On December 1, 2011, the Illinois Supreme Court issued a watershed opinion on the enforceability of restrictive covenants (non-compete, non-solicit, non-disclosure and no-hire agreements) in the employment context, Reliable Fire Equipment v. Arredondo et al. Prior to this point, the court had only rarely spoken on the subject, and never definitively. This lack of input from the state’s high court resulted in some ambiguities and inconsistencies among Illinois’ appellate court decisions in the area. The Reliable Fire Equipment decision, however, has now clarified the legal standards applicable to restrictive covenants and likely made it significantly easier for employers to enforce post-employment restrictive covenants governed by Illinois law -- particularly in cases predicated on an employer’s interest in its customers.
The Former Legal Landscape
The majority of Illinois appellate courts would enforce post-employment restrictive covenants only when they: (1) did not impose an undue hardship on the former employee (e.g. completely preclude him/her from making a living); (2) were not injurious to the public interests; (3) were related to an employer’s “legitimate business interest;” and (4) reasonable in terms of time, activity and geographic area restricted vis-à-vis that business interest. Although this legal standard is close to those used by most other states, Illinois appellate courts have significantly limited the number and type of business interests compelling enough to justify enforcing restrictive covenants in the employment setting.
Specifically, most Illinois courts held that only two business interests would suffice: “near-permanent” customer relationships or confidential information/ trade secrets. Regarding the former, the factors/test employed by the courts to determine the existence of the near-permanent customer interest were rigid and difficult for employers to meet. Some courts looked at a variety of objective factors like whether the relationship was exclusive or long-standing (5 or more years), whether the employer spent significant time and money to obtain the customers; etc; other courts merely held that there could be no near-permanent relationships in “ordinary sale” businesses ( as opposed to professional services)). Thus, in Illinois, it has traditionally been difficult for employers to consistently enforce non-compete and non-solicitation agreements predicated on their relationships with customers.
On the other hand, and as discussed in our November 2009 update, one Illinois appellate court rejected altogether the requirement that an employer demonstrate a legitimate business interest before enforcing any restrictive covenant, regardless of its scope. This case, Sunbelt Rentals, Inc. v. Ehler, stated that because the Illinois Supreme Court had never imposed the legitimate business interest requirement, an employer merely had to show that its restriction was reasonable in time and territory for it to be enforced. The legal alternatives available to the supreme court in Reliable Fire Equipment thus appeared to be: the inflexible, limited and fairly pro-employee tests used by the majority of appellate courts versus the extremely liberal, pro-employer test used by the Sun Belt Rentals court.
The Reliable Fire Equipment Decision
Reliable Fire Equipment involved an employer’s one-year, post-employment restrictions on competition, customer solicitation, and employee solicitation. The trial and appellate courts found the restrictions unenforceable; the supreme court’s decision, however, largely avoided any analysis of the particular facts of the case. Instead, the court looked at the legal test applied by the prior appellate court, namely the “majority rule” that an employer could only establish a legitimate business interest by showing either that : (1) a former employee acquired confidential information or trade secrets as a result of his employment and subsequently tried to use it/them for his own benefit; or (2) the employer had a near-permanent relationship with its customers and that but for the employee’s employment with plaintiff, the employee would never had come into contact with those customers.
The supreme court first reviewed its prior decisions in the area, stating that it had always recognized a “three-pronged inquiry” into the reasonableness/enforceability of restrictive covenants in the employment context: (1) whether enforcement of the restrictions would visit undue hardship on the employee against whom it was to be enforced; (2) whether enforcement of the restrictions would be injurious to the public interest; and (3) whether the restraint imposed were greater than necessary to protect the legitimate business interests of the employer. In so doing, it explicitly rejected the holding of Sunbelt Rentals, i.e. an employer need not show a legitimate business interest prior to enforcing any post-employment restrictive covenant.
The meat of the Reliable Fire Equipment opinion, however, is in its explanation of just how the lower courts are to determine whether an employer has established the legitimate business interests that are a prerequisite to enforcement of restrictive covenants. Specifically, the court emphatically stated that there was no mathematical formula for determining whether a legitimate business interest exists or whether the particular restrictions go further than needed to promote those interests.
Instead, the lower courts must look at the “totality of the circumstances” to determine those questions, rather than just the factors listed in the prior near-permanent customer or the confidential information/trade secret tests. Such tests are no longer “conclusive.” Thus, in cases where post-employment restrictions are predicated on an employer’s interest in its customers, a court may consider the near-permanence of an employer’s relationship with its customer, but the length of the relationship will no longer be determinative. Nor does a court have to give that factor any more weight than any other factor; instead, the particular context of the facts should determine their weight.
Ramifications of Reliable Fire Equipment
Reliable Fire Equipment represents a very significant change in Illinois law on restrictive covenants. Employers are now free to use a much broader variety of facts and arguments to establish the legitimate business required to enforce such restrictions, instead of having to meet the rigid and difficult near-permanent customer relationship or confidential information/trade secret tests. That should make it easier for employers to enforce restrictive covenants, particularly given the high bars set by the prior tests. Of course, litigants will continue to highlight the existence of factors mentioned in the old tests, as they will continue to be relevant, but failure to meet the tests will no longer be fatal. Additionally, employers may point to other relevant factors, such as the extraordinary training an employer had given a departing employee, the amount of money invested by the employer in the employee, and the length of time and means by which the employer supported the employee in his/her customer development efforts.
On the other hand, departing employees and their new employers will likely find it much more difficult to get rid of expensive lawsuits at the earlier stages of litigation through motions to dismiss and motions for summary judgment. Given that the “totality of the circumstances” is what counts, litigants will be forced to engage in extensive and expensive fact discovery to establish those circumstances. Indeed, restrictive covenants cases governed by Reliable Fire Equipment may prove even weaker candidates for resolution at the summary judgment (post-discovery, pre-trial) stage than “likelihood of confusion” trademark cases; federal courts in trademark cases have explicitly held that likelihood of confusion is an issue “ rarely amenable to summary judgment,” yet that issue typically looks at only 6-7 factors, some of which are given much more weight than the others. As a corollary, both sides’ legal counsel will likely find it more difficult to accurately predict results in restrictive covenant cases after Reliable Fire Equipment.
Reliable Fire Equipment also strongly suggests that employers quickly consider the following: (1) employers who have not previously utilized restrictive covenants should seriously consider retaining competent counsel to draft them for maximum enforceability; (2) employers with existing restrictive covenants should consider revising them to ensure that the legitimate business interests they articulate, if any, are sufficiently broad; (3) employers with existing covenants should ensure that they contain (a) one-way attorneys’ fees provisions (in favor of the employer) and (b) injunction without bond provisions given the likely increase in litigation costs; and (4) employers who are contemplating hiring others’ employees should (a) inquire as to and carefully review any restrictions the prospect may be under, and (b) compel incoming employees to sign non-obligation and other agreements to lower the likelihood of lawsuits.
For more information on Lowis & Gellen LLP’s employment law practice, please contact Partner Rob Smeltzer @ (312)456-7952 or rsmeltzer@lowis-gellen.com.
Legal Notice: The content of this email is intended for informational purposes only. It is not intended to solicit business or to provide legal advice. As laws may differ by jurisdiction, the information on this email may not apply to every reader. Consequently, you should not take or refrain from taking any legal action based upon the information contained in this email without first seeking independent counsel. Nor is an attorney-client relationship created between you and Lowis & Gellen LLP by virtue of this email. If you do not wish to receive any more emails of this kind from Lowis & Gellen LLP, simply reply to the email and ask to be removed from our list.
The Former Legal Landscape
The majority of Illinois appellate courts would enforce post-employment restrictive covenants only when they: (1) did not impose an undue hardship on the former employee (e.g. completely preclude him/her from making a living); (2) were not injurious to the public interests; (3) were related to an employer’s “legitimate business interest;” and (4) reasonable in terms of time, activity and geographic area restricted vis-à-vis that business interest. Although this legal standard is close to those used by most other states, Illinois appellate courts have significantly limited the number and type of business interests compelling enough to justify enforcing restrictive covenants in the employment setting.
Specifically, most Illinois courts held that only two business interests would suffice: “near-permanent” customer relationships or confidential information/ trade secrets. Regarding the former, the factors/test employed by the courts to determine the existence of the near-permanent customer interest were rigid and difficult for employers to meet. Some courts looked at a variety of objective factors like whether the relationship was exclusive or long-standing (5 or more years), whether the employer spent significant time and money to obtain the customers; etc; other courts merely held that there could be no near-permanent relationships in “ordinary sale” businesses ( as opposed to professional services)). Thus, in Illinois, it has traditionally been difficult for employers to consistently enforce non-compete and non-solicitation agreements predicated on their relationships with customers.
On the other hand, and as discussed in our November 2009 update, one Illinois appellate court rejected altogether the requirement that an employer demonstrate a legitimate business interest before enforcing any restrictive covenant, regardless of its scope. This case, Sunbelt Rentals, Inc. v. Ehler, stated that because the Illinois Supreme Court had never imposed the legitimate business interest requirement, an employer merely had to show that its restriction was reasonable in time and territory for it to be enforced. The legal alternatives available to the supreme court in Reliable Fire Equipment thus appeared to be: the inflexible, limited and fairly pro-employee tests used by the majority of appellate courts versus the extremely liberal, pro-employer test used by the Sun Belt Rentals court.
The Reliable Fire Equipment Decision
Reliable Fire Equipment involved an employer’s one-year, post-employment restrictions on competition, customer solicitation, and employee solicitation. The trial and appellate courts found the restrictions unenforceable; the supreme court’s decision, however, largely avoided any analysis of the particular facts of the case. Instead, the court looked at the legal test applied by the prior appellate court, namely the “majority rule” that an employer could only establish a legitimate business interest by showing either that : (1) a former employee acquired confidential information or trade secrets as a result of his employment and subsequently tried to use it/them for his own benefit; or (2) the employer had a near-permanent relationship with its customers and that but for the employee’s employment with plaintiff, the employee would never had come into contact with those customers.
The supreme court first reviewed its prior decisions in the area, stating that it had always recognized a “three-pronged inquiry” into the reasonableness/enforceability of restrictive covenants in the employment context: (1) whether enforcement of the restrictions would visit undue hardship on the employee against whom it was to be enforced; (2) whether enforcement of the restrictions would be injurious to the public interest; and (3) whether the restraint imposed were greater than necessary to protect the legitimate business interests of the employer. In so doing, it explicitly rejected the holding of Sunbelt Rentals, i.e. an employer need not show a legitimate business interest prior to enforcing any post-employment restrictive covenant.
The meat of the Reliable Fire Equipment opinion, however, is in its explanation of just how the lower courts are to determine whether an employer has established the legitimate business interests that are a prerequisite to enforcement of restrictive covenants. Specifically, the court emphatically stated that there was no mathematical formula for determining whether a legitimate business interest exists or whether the particular restrictions go further than needed to promote those interests.
Instead, the lower courts must look at the “totality of the circumstances” to determine those questions, rather than just the factors listed in the prior near-permanent customer or the confidential information/trade secret tests. Such tests are no longer “conclusive.” Thus, in cases where post-employment restrictions are predicated on an employer’s interest in its customers, a court may consider the near-permanence of an employer’s relationship with its customer, but the length of the relationship will no longer be determinative. Nor does a court have to give that factor any more weight than any other factor; instead, the particular context of the facts should determine their weight.
Ramifications of Reliable Fire Equipment
Reliable Fire Equipment represents a very significant change in Illinois law on restrictive covenants. Employers are now free to use a much broader variety of facts and arguments to establish the legitimate business required to enforce such restrictions, instead of having to meet the rigid and difficult near-permanent customer relationship or confidential information/trade secret tests. That should make it easier for employers to enforce restrictive covenants, particularly given the high bars set by the prior tests. Of course, litigants will continue to highlight the existence of factors mentioned in the old tests, as they will continue to be relevant, but failure to meet the tests will no longer be fatal. Additionally, employers may point to other relevant factors, such as the extraordinary training an employer had given a departing employee, the amount of money invested by the employer in the employee, and the length of time and means by which the employer supported the employee in his/her customer development efforts.
On the other hand, departing employees and their new employers will likely find it much more difficult to get rid of expensive lawsuits at the earlier stages of litigation through motions to dismiss and motions for summary judgment. Given that the “totality of the circumstances” is what counts, litigants will be forced to engage in extensive and expensive fact discovery to establish those circumstances. Indeed, restrictive covenants cases governed by Reliable Fire Equipment may prove even weaker candidates for resolution at the summary judgment (post-discovery, pre-trial) stage than “likelihood of confusion” trademark cases; federal courts in trademark cases have explicitly held that likelihood of confusion is an issue “ rarely amenable to summary judgment,” yet that issue typically looks at only 6-7 factors, some of which are given much more weight than the others. As a corollary, both sides’ legal counsel will likely find it more difficult to accurately predict results in restrictive covenant cases after Reliable Fire Equipment.
Reliable Fire Equipment also strongly suggests that employers quickly consider the following: (1) employers who have not previously utilized restrictive covenants should seriously consider retaining competent counsel to draft them for maximum enforceability; (2) employers with existing restrictive covenants should consider revising them to ensure that the legitimate business interests they articulate, if any, are sufficiently broad; (3) employers with existing covenants should ensure that they contain (a) one-way attorneys’ fees provisions (in favor of the employer) and (b) injunction without bond provisions given the likely increase in litigation costs; and (4) employers who are contemplating hiring others’ employees should (a) inquire as to and carefully review any restrictions the prospect may be under, and (b) compel incoming employees to sign non-obligation and other agreements to lower the likelihood of lawsuits.
For more information on Lowis & Gellen LLP’s employment law practice, please contact Partner Rob Smeltzer @ (312)456-7952 or rsmeltzer@lowis-gellen.com.
Legal Notice: The content of this email is intended for informational purposes only. It is not intended to solicit business or to provide legal advice. As laws may differ by jurisdiction, the information on this email may not apply to every reader. Consequently, you should not take or refrain from taking any legal action based upon the information contained in this email without first seeking independent counsel. Nor is an attorney-client relationship created between you and Lowis & Gellen LLP by virtue of this email. If you do not wish to receive any more emails of this kind from Lowis & Gellen LLP, simply reply to the email and ask to be removed from our list.
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