by Joshua B. Rosenzweig (Summer 2016)
Restrictive covenants are designed to prevent former employees from using proprietary information gained from an employer against the employer. Restrictive covenants include restraints on the solicitation of clients, prohibitions against competing with a former employer, and restricting disclosure of proprietary information gained through one’s employment. Because restrictive covenants operate as a “restraint on trade,” they are not favored by Illinois courts, and therefore, restrictive covenants come under significant scrutiny.
In Illinois, a restrictive covenant is unenforceable unless the terms of the covenant are reasonable and necessary to protect an employer’s legitimate business interests (see Reliable Fire Equipment Co. v. Arredondo, 2011 IL 111871 (1st Dist. 1992)). Illinois courts conduct a multi-part, multi-layered inquiry to determine the propriety of a restrictive covenant. Courts begin this multi-faceted process by making an initial, two-part inquiry: (1) a restrictive covenant must be ancillary to a valid transaction or relationship such that the covenant is subordinate to the main purpose of the transaction (see Liautaud v. Liautaud, 221 F.3d 981 (7th Cir. 2000)); and (2) a restrictive covenant must be supported by adequate consideration (see Lawrence & Allen, Inc., v. Cambridge Human Resource Group, Inc., 292 Ill.App.3d 131 (2nd Dist. 1997)).
What does it mean for a restrictive covenant to be “ancillary to a valid transaction”? In its most basic terms, a restrictive covenant must not be the main purpose of the agreement between two parties. For example, in Creative Entertainment, Inc., v. Lorenz, 265 Ill.App.3d 343, 348–49 (1st Dist. 1994), the First District considered the enforceability of a restrictive covenant signed by an employee eight months after his employment began. There were no negotiations of the terms of employment. Rather, defendant’s employment was at-will and subject to change at any time in plaintiff’s sole and exclusive discretion. The trial court characterized the agreement as a “naked agreement,” and the First District agreed with that characterization. There was no employment agreement, and therefore, the restrictive covenant was its own, individual agreement, and therefore, it was the main purpose of the agreement.
What is “adequate consideration”? Consideration is a legal concept that, in its most basic form, involves an obligation undertaken by a party. 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 (see Diederich Insurance Agency, LLC v. Smith, 2011 IL App (5th) 100048, ¶ 15). Unless adequate consideration has been given, a restrictive covenant will not be enforced (see Millard Maintenance Service Co. v. Bernero, 207 Ill.App.3d 736, 744 (1st Dist. 1990)).
The Third District Appellate Court has held that where an employee signed a restrictive covenant prohibiting him from competing with an employer, and then resigned only seven months later, adequate consideration had not been given to support the non-compete because he did not work for the employer for two years (see Brown & Brown, Inc. v. Mudron, 379 Ill.App.3d 724, 729 (3rd Dist. 2008)).
Once the court determines that a scrutinized covenant is ancillary to a valid transaction and finds sufficient consideration, the court will determine whether the covenant is “reasonable.” In Illinois, a restrictive covenant is unenforceable unless the terms of the agreement are reasonable and necessary to protect an employer’s legitimate business interests. Reasonableness is determined on a case-by-case basis, which means there is no “hard and fast” rule employers can follow.
To determine reasonableness, Illinois courts engage in an additional multi-part inquiry: (1) the covenant must be no greater than is required for the protection of a legitimate business interest of the employer; (2) it cannot impose undue hardship on the employee; and (3) it cannot be injurious to the public (see Reliable Fire, at ¶ 17).
The existence of a legitimate business interest is based on the facts of each case. Factors to be considered include, but are not limited to, the near-permanence of customer relationships, the employee’s acquisition of confidential information through his/her employment, and time and place restrictions. Customer lists, where secret, will be considered a legitimate business interest an employer can protect (see Reliable Fire, at ¶ 37). The court will then consider the hardship imposed and whether injury to the public will occur. In evaluating these two factors, the courts will, again, look to the intricacies of the particular covenant involved.
If your business intends to use a restrictive covenant, keep in mind that any restrictive covenant in Illinois will be considered a “restraint on trade.” As such, the proposed restrictive covenant will be heavily scrutinized. And, it will be the employer’s burden to demonstrate that the covenant passes the multi-faceted inquiry made by an Illinois court. An employer must keep in mind each facet of the multi-part inquiry a court will make in determining the propriety of a restrictive covenant.