Employment Restrictive Covenants

The issue of enforceability of employment restrictive covenants comes up often in business, including the business of commercial real estate.

http://www.dreamstime.com/stock-photo-confused-business-man-thinking-wich-way-to-go-image28551060A common scenario is as follows:  A person goes to work for a company and is required to sign a Noncompetition and Nonsolicitation Agreement. Typically, it will say something like “during the term of employment, and for a period of one year after termination of employment, the employee will not compete with or solicit any customer or vendor of the employer.”  Sometimes the Noncompetition/Nonsolicitation Agreement is required to be signed as a condition of being hired. Other times the employer will tell an employee who is already employed that signing the Noncompetition/Nonsolicitation Agreement is a condition to continued employment.

Are Employment Noncompetition/Nonsolicitation Agreements enforceable in Illinois?

As a general proposition, Noncompetition/Nonsolicitation Agreements are enforceable in Illinois, as long as they satisfy a three-pronged test:  They: (1) must be no greater in scope and duration than is required for the protection of a legitimate business interest  of the employer-promisee; (2) must not impose undue hardship on the employee-promisor, and (3) must not be injurious to the public.

In a decision filed December 1, 2011, the Illinois Supreme Court shook up the Illinois employment bar by overruling an extensive line of cases that had narrowed the three-pronged test described above to a two-pronged test created by Appellate Court decision in 1973. In a case referred to as the Kolar decision, (Nationwide Advertising Service, Inc. v. Kolar, 14 Ill. Ap. 3d 522 (1973), the Kolar court held that an employment restrictive covenant was valid if there were (i) a near permanent customer relationship with the employer, and (ii) the employee had gained confidential information through its employment. The Illinois Supreme Court emphasized in its December 2011 opinion that the Kolar test is not valid. (Reliable Fire Equipment Company vs. Arredondo 2011 IL 111871). The Illinois Supreme Court, instead, reaffirmed the legitimate business interest test, and clarified that “whether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case. Factors to be considered in the analysis include, but are not limited to, the near-permanence of customer relationships, the employee’s acquisition of confidential information through his employment, and time and place restrictions. No factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.”

For the most part, the Illinois employer’s bar hailed the Arrendondo decision as a victory, believing it gave employers a broader basis for enforcing employment restrictive covenants.  Ironically, many attorney’s representing primarily employees were encouraged by the Arrendondo decision as well, believing it gives employees more room to challenge enforceability by challenging, factually, whether a “legitimate business interest” is at stake.

“Little Known” Two-Year Rule for Employment Restrictive Covenants – Illinois

While the foregoing is all well and good, a fundamental concept of law is that employment restrictive covenants are creatures of contract. Employment restrictive covenants exist, and are enforceable, only if created by valid contract. If there is no valid contract, there is no enforceable restrictive covenant.

Basic contact law requires three elements as a condition to contract formation: (i) offer, (ii) acceptance, and (iii) adequate consideration.

Irrespective of what we learned in law school about “peppercorns” being adequate consideration, it is precisely the consideration aspect of contact formation that renders many employment restrictive covenants unenforceable.

By Appellate Court decision handed down on June 24, 2013, we are “reminded” of a body of Illinois case law that renders many employment restrictive covenants unenforceable by employers of Illinois-based employees.  With internal citations and extraneous text omitted for this post, the First District Appellate Court [Fifield and Enterprise Financial Group, Inc. vs. Premier Dealer Services, Inc., 2013 IL App (1st) 120327] held as follows:

“Postemployment restrictive covenants [i.e. restrictive covenants that purport to apply after employment ends] are carefully scrutinized by Illinois courts because they operate as partial restrictions on trade. In order for a restrictive covenant to be valid and enforceable, the terms of the covenant must be reasonable. However, before even considering whether a restrictive covenant is reasonable, the court must make two determinations: (1) whether the restrictive covenant is ancillary to a valid contract; and (2) whether the restrictive covenant is supported by adequate consideration.”

“Under Illinois law, continued employment for a substantial period of time beyond the threat of discharge is sufficient consideration to support a restrictive covenant in an employment agreement.  Illinois courts analyze the adequacy of consideration in the context of post-employment restrictive covenants because it has recognized that a promise of continued employment may be an illusory benefit where the employment is at-will. Generally, Illinois courts have held that continued employment for two years or more constitutes adequate consideration. The restrictive covenant will not be enforced unless there is adequate consideration given.”

[The Court noted that it makes no difference whether the restrictive covenant is required as a condition to being hired, or required as a condition of continued employment.]

“Illinois courts have repeatedly held that there must be at least two years or more of continued employment to constitute adequate consideration in support of a restrictive covenant. The rule is maintained even if the employee resigns on his own instead of being terminated.”

 What Does This Mean?

In a nutshell, it means that in a typical employment restrictive covenant situation [as distinguished from a special circumstance where a restrictive covenant may be entered into as part of a business sale], the restrictive covenant will likely be unenforceable in Illinois unless the employee continues working for the employer for at least two years after the restrictive covenant is signed.

I’ll bet most employers – and their attorneys – don’t know that.

Like it or not – that is the current state of the law in Illinois.

For run-of-the-mill employment arrangements, it is an unavoidable reality.  In special circumstances, where binding an employee to an enforceable restrictive covenant is of critical importance, a proper solution will take creativity to assure adequate consideration to support enforceability.

Thanks for listening,