examining the reasonableness of the particular factual setting to which it is applied.”

Here, there was no argument that the five-mile territorial radius was not unduly burdensome. Similarly, the duration of the radius restriction was inoffensive because it was coterminous with the lease’s term. That left a dispute about the “scope of activity” covered. Here is where a drafting lesson might be learned.

The tenant’s primary argument was that the radius restriction was overly broad. It asserted that the radius restriction, “probably construed,” would unreasonably prohibit it “from opening or operating a store of any type, not merely a women’s clothing and accessories boutique bearing” [its trade name]. It was able to make this argument with a straight face because the radius restriction, literally read, covered any kind of store that this tenant might have opened within the five-mile radius, even if not, in the least, competitive with the store that was subject of the lease itself.

This shortcoming in the drafting of the radius restriction allowed a number of attorneys to send their respective children to college. If the provision had been drafted by an attorney, that attorney may have earned a bonus for her or his rainmaking prowess. Imagine how much simpler it would have been to deal with this matter had the text of restrictive covenant been written correctly instead of allowing for multiple interpretations.

We promised to touch on the issue of judicial interpretation. So, we now fulfill that promise. The two courts (lower and appellate) correctly observed that the text of the radius restriction did not apply to just “any store” or to “stores of any kind,” but prohibited the tenant from operating “another store.” That gave those courts the opportunity to find an “ambiguity” and to choose between or among two or more different, reasonable interpretations. In doing so, as Ruminations has written many times before, courts will examine agreements as a whole and interpret their words using their plain and ordinary meanings. Once the courts in Georgia determined that the lease, as a whole, was for a specific type of store, and after looking at other places in the lease where the word “store” was used, they had no difficulty in interpreting the radius restriction as pertaining only to clothing stores operated by the tenant.

When deciding whether and how to enforce restrictive covenants, including radius restrictions, courts generally employ two different approaches. One approach, utilized in any number of states, is to refuse to enforce a restrictive covenant that is defective, in any way, as to scope or duration, or where there is no legitimate interest on the part of the party seeking to impose the restriction, or that where the restriction is antithetical to the public interest. Basically, if a restrictive covenant in those states is defective, courts will “throw out” the covenant.

In Georgia (by virtue of 2011 legislation), the “blue pencil” approach is followed. Basically, under this approach, common in a large number of states, a court will “edit” an otherwise defective provision of a restrictive covenant to make it fall within the general principle that, to be enforceable, restrictive covenants must be reasonable in a number of different ways. One example is that if a lease’s radius restriction extended for 50 years after the end of the lease term, a court in a state that uses the “blue pencil” approach would not throw out the entire covenant. It would reduce its duration to one that would probably match the lease’s term. In this Georgia case, that may have actually been what the court did with respect to the “scope” of the radius restriction when it determined that the scope would only cover clothing stores.

Well, that’s the end of our thoughts for today. But, it’s not the end of what Ruminations has to say. We have two more “administrative” items. First, if you’ve read our two immediately prior postings about builder’s risk insurance, but have not seen an extensive comment that was posted last week, you might want to do so by clicking: HERE. Kevin Connolly, a fellow Ruminator, has shared some very important thoughts that serve to extend the basic information contained in our blog postings. If you have any curiosity about inland marine insurance coverage, his comment is “must” reading.

Our second thought is about the definition of “sandwich,” a topic covered quite some time ago in a Ruminations’ posting that can be seen by clicking: HERE. It consists of a feature article in the New York Times about sandwiches. Here is a link to that article: LINK. It will especially appeal to “foodies” and actually has a reference to the Massachusetts case that taught us that a burrito is not a sandwich.

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