Illinois Supreme Court Issues Landmark Decision on Non-Compete Agreements

December 06, 2011

Summary:

Last Thursday, the Illinois Supreme Court issued an important decision in a case involving the enforceability of non-compete agreements. Since 2009, lower courts in Illinois have been debating whether an employer needs to show the existence of a "legitimate business interest" in order to enforce a restrictive covenant against a former employee. In Reliable Fire Equipment Co. v. Arredondo, the Illinois Supreme Court held that proof of a legitimate business interest remains necessary. At the same time, the court rejected prior cases in which legitimate business interests were narrowly defined or were subject to rigid tests. Instead, the court said that each case must be determined on its own facts based on a "totality of the circumstances." As a result of the court’s opinion in Reliable Fire, it probably will be easier for employers to enforce restrictive covenants in Illinois, although it will remain important for such covenants to be narrowly tailored to reduce the hardship on the employee and the injury to the public.

Action Item:

Employers should review their employee non-compete and non-solicitation agreements to ensure that such agreements are no broader than necessary to protect the employer’s legitimate business interests. In addition, employers should continue to ensure that newly hired employees honor any prior legal obligations they may owe to former employers.

Discussion:

For many years, courts in Illinois have required employers to show the existence of a "legitimate business interest" as the first step in enforcing a restrictive covenant, such as a non-compete or non-solicitation agreement. Over time, this requirement has become increasingly rigid. In fact, some courts had taken the position that there were only two possible legitimate business interests: the protection of "near-permanent" customer relationships and the protection of confidential information/trade secrets. If the employer could not show that the covenant protected one of these interests, then these courts would refuse enforcement, even if the restriction was otherwise reasonable in its scope and duration.

Rebelling against the inflexibility of this analysis, the 4th District of the Illinois Appellate Court announced in 2009 in Sunbelt Rentals, Inc. v Ehlers that it was no longer going to apply the "legitimate business interest" test. The Sunbelt Rentals Court deemed the test an inappropriate gloss on prior Illinois caselaw. Instead, the 4th District held that the only relevant question in cases involving a restrictive covenant was whether the covenant was reasonable – in other words, did the covenant impose an undue burden on the employee or the public and was it broader than necessary? This standard was generally viewed to be more favorable to employers seeking to enforce non-compete agreements against former employees. As a result of the decision in Sunbelt Rentals, a split developed between the districts of the Illinois Appellate Court, with some courts applying the prior "legitimate business interest" test and other courts ignoring this requirement altogether.

In Reliable Fire Equipment Co. v. Arredondo, the Illinois Supreme Court finally clarified the standard to be applied. Reliable Fire involved a suit by an employer against two former employees and their new company. The employer alleged, among other things, that the former employees breached a one-year non-compete, a customer non-solicit, and an employee non-solicit. The trial court held for the defendants, ruling that the employer’s non-compete and non-solicit provisions were unenforceable because the employer could not show the existence of a "legitimate business interest." A panel of the Illinois Appellate Court sharply split in its reasoning, but ultimately affirmed the trial court’s decision.

Reversing and remanding the case for further proceedings, the Illinois Supreme Court held that restrictive covenants are governed by a "rule of reason" consisting of "three prongs":

1. The covenant must be no greater than necessary for the protection of the employer’s reasonable business interest;

2. The covenant must not impose an undue hardship on the employee; and

3. The covenant must not be injurious to the public.

In addressing the first requirement, the court stated that the employer’s legitimate business interest must be more than simply a desire to suppress ordinary competition. At the same time, the interest need not fall into one of the two rigid categories that been developed in some prior cases. The court stated that "near permanent" customer relationships and confidential information/trade secrets are merely two examples of legitimate business interests that might exist for an employer. Moreover, the court refused to endorse any of the previous tests that had been used by lower courts to determine whether a legitimate business interest existed. Instead, the court held that judges should examine the "totality of the circumstances" in the case to determine whether a covenant is enforceable.

The result of the court’s decision in Reliable Fire is undoubtedly to make it easier for employers to show the existence of a legitimate business interest and thereby to enforce restrictive covenant agreements. However, the Illinois Supreme Court expressly overruled the approach of the 4th District in Sunbelt Rentals that would have done away with the legitimate business interest test altogether. Therefore, employers will need to continue to provide a business-based justification for restrictive covenants and ensure that such covenants are appropriately limited in the activity that they prohibit, the geographic area to which they apply, and the time period during which they remain in effect.

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