New Standards in Drafting and Enforcing Covenants Not to Compete Under Illinois Law

Our firm's clients regularly ask for advice regarding the enforceability of covenants not to compete. Unlike most contracts, restrictive covenants are not automatically enforced by the courts since they constitute a restraint of trade. Contracts containing covenants not to compete are only upheld if deemed "reasonable" by examining a variety of factors established by the courts in Illinois. It is crucial to have well drafted agreements in cases where covenants not to compete are necessary to protect the legitimate business interests of a client, such as in an employer/employee relationship or the purchase or sale of businesses. The Illinois Supreme Court recently issued its decision in Reliable Fire Equipment Co v Arredondo, 2011 IL 11171 (2011), which changed the standards for the enforceability of covenants not to compete in Illinois in the employment arena.

I. Supreme Court of Illinois Decision in Reliable

Reliable was a company seeking to enforce employment agreements signed by two of its employees, which included agreements on the part of the employees not to compete with the company and not to solicit the company's employees to leave their jobs. The employees formed a competing company and left their employment with Reliable. Subsequently, the company filed a complaint alleging that its former employees had violated the noncompete provisions of their employment agreements. Following a trial, the court ruled that the noncompete covenants contained in the employment agreements were overbroad and therefore unenforceable. The case was appealed to the Appellate Court of Illinois and, eventually, to the Supreme Court of Illinois.

The Supreme Court ruled that a three-part test for reasonableness exists for covenants not to compete in the context of employment relationships: 1) whether the restraint imposed by the covenant is not greater than necessary to protect the legitimate business interest of the employer; 2) whether no undue hardship is imposed on the employee; and 3) whether there is no injury imposed on the public by enforcement of the covenant.

Under the three-part test, the employer must possess a "legitimate business interest" in order to enforce a covenant not to compete made by an employee. The Supreme Court found that there is "no exact formula" or "conclusive" test to assess an employer's legitimate business interest. Prior to the Reliable case, courts required employers to prove a "near permanent" relationship with their customers according to a rigid test in order to enforce most covenants not to compete. The Supreme Court in the Reliable decision created the following new test for evaluating the enforceability of employee covenants not to compete:

[W]hether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case. Factors to be considered in this analysis include, but are not limited to, the near-permanence of customer relationships, the employee's acquisition of confidential information through his employment, and time and place restrictions. No factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.

The Reliable case was returned to the trial court for further proceedings to allow the employer to introduce additional evidence and argument regarding the new totality of the circumstances test.

II. Other Important Standards Applicable to Covenants Not To Compete

If a covenant not to compete is introduced or modified after the start of the employment relationship, it must be supported by new consideration, such as a bonus paid above the employee's regular salary or continued employment for a reasonable period, depending on the individual circumstances of the case. If the covenant not to compete includes a provision stating that Illinois law or some other state's law applies, Illinois courts generally will enforce such a provision. An employer may choose to have the agreement governed by the laws of another state in cases where a particular state's laws are more favorable to employers. However, if the chosen law has no connection to the parties or if it is contrary to Illinois' public policy, it may not be enforced. One court in Illinois rejected the parties' choice of Florida law in an employment agreement because it did not allow consideration of the hardship to the employee imposed by the terms of the agreement.

A covenant not to compete may include a provision that if the employee is in breach, the non-competition period will be extended by a time equal to the period of time during which the employee was in violation of the noncompete provisions. In addition to a covenant not to compete, an employer should consider including separate covenants for non-solicitation of customers, non-solicitation of employees, as well as confidentiality agreements.

III. Conclusion

We recommend that existing covenants not to compete governing employees be reviewed given the recent changes in the law and the broad discretion now given to courts to consider the totality of the circumstances as the new standard laid down by the Illinois Supreme Court in Reliable. Each situation must be considered individually to determine if a covenant not to compete is enforceable. Some employers may be well advised to re-draft existing covenants not to compete or adjust their litigation strategies. Employees must also re-evaluate their positions if they are considering executing a covenant not to compete or are involved in a dispute with their employer regarding such a covenant.

The bottom line is that the Illinois Supreme Court's decision in Reliable has broadened the potential enforceability of covenants not to compete and given trial courts greater discretion in evaluating the totality of the circumstances supporting the enforcement of such a covenant. It is essential for clients to evaluate their employment agreements under these new standards. Our firm has a broad depth of experience in negotiating, drafting, enforcing and litigating covenants not to compete, whether in employment situations or in the context of the purchase or sale of a business.