September 16, 2013

From time to time we have discussed the enforceability of restrictive covenants, including non-compete and non-solicitation agreements. In general, these agreements restrict employees from either competing with their former employers or from soliciting its customers. Restrictive covenants can be extremely important to a business, as we all know. Generally, they are enforceable if narrowly drawn to protect a legitimate interest of the employer. The covenant, however, cannot restrict competition per se. Rather, there must be something other than mere competition that needs to be protected.

Traditionally, two types of protectable interest have been recognized by Illinois courts: confidential information and near-permanent relationships with customers. But in December 2011, the Illinois Supreme Court expanded these categories, creating the "totality of the circumstances" test (Reliable Fire Equipment Company v. Arredondo). Under that test a court looks at all of the circumstances to see if the employer is actually trying to protect a legitimate interest rather than merely preventing competition.

The Nature of Restrictive Covenants

Restrictive covenants are contracts, however, and as such must be supported by consideration. There must be some quid pro quo given to the employee for the agreement to be valid. Unlike ordinary contracts, however, the consideration must be adequate. Generally, any type of consideration is sufficient to support a contract. In most cases, the court does not examine whether that consideration is fair or sufficient, but simply whether it exists. But with restrictive covenants, the courts do examine the consideration given to make sure that it is fair or commensurate with the promise not to compete.

For years, Illinois courts have deemed employment to be adequate consideration for a restrictive covenant, provided that the employment was "substantial." This principle mostly came up in the context of an already-hired employee who was required to sign a non-compete. In that situation, the courts have said that continuing employment is sufficient consideration, again provided it is substantial. (See below for what is meant by “substantial.”) But a number of cases applied the same principle to a new hire. This makes sense, since in both cases the only consideration given for the non-compete is employment.

Because Illinois is an "at will" state, an employer can generally fire an employee for any reason or no reason at all (except for certain proscribed reasons such as the employee’s sex, religion, and so on). Without the protection of substantial employment, an employee could sign a non-compete on day one and then be fired on day two or three (or day 60 or 90) and be prevented from competing or soliciting customers for two or three years. Putting a person in that position is fundamentally unfair, which the courts recognize.

What Is Substantial Employment?

Until recently, there was some ambiguity in the case law regarding "how much employment is enough." Virtually every Illinois case found that employment lasting less than two years did not qualify as substantial. Most of these cases dealt with employment that was actually under one year and often as little as a few months. Thus, although the courts talked about a two-year limitation, it was mostly in general terms, and some practitioners did not believe that two years was a set rule. 

That all changed in June 2013. In Fifield v. Premier Dealer Services, a case we successfully prosecuted, the Illinois Appellate Court, First District, explicitly held that, whenever employment is the sole consideration, that employment must last at least two years in order to be sufficient to support a restrictive covenant. The court also held that this principle applied to a new hire or continuing employment, or if the employee quits or is fired. It was a bright line rule.

What Does This Mean to You?

The court’s ruling means that a company has to give something more than mere employment to support a restrictive covenant if that company wants to be sure that the consideration is sufficient. Otherwise, if the employee does not actually remain with the company for two years after signing the restriction, there is a very good chance that the restriction will not be enforceable.

To avoid this result, companies can likely do a number of things, although the courts have not yet delineated exactly what will be appropriate. For example, a company might provide a real (not nominal or illusory) signing bonus or an agreed-upon term of employment—in which the employee cannot be fired except for cause. Similarly, it can perhaps promote the employee or agree to teach him or her certain valuable skills.

How Should Companies Deal with Existing Agreements?

We recommend that you and your counsel review all of the existing restrictive covenants that you have and determine the best course of action. If employment is the sole consideration for those agreements, and if the employee has not continued employment for at least two years, then you should seriously consider amending the agreement and providing additional consideration, whether it is a signing bonus, a promotion or something else that is real and tangible.

This is the law in Illinois at the moment, but the employer in the Fifield case has sought leave to appeal to the Illinois Supreme Court. Whether the court will take the case is anybody's guess. We likely will not hear from the court for many months, but will continue to keep you posted on the latest developments.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.