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Restrictive Covenants and a Changing Legal Landscape:

Helping Employees and Employers Navigate Uncertainty – Part II

Sarah R. Marmor

Scharf Banks Marmor LLC

This is Part II in a two-part series about restrictive covenants and the laws that govern them.

Part I of this article laid out the basic principles of restrictive covenants and contemplated how these agreements may affect the fictional executive seeking to work for a competitor.

 Illinois: A Case Study in What is Changing and What Remains the Same

Illinois traditionally was a pretty middle-of-the road state in terms of enforcing restrictive covenants. It did not, like California, ban such agreements outright. Under California Business and Professions Code section 16600, “every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” (There are nuances even here—employee non-solicits generally are enforceable and confidentiality provisions certainly are). In Illinois, as in most other states, restrictive covenants can be enforced so long as they are reasonable in scope and time. But over the past several years, Illinois has been part of a trend towards putting some guard rails around these sorts of agreements—especially as they pertain to low-wage workers.

In 2016, Illinois passed the Illinois Freedom to Work Act (IFWA), which prohibits restrictive covenant agreements for employees who earn less than the greater of an hourly rate equal to the applicable federal, state or local minimum wage, or $13 per hour. 820 ILCS § 90/10. This law was triggered in part by a lawsuit brought against a fast-food chain over “highly restrictive non-compete agreements on . . . low-wage sandwich shop employees and delivery drivers whose primary job tasks are to take food orders and make and deliver sandwiches.” This was a pretty reasonable limitation—it’s hard to justify barring a worker making $12 an hour from taking any other job. If the employer isn’t investing that much in its employees, it seems unfair to interfere with their mobility.

In May 2021, the Illinois legislature amended and expanded the IFWA. The amendments are expected to become effective on January 1, 2022 but will not be retroactive. In many respects, the amendments simply codify existing Illinois common law regarding restrictive covenants. What is really new are salary thresholds defining who can and cannot be subject to these sorts of agreements; a special rule for pandemic (and like) terminations and furloughs; and “due process” rights to ensure employees are told to get, and have time to obtain, legal advice before signing a restrictive covenant agreement.

While those “due process” rules may require more upfront work by employers as well as revisions to their agreements, in the long run, this should help employers who want to enforce their agreements later, as many employees seem not to pay sufficient attention to these agreements and sign them at the beginning of their employment and then forget about them. However, the statute also permits a prevailing employee to recover attorney’s fees—a major shift in the law that levels the playing field in an area where many restrictive covenant agreements have a one-way fee provision that only permits the employer to recoup prevailing party fees. The upside for some employers, however, is that this new rule may make a former employer less likely to sue over a departing employee—a boon to the company the employee wants to join.

Finally, the statute also provides parameters under which a court may “blue pencil” a restrictive covenant agreement—i.e., rewrite an otherwise unenforceable provision or enforce part of an agreement even if other parts are invalid.

The amendment codifies the factors Illinois courts already consider in determining whether a covenant not to compete or a covenant not to solicit is enforceable:

Sec. 15. Enforceability of a covenant not to compete or a covenant not to solicit. A covenant not to compete or a covenant not to solicit is illegal and void unless (1) employee receives adequate consideration, (2) the covenant is ancillary to a valid employment relationship, (3) the covenant is no greater than is required for the protection of a legitimate business interest of the employer, (4) the covenant does not impose undue hardship on the employee, and (5) the covenant is not injurious to the public.

The amendment also codifies the “two-year” rule for “adequate consideration” articulated in Fifield v. Premier Dealer Services, Inc., 2013 Ill. App. (1st) 120327 under which a restrictive covenant agreement (non-compete and non-solicit obligations) will only be deemed enforceable either if the employee has worked for the employer for at least two years after signing the agreement or the employer otherwise provided consideration for the agreement. Courts and commentators have been uncertain what constitutes adequate consideration for restrictive covenant agreements—whether a cash payment or training or something else—and the new law at least attempts to define this aspect of “adequate consideration” as:

the employer otherwise provided consideration adequate to support an agreement to not compete or to not solicit, which consideration can consist of a period of employment plus additional professional or financial benefits or merely professional or financial benefits adequate by themselves.

While this definition is not particularly prescriptive, the provision as a whole resolves a long-standing split between federal and state courts in Illinois. Many federal courts had refused to follow the two-year bright-line rule set out by Fifield, while state courts did. This split provided an incentive, depending on which side one was on, to forum shop in Illinois—which now should be unnecessary as federal courts can be expected to follow the terms of the statute.

Section 7 of the statute codifies how courts will determine “legitimate business interests of the employer.” In Illinois, for a restrictive covenant agreement to be enforceable, the employer must show that the restrictions serve a legitimate business interest. In Reliable Fire Equipment Co. v. Arredondo, 2011 IL 111871, the Illinois Supreme Court adopted a “totality of the circumstances” approach to making a “legitimate business interest” determination, and the new statute adopts the same approach:

In determining the legitimate business interest of the employer, the totality of the facts and circumstances of the individual case shall be considered. Factors that may be considered in this analysis include, but are not limited to, the employee’s exposure to the employer’s customer relationships or other employees, the near-permanence of customer relationships, the employee’s acquisition, use, or knowledge of confidential information through the employee’s employment, the time restrictions, the place restrictions, and the scope of the activity 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. Such factors are only non-conclusive aids in determining the employer’s legitimate business interest, which in turn is but one component in the 3-prong rule of reason, grounded in the totality of the circumstances. Each situation must be determined on its own particular facts. Reasonableness is gauged not just by some, but by all of the circumstances. The same identical contract and restraint may be reasonable and valid under one set of circumstances and unreasonable and invalid under another set of circumstances.

While the “2-year or other consideration” rule gives litigants a fairly bright-line test for enforceability, the “legitimate business interest” rule as articulated by the legislature is a reminder that litigation in this area is fact-intensive. Employers seeking to enforce their agreements will need to come to court prepared to tell a compelling story about why an employee’s violation of an agreement requires redress. Even if on its face an agreement is enforceable, the nature of the specific employee’s job, what information the employee possesses, and the damage the employee has done or could do if working for a competitor or soliciting clients or employees all will determine if an employer really has the ability to enforce the terms of the agreement.

Building on the original statute, the amendments set even higher bars against applying non-competes and non-solicits to relatively low-wage workers and, for the first time, provide relief to employees who are laid off because of pandemics. The law bars covenants not to compete for any employee making less than $75,000 per year. This threshold will rise by $5,000 increments every five years after 2022, through January 1, 2037. There also is a threshold for covenants not to solicit employees or clients. These can only apply to employees making more than $45,000 a year (“annualized rate of earnings”). That threshold will rise by $2,500 every five years after 2022, through January 1, 2037.

As to all employees, employers may not enter into either non-competes or non-solicits with an employee who was laid off or furloughed as a result of business circumstances related to the Covid-19 pandemic or similar circumstances—unless enforcement includes payment of base salary for the duration of the restricted period, minus pay the employee is able to earn during the enforcement period. The amendment also requires employers to (1) advise the employee in writing to consult with an attorney before signing an agreement and (2) provide the employee fourteen calendar days to consider the agreement.

The Illinois amendment is a model that other states may emulate. It puts in one statutory place all of this state’s law with respect to restrictive covenant agreements (with the exception of confidentiality and trade secret matters); highlights the fact-specific nature of most of these disputes; and sets real bright-line rules that ought to help employers and employees alike determine when these sorts of restrictions are appropriate and whether they can be enforced.

 Practical Tips for Negotiating a Job Transition

This, as they say, is a lot. How does our highly paid executive with a 2013 agreement that may be enforceable as a general matter navigate her way out of the old job and into the new one? The executive doesn’t want a dissertation on the nuances of consideration or the “totality of the circumstances.” The good news is that her employer and prospective employer probably feel the same way. Most sophisticated companies know that the door between them and their competitors is likely to revolve—and what goes around comes around. Neither company likely wants the expense and uncertainty of litigation, even for very top executives. With a little advance planning and some creativity, even the most forbidding restrictive covenant agreements can be managed if you follow these principles.

First, be “Caesar’s Wife.” The old adage that Caesar’s wife must be above suspicion is the single most important advice you can give your client, whether it’s the executive or the company who wants to hire her. In practice, this means the executive should disclose her agreement to the new employer (if she knows she has one). Even more important, she must not do anything to suggest that she has downloaded or otherwise copied her employer’s confidential information, has tried to get others to leave with her, or has told clients she is leaving and encouraged them to come with her (or worse, disparaged her employer). Such behavior is likely to trigger litigation by an angry former employer. (See Lyft’s lawsuit against its former COO when he allegedly downloaded 1,400 files and folders to his personal dropbox before leaving to work for Uber.) Even in employee-friendly California, if a departing employee has engaged in such “bad faith” behavior, a court might impose a non-compete or non-solicitation obligation as a penalty. In other states, such behavior can be used as proof that the employee knows she is going to a competitive role and intends to use her knowledge to her former employer’s detriment—strongly enhancing the chances that the restrictive covenant agreement will be enforced.

There is no upside to downloading in the weeks leading up to a departure. If the executive has personal items she wants to take off her devices before she leaves, she can manage that after she has given notice and with full disclosure to the employer. Most large employers have a process to allow such a transfer to happen cleanly. Even if the executive meant well, trust will be broken, and it will be that much harder to exit without litigation or more significant compromises than otherwise would be necessary. And in extreme cases, the executive could open the new employer up to its own liability—which is not the best way to start a new job.

Second, be prepared and transparent. When giving notice, think about what the employer will be worried about. Have a job description at the ready that demonstrates the differences between the old job and the new one. Don’t use the generic job description from the new employer (these are almost always vague and overbroad and can be twisted to mean anything) but do make sure the new employer has reviewed and approved the description. Identify the title of the job, the business unit and geographic scope (if applicable) and a few sentences about the functional duties of the role. Contrast that with what the executive did for the old employer. And if there are obvious areas of concern—if, for example, there’s some aspect of the job the executive knows would raise red flags—lead with a proposed compromise, demonstrating that the executive understands points of contention and is prepared to address them fairly. Of course, this requires that the executive and her new employer agree on the compromise—and agree she will be able to thrive in the new job with whatever that limitation is.

Finally, craft solutions to align both with the legal standards and company interests. The executive may think she has only ten “hands off” clients that she can’t solicit. It is common for the employer to argue there are more. If the old employer comes back with a few more names, and if the new one doesn’t care, then it may be wise just to agree to the additions to reach a conclusion. But if the list comes back with 300 names (this has happened in my own experience, albeit only once), look to the law of the jurisdiction and push back forcefully. Some non-solicits purport to bar solicitation of all of a company’s clients, but it is unlikely such a provision would ever be enforced in any state, including those that are thought to be more employer-friendly (e.g., Georgia or Florida). Frame the argument in terms the company’s lawyers will understand—in New York, one could argue there’s no risk of “inevitable disclosure” of confidential information relating to clients the executive never worked on, in line with the seminal decision in IBM v. Visentin, 2011 U.S. Dist. LEXIS 15342 (S.D.N.Y. Feb. 16, 2011), in which the court refused to enjoin an IBM executive’s departure to Hewlett-Packard absent evidence he would inevitably disclose confidential information in the new job. In Illinois, one could argue the clients did not have a “near-permanent relationship” with the company, in accord with Reliable Fire. The point is not to trigger a court fight; rather, it is to show there isn’t a good reason for the employer to start one.

At the end of the day, most employees are able to move from one competitor to another without too much pain and drama. Approaching restrictive covenant agreements with some imagination and flexibility ought to result in the executive being free to carry on her career and hopefully without any ill will from her former employer.

Sarah R. Marmor heads Scharf Banks Marmor’s Employment Counseling and Litigation Practice. She concentrates her practice on employment law, complex business litigation, and life sciences/product liability. Sarah has tried complex cases throughout the United States, in state courts in Illinois, Colorado, Oklahoma, Louisiana and Texas and in federal courts in Illinois, Michigan, California and New York. Sarah co-presented Hot Topics in Compliance and Ethics, available from PLI Programs On Demand, and co-authored Product Liability Litigation: Current Law, Strategies and Best Practices (Second Edition) (read now on PLUS).

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