Are Executive Non-Compete Agreements Enforceable?
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Table of Contents
An executive non-compete agreement is a contract between an employer and an employee in which the employee agrees, should he or she leave the employer, not to reveal confidential information to competitors or engage in other activities the employer deems damaging to its interests.
The agreements are commonly used by businesses to protect vital interests, such as trade secrets, confidential information, and customer lists. Although the agreements are commonly referred to as "executive" non-compete agreements, executives aren't the only ones asked to sign them; other employees with access to sensitive information, such as salespeople or research scientists, are as well.
B. Trade Restraint
A covenant not to compete is, of course, an attempt to restrain trade. It is, as one court said, an infringement "upon the economic mobility of employees as well as their freedom to follow personal interests." Wessel Company, Inc. v. Busa, 28 Ill. App. 3d 686, 329 N.E. 2d 414 (1975). They could also impair the availability of services and interfere with competition. Rao v. Rao, 718 F. 2d 219 (1993).
As a result, they are not looked upon with favor by the law. Carter-Shields v. Alton Health Institute, 317 Ill. App. 3d 260, 250 Ill. Dec. 806, 739 N.E. 569 (Ill. App. 5 Dist 2000). The disfavor means that courts will scrutinize the agreements carefully. Hydroaire, Inc. v. Sager, 98 Ill. App. 3d 758, 53 Ill. Dec. 928, 424 N.E. 2d 719 (1981).
An employer's business interests, however, are also worth protecting. Non-compete agreements "do serve a real and measurable social utility in that they protect the employer from an unwarranted erosion of confidential information, and thereby foster the growth of innovative ideas." Wessel Company, Inc. v. Busa, 28 Ill. App. 3d 686, 329 N.E. 2d 414 (1975).
C. General Rule
Thus, the general rule in Illinois is that executive non-compete agreements are enforceable if the terms of the agreement are reasonable and necessary to protect an employer's legitimate business interest, which depends upon the facts and circumstances of each case. Office Mates 5, North Shore v. Hazen, 234 Ill. App. 3d 557, 175 Ill. Dec. 58, 599 N.E. 2d 1306 (Ill. App. 1 Dist. 1985).
The enforceability of any given agreement thus rests upon an inquiry into whether the agreement was properly entered into, whether the employer is protecting a legitimate business interest, and whether the employer's means for protecting the interest is reasonable.
A. Ancillary to Transaction or Relationship
In order for a non-compete agreement to be valid in Illinois, it must be ancillary to a valid transaction, such as a contract, or a valid relationship. Abel v. Fox, 274 Ill. App. 3d 811, 211 Ill. Dec. 129, 654 N.E. 2d 591, 596 (1995).
Although the main purpose of the transaction is typically an employment relationship or the sale of a business, another valid transaction, such as a gift, may support a covenant not to compete. Liautaud v. Liautaud, 221 F. 2d 981 (7th Cir. 2000).
Because non-compete agreements can be based on a valid relationship, agreements entered into with at-will employees meet the ancillarity requirement. Lawrence and Allen, Inc. v. Cambridge Human Resources Group, Inc., 292 Ill. App. 3d 131, 226 Ill. Dec. 331, 685 N.E. 2d 434 (Ill. App. 2 Dist. 1997) (declining to follow Creative Entertainment, Inc. v. Lorenz, 265 Ill. App. 3d 343, 202 Ill. Dec. 571, 638 N.E. 2d 217 (Ill. App. 1 Dist. 1994), which had found that at-will relationships did not meet the ancillarity requirement).
B. Adequate Consideration
For the agreement to be valid, adequate consideration must be paid for the promise not to compete. Millard Maintenance Service Co. v. Bernero, 207 Ill. App. 3d 736, 745, 152 Ill. Dec. 692, 566 N.E. 2d 379 (1990). Under Illinois law, a promise by one not to compete against another, without consideration, is invalid as against public policy because it injures the public and the promisor, and serves no protectable interest of the promisee. Abel v. Fox, 274 Ill. App. 3d 811, 211 Ill. Dec. 129, 654 N.E. 2d 591, 596 (1995).
Lack-of-consideration arguments have generally failed, in large part because the courts have repeatedly ruled that continued employment is sufficient consideration for the promise not to compete. McRand, Inc. v. Van Beelen, 138 Ill. App. 3d 1045, 1055, 93 Ill. Dec. 471, 486 N.E. 2d 1306 (1985). How much continued employment is necessary is not entirely clear, although two years has been found to be sufficient. Agrimerica, Inc. v. Mathes, 199 Ill. App. 3d 435, 442, 145 Ill. Dec. 587, 557 N.E. 2d 357 (1990).
Employers today generally avoid the lack of consideration challenge by expressly giving the employee money in exchange for the promise not to compete.
C. Adhesion Contracts
Employers cannot use their superior positions to coerce employees into signing a non-compete agreement. The Illinois courts generally don't find that non-compete agreements are contracts of adhesion, especially where the employees are competent to look out for their own interests and enjoy the benefits of their executive positions. McRand, Inc. v. Beelen, 138 Ill. App. 3d 1045, 93 Ill. Dec. 471, 486 N.E. 2d 1306 (Ill. App. 1 Dist. 1985).
In addition, conditioning a promotion on the signing of a non-compete agreement is not an adhesion contract. In re Hallahan, 113 B.R. 975, affirmed 936 F. 2d 1486 (1990).
Non-compete agreements will be struck down as adhesion contracts in extreme cases. For example, an agreement was struck down where an employer forced employees to sign an agreement by threatening to withdraw financial support of the employees' defense in a suit against their former employer. Jefco Laboratories v. Carroo, 136 Ill. App. 3d 793, 91 Ill. Dec. 513, 483 N.E. 2d 999 (1985).
D. Other Considerations
Non-compete agreements are typically signed pre-employment, but they are still valid if signed after employment begins, provided that the terms are reasonable. Mid-Town Petroleum, Inc. v. Gowen, 243 Ill. App. 63, 65, 183 Ill. Dec. 573, 611 N.E. 2d 1221 (1993).
Non-compete agreements do not need to be in writing, although they should be. Amendments to agreements are allowed and must adhere to the requirements imposed on any contractual amendment.
Non-complete agreements will not be enforced unless there is a legitimate business interest to be protected. Carter-Shields v. Alton Health Institute, 317 Ill. App. 3d 260, 250 Ill. Dec. 806, 739 N.E. 569 (Ill. App. 5 Dist 2000).
An agreement that doesn't protect a legitimate business interest will be struck down on the ground that it is a contract merely to prohibit ordinary competition. Reinhardt Printing Co. v. Feld, 142 Ill. App. 3d 9, 15, 96 Ill. Dec. 97, 490 N.E. 2d 1302, 1307 (1986) (involving a former employee's solicitation of customers who had no special relationship to the employer).
Employees are free to take with them their general skills and the knowledge they acquired during their employment when they change jobs. Rao v. Rao, 718 F. 2d 219 (1993). Non-compete agreements that prevent them from doing so will be declared invalid.
What, then, is a legitimate business interest in Illinois? Not all employer interests are legitimate in this context, of course. An employer's interest in attracting well-qualified employees, for example, however noble, is not a legitimate interest. American Hardware Mut. Ins. Co. v. Moran, 705 F. 2d 219 ().
The Illinois courts have repeatedly said that there are only two situations in which an employer will be found to have a legitimate business interest.
A. Trade Secrets
The first is where the former employee acquired confidential information or trade secrets through his employment and tries to use it for his own benefit. Office Mates 5, North Shore v. Hazen, 234 Ill. App. 3d 557, 175 Ill. Dec. 58, 599 N.E. 2d 1306 (Ill. App. 1 Dist. 1985).
A trade secret has been defined as a "plan, process, tool, mechanism, compound or informational data utilized by a person in his business operations and known only to him and such limited other persons to whom it may be necessary to confide it." Reinhardt Printing v. Feld, 490 N.E. 1302 (Ill. App. 1 Dist. 1986). Information is not a trade secret if it is generally known within the industry or has been disclosed by the employer in its own catalogs or literature.
The Illinois Supreme Court has adopted the Restatement of Torts position that the factors to be used in determining the existence of a trade secret are (1) the extent to which the information is known outside the business, as well as to employees and others involved in the business, (2) the extent of measures taken to guard the secrecy of the information, (3) the value of it to the employer and to his competitors, (4) the amount of effort and/or money expending in developing the information, and (5) the ease or difficulty with which it could be acquired or duplicated by others. ILG Industries, Inc. v. Scott, 49 Ill. 2d 88, 93, 273 N.E. 2d 393, 396 (1971).
Are customer lists confidential information? The Illinois rule is that businesses don't have a proprietary interest in their customers, but they may have one in a customer list, if certain conditions are met. Image Supplies, Inc. v. Hilmert, 71 Ill. App. 3d 710, 28 Ill. Dec. 86, 390 N.E. 2d 68 (1979).
The conditions that must be met are that the customer information must have been (1) developed over a number of years, (2) developed at great expense, and (3) kept under tight security. Reinhardt Printing v. Feld, 490 N.E. 1302 (Ill. App. 1 Dist. 1986).
An employer's customer list was deemed to be confidential in one case where the following conditions were present: (1) the employer marked the list "Confidential," (2) the employer kept the list on its premises under lock and key, (3) a security system was provided at the location where the information was kept, and (4) keys were available only to certain officers and employees. Packaging House, Inc. v. Hoffman, 114 Ill. App. 3d 284, 70 Ill. Dec. 69, 448 N.E. 2d 947 (Ill. App. 1 Dist. 1983).
A customer list, on the other hand, was deemed not to be confidential where customer information could be obtained from trade publications and phone books. Image Supplies, Inc. v. Hilmert, 71 Ill. App. 3d 710, 28 Ill. Dec. 86, 390 N.E. 2d 68 (1979).
B. Near-Permanent Customer Relationships
The second legitimate business interest involves customer relationships. Employers have a protectable interest in their relationships with their customers, where two conditions exist.
First, the customer relationships must be near permanent. Nationwide Advertising Service, Inc. v. Kolar, 28 Ill. App. 3d 671, 673, 329 N.E. 2d 300, 302 (1975).
Second, it must be true that the employee would never have had contact with the customers, "but for" the employee's association with the employer. Thus, an employer cannot restrict a former employee from soliciting customers that he or she knew prior to his or her employment. Com-Co Ins. Agency, Inc. v. Service Ins. Agency, Inc., 321 Ill. App. 3d 816, 254 Ill Dec. 852, 748 N.E. 2d 298 (Ill. App. 1 Dist. 2001).
Unlike the confidential information interest, the near-permanent relationship interest has generated a great deal of uncertainty, particularly with regard to what is meant by "near permanent."
Exclusivity not required
Although what constitutes a near-permanent relationship is not entirely clear, it is clear that the relationship does not have to be exclusive in order to be near-permanent. Instrumentalist Co. v. Band, Inc., 480 N.E. 2d 1273 (Ill. App. 1 Dist. 1985). It should be long-term or long-standing, but it can still be near permanent if the customer uses other suppliers of the same goods or services.
The Illinois courts have developed a seven-factor test to determine if a near-permanent relationship exists between a company and its customers: (1) the number of years required to develop the clientele, (2) the amount of money invested to acquire clients, (3) the degree of difficulty in acquiring clients, (4) the extent of personal customer contact by the employee, (5) the extent of the employer's knowledge of its clients, (6) the duration of the customers' association with the employer, and (7) the continuity of the employer-customer relationship. Agrimerica, Inc. v. Mathes, 199 Ill. App. 3d 435, 443, 557 N.E. 2d 357, 363 (Ill. App. 1 Dist. 1990).
Some Illinois courts have ignored the seven-factor test and applied their own tests. One example is the nature-of-the-business test, which says that the near-permanency test "turns in large degree on the nature of the business involved, and certain businesses are just more amenable to success under it." Office Mates 5, North Shore v. Hazen, 234 Ill. App. 3d 557, 175 Ill. Dec. 58, 599 N.E. 2d 1306 (Ill. App. 1 Dist. 1985) (in which the court noted that the result would have been the same had it applied the seven-factor test).
Under this test, businesses in highly competitive industries are pretty much out of luck ("highly competitive" meaning that customers change suppliers frequently and have little or no brand loyalty). The ones who are likely to succeed under this test are (1) professional and pseudo-professional businesses (pseudo-professional businesses include insurance brokers, on-air radio personalities, and those who administer electrolysis), (2) businesses that provide a unique product or service, and (3) businesses under contract with customers.
Even if the rules for formation are met and even where a legitimate business interest exists, a non-compete agreement will not be valid unless the method used to protect the interest is reasonable. Reasonableness depends upon the facts and circumstances of each case. Label Printers v. Pflug, 206 Ill. App. 3d 483, 491, 151 Ill. Dec. 720, 725, 564 N.E. 2d 1382, 1387 (1991).
Reasonableness is measured by its hardship to the employee, its effect upon the general public, and the reasonableness of the time, territory, and activity restrictions. Abbott-Interfast Corp. v. Harkabus, 250 Ill. App. 3d 13, 17, 189 Ill. Dec. 288, 619 N.E. 2d 1337 (1993).
A. Hardship to Employee
The courts may strike down an otherwise valid agreement if the employee is left without a livelihood, such as where he is prevented from soliciting the only customer in a particular market. Emery-Drexel Livery v. Cook-DuPage Transp. Co., 40 Ill. App. 3d 937, 353 N.E. 2d 182 (1976) (where the Department of Public Aid was the sole customer).Otherwise, however, the courts have tended to define employee hardship rather narrowly. For example, it was not unreasonable for a physician who wanted to start his own practice to have to move to a different city to do so. Canfield v. Spear, 44 Ill. 2d 49. 254 N.E. 2d 433 (1969).
B. Effect Upon the Public
The courts may strike down an otherwise valid agreement if the public is harmed by the agreement, such as by having its consumer choices greatly reduced or eliminated. Generally, if the employer is seeking to protect what is determined to be a legitimate business interest, and the other requirements for a valid non-compete agreement are met, the Illinois courts will not invalidate the agreement on injury-to-public grounds unless there is a fairly severe restraint on trade.
For example, where a small-town medical practice has a single pediatrician, the courts would presumably strike down any attempt to restrict her from opening her own practice, if the town would otherwise be without a pediatrician if the agreement were upheld.
The courts would also presumably strike down any attempt to restrict the activities of an employee where the employee's special skills were the reason that customers did business with the employer, such as a renowned chef or photographer, on the ground that the public would be deprived of those special skills if the agreement were enforced.
The length of time contained in a non-compete agreement must be reasonably related to the needs of the employer's business. Liautaud v. Liautaud, 221 F. 2d 981 (7th Cir. 2000). One rule that has been used is that reasonableness as to time should correlate to the time it takes an employer in that industry to establish a near-permanent relationship with a customer. McRand, Inc. v. Van Beelen, 138 Ill. App. 3d 1045, 1055, 93 Ill. Dec. 471, 486 N.E. 2d 1306 (1985). (upheld one-year and two-year limits where it took employer one to three years to establish a relationship).
The general rule for reasonableness as to territory is that it match the area where the employer does business, which means where its customers live. Lawrence & Allen v. Cambridge Human Res., 292 Ill. App. 3d 131, 226 Ill. Dec. 331, 685 N.E. 2d 434 (Ill. App. 2 Dist. 1997) (invalidated a non-compete agreement that contained no geographic limit). If customers live throughout the U.S., an agreement preventing the former employee from opening a similar business, soliciting customers, or selling similar products or services anywhere in the U.S. would presumably be upheld.
The general rule for reasonableness as to activity is that it be limited to activities that actually incorporate the confidential information or match the tasks the employee performed while employed. Liautaud v. Liautaud, 221 F. 2d 981 (7th Cir. 2000) (invalidated agreement that prohibited sandwich shop employee who had trade secrets from opening any type of sandwich shop). It cannot prevent a former employee from engaging in activities that he or she did not engage in for the former employer.
Activity covenants that are intended to protect customer relationships do not need a geographical limitation because they are not designed to prohibit competition. McRand, Inc. v. Van Beelen, 138 Ill. App. 3d 1045, 1055, 93 Ill. Dec. 471, 486 N.E. 2d 1306 (1985) (involving covenants prohibiting former employees from both soliciting and rendering services to past or current customers). Activity covenants that are designed to prohibit competition, such as those that prevent a former employee from opening a similar business, do require a reasonable geographical limitation.
Even if all the conditions are met, an employer cannot enforce its non-compete agreement, unless it can show injury to its business interests. It is not enough merely to show that the former employee breached the agreement. An attempt to enforce an agreement without injury will be invalid as an effort to prevent competition per se. Hydroaire, Inc. v. Sager, 98 Ill. App. 3d 758, 53 Ill. Dec. 928, 424 N.E. 2d 719 (1981).
The Illinois courts have generally been reluctant to rescue a non-compete agreement by modifying terms that they consider unreasonable or overbroad. It's usually just a thumbs-up or thumbs-down decision. Thus, an otherwise well-drawn agreement risks being invalidated by a single poorly drawn provision.
In one case, however, an Illinois appellate court upheld a non-compete agreement - even though it failed to restrict the former employees' activities to all customers, not just those with whom the former employees had developed relationships - because the agreement stated that the terms were severable and the employer said at trial that it was willing to have the court modify the agreement. McRand, Inc. v. Van Beelen, 138 Ill. App. 3d 1045, 1055, 93 Ill. Dec. 471, 486 N.E. 2d 1306 (1985).
Judicial modifications, however, are rare in Illinois.
Tony Valiulis is an accomplished litigator with 40 years of experience in a broad range of state and federal civil trial and appellate matters. As counsel for both plaintiffs and defendants, he has first-chaired numerous jury and bench trials in federal and state courts and argued a wide variety of appeals throughout the country, including in the Illinois Supreme Court. A Principal of the firm since 1979 and a member of the Management Committee from 2010-2013, Tony served as Chair of the Litigation & Dispute Resolution practice group for more than 20 years.
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