Illinois Appellate Court Departs From Thirty Years of Precedent and Signals a Significant Change in Restrictive Covenant Law
November 2, 2009
Francesco M. "Frank" Nardulli- Chicago
The Fourth District Appellate Court of Illinois recently departed from three decades of state case law concerning restrictive covenants in a decision that could signal a major shift in how Illinois courts analyze and enforce non-compete agreements. In Sunbelt Rentals, Inc. v. Ehlers, No. 4-09-0290 (Ill. App. Ct. 4th Dist. Sept. 23, 2009), the court ruled that employers do not need to establish a legitimate or protectable business interest under Illinois law to create an enforceable non-compete agreement; rather, they must only show that the covenant is “reasonable” both as to duration and territorial scope.
As a result of the court’s decision, it will become less difficult to enforce non-compete agreements in the Fourth Appellate District, and such covenants will no longer be limited to those industries and employers that have traditionally been able to establish a legitimate business interest. Although the Sunbelt decision may seem like a boon to employers that require employees to agree to restrictive covenants as part of their employment, the court’s ruling creates significant risks for employers who hire an individual who is subject to a non-competition agreement with a former employer, and thus could hamper employers’ ability to hire individuals with significant work experience.
Legal Background
Generally, an employer may preclude a former employee from competing with it or becoming employed by a competitor if it can show: (1) that its former employee agreed to a non-compete agreement that was supported by adequate consideration, and (2) that the terms of the non-compete agreement are reasonable and necessary to protect a legitimate business interest of the employer. For more than 30 years, Illinois courts have required employers to demonstrate a legitimate business interest to support a non-competition agreement to ensure that employers are not simply insulating themselves from ordinary competition.
As a result, in most Illinois jurisdictions, to prohibit a former employee from competing or working for a competitor, the employer must show: (1) that it has a legitimate and protectable business interest, and (2) that the terms of the covenant are reasonable as to duration and geographic reach. Under this test, employers can show that a legitimate business interest exists: (1) where the customer relationships are near-permanent and but-for the employee’s association with the employer, the employee would not have had contact with the customers; and (2) where the former employee acquired trade secrets or other confidential information through his/her employment and subsequently tried to use it for his/her own benefit. Until Sunbelt, Illinois courts have typically refused to enforce non-compete agreements if the employer could not establish a legitimate and protectable business interest.
The Sunbelt Decision
Sunbelt arose out of the defendant’s acceptance of a position that was similar to the position he held for the plaintiff, Sunbelt Rentals, a company that rents and sells industrial equipment to both commercial and residential customers. The defendant, Neil Ehlers, first worked at Sunbelt’s Bloomington, Illinois branch as a sales representative, until he was transferred to its branch in Champaign. Prior to his employment with Sunbelt, Ehlers signed an employment agreement with a covenant restricting him from working, for one year following the termination of his employment, with a competitor within 50 miles of any Sunbelt Rentals branch where he had been employed.
Six years after he started working for Sunbelt, Ehlers applied for and was offered a sales representative position with Midwest Aerials & Equipment, a company that rents and sells aerial equipment to industrial and construction customers. While he was employed with Midwest, Ehlers worked within the territorial scope of the non-compete agreement he had signed.
When Sunbelt learned that Ehlers was working as a sales representative for Midwest Aerials, it filed an action to enjoin both Ehlers and Midwest Aerials from continuing to violate the terms of the restrictive covenant Ehlers had signed. The lower court granted Sunbelt’s injunction without applying the legitimate business interest test because it found the restrictive covenant to be reasonable in time and geographic scope. It did so because it found that the test “had been encompassed by the Illinois Supreme Court’s time-and-territory reasonableness test.” The defendants appealed the decision, arguing that the lower court failed to apply controlling precedent, that it did not apply the legitimate business interest test, and that the non-compete agreement was not reasonable as to both time and geographic scope.
The trial court’s decision – that the 50-mile, one-year non-compete agreement was reasonable and thus enforceable – was affirmed on appeal. In reaching that result, however, the appellate court rejected the “legitimate business interest” test altogether and the substantial body of law supporting it. The appellate court found that the test was inconsistent with Illinois Supreme Court precedent; also, that the Illinois Supreme Court had never applied the test to non-compete agreements.
According to the court, “when presented with the issue of whether a restrictive covenant should be enforced,” courts “should evaluate only the time-and-territory restrictions contained therein.” It went on to announce that whether a time and territory restriction is reasonable depends on: (1) whether enforcement would be injurious to the public or cause undue hardship to the employee, and (2) whether the restrain imposed is greater than necessary to protect the employer. Without any reference to a protectable interest of the employer, such a stand-alone reasonableness test could be applied so broadly as to swallow the rule that restrictive covenants should be limited in scope.
Potential Effect on Employers
As noted, Sunbelt is a significant departure from decades of Illinois precedent concerning the enforceability of non-compete agreements. Employers should keep in mind, however, that the decision does not bind the courts of Cook County or any other court outside of the Fourth Appellate District, which covers central Illinois. Other courts may continue to apply the legitimate business interest despite the reasoning of the Fourth District – although at least one dissenting judge in the Third Appellate District has supported the Fourth District’s reasoning. It is also likely that the defendants will seek a review of Sunbelt from the Supreme Court of Illinois because the Fourth Appellate District Court’s reasoning is problematic. It relies on a line of cases involving professional service employees, but does not acknowledge that it is presumed that a legitimate business interest exists in such instances because professionals form a “near permanent” relationship with clients. Also, it can be challenged on public policy grounds, because it essentially allows an employer to tie up any employee regardless of any necessity so long as the restriction is reasonable in time and territory.
In the meantime, Illinois employers must be prepared to address the consequences of the Sunbelt decision. In the short term, the decision probably does not affect the drafting of non-competition agreements, and it likely will make such agreements easier to enforce against departing employees. The real impact, however, is on employers who hire individuals who are subject to non-competition agreements, because this decision will make it much harder to defend against a lawsuit by arguing that the non-competition agreement signed by the employee you hired is not enforceable.
Regardless of their exposure to trade secrets or the nature of client relationships in a particular industry, candidates with invaluable industry experience could now be subject to a non-compete agreement. Accordingly, before hiring new employees, employers should confirm that applicants and potential hires have not entered into non-compete agreements with their former employers. Employers should require that all applicants reveal any non-competes to which they are subject and that they produce of a copy of any such agreement. Furthermore, all offer letters and employment agreements should specify that failure to disclose an applicable restrictive covenant is grounds for immediate discharge.
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