Please Release Me: Analyzing the Enforceability of Restrictive Covenants in Employment Agreements

1. Please Release Me: Analyzing the Enforceability of Restrictive Covenants in Employment Agreements Mary Anne Mason Justice of the Appellate Court, First District Kathleen Pantle Judge of the Circuit Court of Cook County April 25, 2014

2. Life was so simple then…. Many decades ago, Fred began taking lessons at Arthur Murray Dance Studio in Cleveland, Ohio

3. Fred progressed from having two left feet to the pinnacle of modern dance becoming Arthur Murray’s most popular instructor But Fred tired of barely eking out a living and decided to branch out and a loyal clientele followed.

4. But although Fred was fleet of foot, Arthur Murray took a heavy-handed approach to enforcing Fred’s restrictive covenant.

5. More than 60 years ago, the court of Common Pleas in Cuyahoga County, Ohio described the law regarding an employee’s covenant not to compete: “It is a sea – vast and vacillating, overlapping and bewildering. One can fish out of it any kind of strange support for anything, if he lives so long.” Arthur Murray Dance Studio v. Witter, 105 N.E.2d 685 (1952)

6. In the more than 6 decades following that observation, that sea has become a legal tsunami, threatening to overwhelm even the most experienced jurist.

7. If you Google “restrictive covenants in employment”, it generates more than 550,000 results. In the short time we have here today, Judge Pantle and I will attempt to navigate the treacherous seas of restrictive covenants.

8. What is a restrictive covenant? A means by which an employer seeks to limit an employee’s post-employment conduct by imposing restrictions defined by time, geographical area, activity and/or disclosure of confidential information

9. Two Kinds of Restrictive Covenants Those ancillary to the sale of a business Those ancillary to a valid employment relationship Today we will be concentrating on those covenants that are ancillary to a valid employment relationship

10. Pre-Reliable Fire enforceability analysis: • Restrictions were only justified if founded upon a “legitimate business interest: consisting of either • 1. near-permanent customer relationships or • 2. trade secrets

11. In the absence of one or both of these protectable interests, many courts found that efforts to circumscribe an employee’s ability to compete following termination of employment were impermissible, e.g. Office Mates 5 v. Hazen, 234 Ill. App.3d 557 (1992)

12. ALLIGATOR PIT "Upset at you for breaching the non-compete? Of course not."

13. Reliable Fire Equipment Co. v. Arredondo, 2011 IL 111871 Plaintiff filed a complaint alleging that Defendants violated restrictive covenants contained in their valid and enforceable employment agreements by engaging in sales activities and providing services to Plaintiff’s customers; soliciting referrals from Plaintiff’s referral sources; and soliciting several named Plaintiff employees to leave their employment with Plaintiff.

14. After trial, the trial court ruled that the restrictive covenants were unenforceable concluding that Plaintiff failed to prove the existence of a legitimate business interest. Reliable Fire, 2011 IL 111871 at ¶8. A “sharply divided” appellate court affirmed. Id. at ¶9. The Illinois Supreme Court reversed.

15. Adhered to well-established Illinois law: Contracts in total and general restraint of trade are void as against public policy…

16. But, a contract which is only in partial restraint of trade is valid provided, • It is reasonable AND • It has a consideration attached to it. • Reliable Fire, 2011 IL 111871, ¶16, quoting Hursen v. Gavin, 162 Ill. 377 (1896). • Any covenant must be ancillary to either the sale of a business or a valid employment relationship

17. Three-Prong Rule of Reason • A court must consider whether the covenant: • Is no greater than is required for the protection of a legitimate business interest of the employer-promisee; • Does not impose undue hardship on the employee-promisor; AND • Is not injurious to the public

18. Legitimate Business Interest • Factors include but are not limited to: • Near permanence of customer relationships • Employee’s acquisition of confidential information through his employment • Time and place restrictions

19. The extent of the employer’s legitimate business interest may be limited by: • Type of activity • Geographic area • Time

20. In the absence of a legitimate business interest in need of protection, a plaintiff cannot satisfy the three-prong rule of reasonableness necessary to entitle it to judicial enforcement of a restrictive covenant contained in an employment agreement. Gastroenterology Consultants of the North Shore, S.C. v. Meiselman, 2013 IL App (1st) 123692.

21. Factors the courts used to hold as conclusive are now only non-conclusive aids in determining the promisor’s legitimate business interest, which is but one component in the three-prong rule of reason, grounded in the totality of the circumstances

22. Vast body of case law establishing factors that a court can consider in determining the employer’s legitimate interest remains intact EXCEPT Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App.3d 421 (4th Dist. 2009) was expressly overruled; and The two-factor test established in Nationwide Advertising Service, Inc. v. Kolar, 28 Ill. App.3d 671 (1st Dist. 1975) is no longer conclusive.

23. After being laid off Jack, Larry, and Stan decide to form their own competing company. All three had signed agreements with their former employer which contained restrictive covenants. Their employment agreements were not identical. They did not receive stock options, bonuses, or a higher salary for agreeing to the restrictive covenants.

24. Jack, Larry, and Stan worked in the automotive industry for a company named “Rustbucket, Inc.”. Jack is an engineer with detailed knowledge of patented manufacturing processes. Larry was a salesperson with no specialized knowledge, but lots of customer contact. Stan was an executive vice-president who negotiated his non-compete prior to accepting the job.

25. Scenario Rustbucket, Inc. sues all three men alleging violations of their restrictive covenants. Stan, the executive vice-president, worked for the Plaintiff for eight months. He now moves for declaratory relief on the grounds of inadequate consideration.

26. Should Stan’s motion for declaratory relief be granted? • Yes • No

27. Adequate Consideration 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. Fifield v. Premier Dealer Services, Inc., 2013 IL App (1st) 120327, ¶ 14.

28. “Generally, Illinois courts have held that continued employment for two years or more constitutes adequate consideration.” Fifield, 2013 IL App (1st) 120237, ¶ 14.

29. Jack’s (the engineer) employment agreement contains a provision that prohibits Jack from competing for a five-year period anywhere in the United States in the area of the “manufacture, sale, distribution, or servicing of computer equipment found in or on any automobile”.

30. Jack moves to dismiss under section 2-615 on the grounds that the temporal and geographic restrictions are overbroad.

31. Rustbucket, Inc. argues that the restrictive covenant is not overbroad because it manufactures cars that are sold in every State and therefore Jack would be competing anywhere he worked in the United States. Also, the temporal restriction is valid because its employees usually work for them for more than five years.

32. The Motion to Dismiss is • Granted • Denied

33. “At the outset, we question whether a section 2-615 motion to dismiss is an appropriate vehicle to decide issues that are essentially very fact-intensive, since section 2-615 restricts the trial court to the ‘four corners’ of the complaint.” Baird & Warner Residential Sales, Inc. v. Mazzone, 384 Ill. App.3d 586, 591 (1st Dist. 2008).

34. Larry’s (the salesperson) employment agreement prohibits him from soliciting existing customers, including but not limited to customers with whom he had personal contact, and potential customers, including prospects, anywhere in the United States for a period of two years following termination of his employment.

35. Larry moves to dismiss on the grounds that the covenant is vague and overbroad.

36. The Motion to Dismiss is • Granted • Denied • Granted in part, denied in part

37. As a matter of law, an employer cannot have a protectible interest in future customers who do not yet exist. Eichmann v. Nat’l Hospital & Health Care Services, Inc., 308 Ill. App.3d 337, 346 (1st Dist. 1998).

38. BEWARE! (However) If the employer is operating in a niche market and devotes substantial time and resources to the development of prospects, the employee could be enjoined from utilizing the prospect list for his own benefit after termination.

39. In addition, the covenant prohibits Larry from soliciting other salespeople to leave Rustbucket’s employ. After Larry is terminated, he promptly asks others in the sales department to join him in the new firm and proceeds to contact his five largest customers.

40. Larry’s covenant also prohibits him from disclosing any of Rustbucket’s “confidential information” defined in the agreement as “all information in whatever form, relating to the company’s business, including, but not limited to customer lists, customer contact information, customer ordering history, customer pricing, automotive equipment specifications, the company’s suppliers, and employee training manuals.”

41. Larry moves to dismiss, asserting that, as a matter of law, his restrictive covenant is overbroad in that its non-disclosure provisions cover virtually every aspect of the company’s business and encompasses information that is clearly not confidential or a trade secret. Rustbucket responds contending the covenant is valid and further responds that, if the court finds that only some parts of the covenant are valid, it should enforce those provisions.

42. What are the relevant factors? • Consider: • Are the provisions clearly reasonable in time and activity restrictions? • Has Larry violated those provisions? • Do the non-disclosure provisions work a hardship on Larry? • Would denying enforcement of the covenant because of the over-breadth of a portion of it deprive the employer of bargained-for protections?

43. Is there a severability clause in the parties’ agreement?

44. Blue-Pencilling “Blue-pencilling “= Editing in order to carve out certain unenforceable provisions while preserving reasonable restraints, i.e. enforceable provisions. Does “blue-pencilling” result in significant alteration of the agreement?

45. “Slight” modifications have been upheld where the balance of the restrictions were reasonable and necessary to protect the employer’s interests. Arpac Corp. v. Murray, 226 Ill. App.3d 65, 80 (1992) (Court found covenant restricting ex-employee from competing in the shrink-wrap industry “in any capacity” overbroad, but enforced other reasonable restrictions.

46. But, even if the parties include a “reformation clause”, rewriting an overbroad covenant is inadvisable. Cambridge Engineering, Inc. v. Mercury Partners, 378 Ill. App.3d 437 (2007).

47. Assume that the motions to dismiss have been denied. After discovery, Jack, Larry, & Stan move for summary judgment because they claim that the evidence does not establish “near permanence of customer relationships.”

48. Plaintiff argues that it has established near-permanence because • The Defendants would not have come into contact with the customers but for their employment with Plaintiff. • There is a limited number of customers.

49. Plaintiff makes sure it contacts its customers at least once a month to make sure the customer is satisfied. • It takes about 6 months to develop a relationship whereby the customer decides to hire Plaintiff.

50. The Motion for Summary Judgment is • Granted • Denied