Breaking Up is Hard to Do: Restrictive Covenants

Please Release Me: Analyzing the
Enforceability of Restrictive
Covenants in Employment
Agreements
Mary Anne Mason
Justice of the Appellate Court, First District
Kathleen Pantle
Judge of the Circuit Court of Cook County
April 25, 2014
 Life was so simple then….
 Many decades ago, Fred began taking
lessons at Arthur Murray Dance Studio
in Cleveland, Ohio
 Fred progressed from having two left feet
to the pinnacle of modern dance becoming
Arthur Murray’s most popular instructor
 But Fred tired of barely eking out a living
and decided to branch out and a loyal
clientele followed.
 But although Fred was fleet of foot,
Arthur Murray took a heavy-handed
approach to enforcing Fred’s restrictive
covenant.
 More than 60 years ago, the court of Common
Pleas in Cuyahoga County, Ohio described the law
regarding an employee’s covenant not to compete:
 “It is a sea – vast and vacillating, overlapping and
bewildering. One can fish out of it any kind of
strange support for anything, if he lives so long.”
 Arthur Murray Dance Studio v. Witter, 105 N.E.2d 685
(1952)
 In the more than 6 decades following
that observation, that sea has become a
legal tsunami, threatening to
overwhelm even the most experienced
jurist.
 If you Google “restrictive covenants in
employment”, it generates more than
550,000 results.
 In the short time we have here today,
Judge Pantle and I will attempt to
navigate the treacherous seas of
restrictive covenants.
 What is a restrictive covenant?
 A means by which an employer seeks to
limit an employee’s post-employment
conduct by imposing restrictions
defined by time, geographical area,
activity and/or disclosure of confidential
information
Two Kinds of Restrictive Covenants
 Those ancillary to the sale of a business
 Those ancillary to a valid employment
relationship
 Today we will be concentrating on those
covenants that are ancillary to a valid
employment relationship
 Pre-Reliable Fire enforceability analysis:
 Restrictions were only justified if founded
upon a “legitimate business interest:
consisting of either
1. near-permanent customer relationships
or
2. trade secrets
 In the absence of one or both of these
protectable interests, many courts
found that efforts to circumscribe an
employee’s ability to compete following
termination of employment were
impermissible, e.g. Office Mates 5 v.
Hazen, 234 Ill. App.3d 557 (1992)
"Upset at you for breaching the
non-compete? Of course not."
Reliable Fire Equipment Co. v.
Arredondo, 2011 IL 111871
 Plaintiff filed a complaint alleging that
Defendants violated restrictive covenants
contained in their valid and enforceable
employment agreements by engaging in sales
activities and providing services to Plaintiff’s
customers; soliciting referrals from Plaintiff’s
referral sources; and soliciting several named
Plaintiff employees to leave their employment
with Plaintiff.
 After trial, the trial court ruled that the
restrictive covenants were unenforceable
concluding that Plaintiff failed to prove the
existence of a legitimate business interest.
Reliable Fire, 2011 IL 111871 at ¶8.
 A “sharply divided” appellate court affirmed.
Id. at ¶9.
 The Illinois Supreme Court reversed.
Adhered to well-established Illinois law:
Contracts in total and general restraint of
trade are void as against public policy…
 But, a contract which is only in partial restraint of
trade is valid provided,
 It is reasonable AND
 It has a consideration attached to it.
 Reliable Fire, 2011 IL 111871, ¶16, quoting Hursen v.
Gavin, 162 Ill. 377 (1896).
 Any covenant must be ancillary to either the sale
of a business or a valid employment relationship
Three-Prong Rule of Reason
 A court must consider whether the covenant:
 Is no greater than is required for the
protection of a legitimate business interest
of the employer-promisee;
 Does not impose undue hardship on the
employee-promisor; AND
 Is not injurious to the public
Legitimate Business Interest
Factors include but are not limited to:
 Near permanence of customer
relationships
 Employee’s acquisition of confidential
information through his employment
 Time and place restrictions
 The extent of the employer’s legitimate
business interest may be limited by:
 Type of activity
 Geographic area
 Time
 In the absence of a legitimate business interest in
need of protection, a plaintiff cannot satisfy the
three-prong rule of reasonableness necessary to
entitle it to judicial enforcement of a restrictive
covenant contained in an employment agreement.
 Gastroenterology Consultants of the North Shore,
S.C. v. Meiselman, 2013 IL App (1st) 123692.
 Factors the courts used to hold as
conclusive are now only non-conclusive
aids in determining the promisor’s
legitimate business interest, which is but
one component in the three-prong rule of
reason, grounded in the totality of the
circumstances
 Vast body of case law establishing factors that a
court can consider in determining the employer’s
legitimate interest remains intact EXCEPT
 Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App.3d 421 (4th
Dist. 2009) was expressly overruled; and
 The two-factor test established in Nationwide
Advertising Service, Inc. v. Kolar, 28 Ill. App.3d 671
(1st Dist. 1975) is no longer conclusive.
 After being laid off Jack, Larry, and Stan decide to
form their own competing company.
 All three had signed agreements with their former
employer which contained restrictive covenants.
 Their employment agreements were not identical.
 They did not receive stock options, bonuses, or a
higher salary for agreeing to the restrictive
covenants.
 Jack, Larry, and Stan worked in the automotive
industry for a company named “Rustbucket, Inc.”.
 Jack is an engineer with detailed knowledge of
patented manufacturing processes.
 Larry was a salesperson with no specialized
knowledge, but lots of customer contact.
 Stan was an executive vice-president who negotiated
his non-compete prior to accepting the job.
Scenario
 Rustbucket, Inc. sues all three men alleging
violations of their restrictive covenants.
 Stan, the executive vice-president, worked
for the Plaintiff for eight months. He now
moves for declaratory relief on the grounds
of inadequate consideration.
Should Stan’s motion for declaratory
relief be granted?
A. Yes
B. No
0%
A.
0%
B.
Adequate Consideration
 Continued employment for a substantial
period of time beyond the threat of
discharge is sufficient consideration to
support a restrictive covenant in an
employment agreement.
 Fifield v. Premier Dealer Services, Inc., 2013 IL
App (1st) 120327, ¶ 14.
 “Generally, Illinois courts have held that
continued employment for two years or
more constitutes adequate
consideration.”
 Fifield, 2013 IL App (1st) 120237, ¶ 14.
 Jack’s (the engineer) employment
agreement contains a provision that
prohibits Jack from competing for a fiveyear period anywhere in the United States in
the area of the “manufacture, sale,
distribution, or servicing of computer
equipment found in or on any automobile”.
 Jack moves to dismiss under section 2-615
on the grounds that the temporal and
geographic restrictions are overbroad.
 Rustbucket, Inc. argues that the restrictive
covenant is not overbroad because it
manufactures cars that are sold in every State
and therefore Jack would be competing
anywhere he worked in the United States. Also,
the temporal restriction is valid because its
employees usually work for them for more than
five years.
The Motion to Dismiss is
A. Granted
B. Denied
0%
A.
0%
B.
 “At the outset, we question whether a section 2-615
motion to dismiss is an appropriate vehicle to
decide issues that are essentially very factintensive, since section 2-615 restricts the trial court
to the ‘four corners’ of the complaint.”
 Baird & Warner Residential Sales, Inc. v. Mazzone,
384 Ill. App.3d 586, 591 (1st Dist. 2008).
 Larry’s (the salesperson) employment
agreement prohibits him from soliciting
existing customers, including but not limited
to customers with whom he had personal
contact, and potential customers, including
prospects, anywhere in the United States for
a period of two years following termination
of his employment.
 Larry moves to dismiss on the
grounds that the covenant is vague
and overbroad.
The Motion to Dismiss is
A. Granted
B. Denied
C. Granted in
part, denied in
part
0%
A.
0%
B.
0%
C.
 As a matter of law, an employer cannot
have a protectible interest in future
customers who do not yet exist.
 Eichmann v. Nat’l Hospital & Health Care
Services, Inc., 308 Ill. App.3d 337, 346
(1st Dist. 1998).
 BEWARE! (However)
 If the employer is operating in a niche
market and devotes substantial time
and resources to the development of
prospects, the employee could be
enjoined from utilizing the prospect list
for his own benefit after termination.
 In addition, the covenant prohibits Larry
from soliciting other salespeople to
leave Rustbucket’s employ.
 After Larry is terminated, he promptly
asks others in the sales department to
join him in the new firm and proceeds to
contact his five largest customers.
 Larry’s covenant also prohibits him from disclosing
any of Rustbucket’s “confidential information”
defined in the agreement as “all information in
whatever form, relating to the company’s business,
including, but not limited to customer lists, customer
contact information, customer ordering history,
customer pricing, automotive equipment
specifications, the company’s suppliers, and
employee training manuals.”
 Larry moves to dismiss, asserting that, as a matter of
law, his restrictive covenant is overbroad in that its
non-disclosure provisions cover virtually every aspect
of the company’s business and encompasses
information that is clearly not confidential or a trade
secret.
 Rustbucket responds contending the covenant is
valid and further responds that, if the court finds that
only some parts of the covenant are valid, it should
enforce those provisions.
What are the relevant factors?
 Consider:
 Are the provisions clearly reasonable in time
and activity restrictions?
 Has Larry violated those provisions?
 Do the non-disclosure provisions work a
hardship on Larry?
 Would denying enforcement of the covenant
because of the over-breadth of a portion of it
deprive the employer of bargained-for
protections?
 Is there a severability clause in the
parties’ agreement?
Blue-Pencilling
 “Blue-pencilling “= Editing in order to
carve out certain unenforceable
provisions while preserving reasonable
restraints, i.e. enforceable provisions.
 Does “blue-pencilling” result in
significant alteration of the agreement?
 “Slight” modifications have been upheld where
the balance of the restrictions were reasonable
and necessary to protect the employer’s interests.
 Arpac Corp. v. Murray, 226 Ill. App.3d 65, 80 (1992)
(Court found covenant restricting ex-employee
from competing in the shrink-wrap industry “in
any capacity” overbroad, but enforced other
reasonable restrictions.
 But, even if the parties include a
“reformation clause”, rewriting an
overbroad covenant is inadvisable.
 Cambridge Engineering, Inc. v. Mercury
Partners, 378 Ill. App.3d 437 (2007).
 Assume that the motions to dismiss
have been denied.
 After discovery, Jack, Larry, & Stan
move for summary judgment because
they claim that the evidence does not
establish “near permanence of
customer relationships.”
 Plaintiff argues that it has established nearpermanence because
 The Defendants would not have come into
contact with the customers but for their
employment with Plaintiff.
 There is a limited number of customers.
 Plaintiff makes sure it contacts its
customers at least once a month to
make sure the customer is satisfied.
 It takes about 6 months to develop a
relationship whereby the customer
decides to hire Plaintiff.
The Motion for Summary Judgment is
A. Granted
B. Denied
0%
A.
0%
B.
 Marsha Smith has been employed by
ABC Insurance Company as a
commercial lines insurance salesperson
for 10 years.
 The market for commercial lines
insurance is highly competitive. Policies
come up for renewal every year.
 Marsha’s employment agreement with ABC
prohibits her, for a period of one year after
the termination of her employment from
soliciting or accepting commercial lines
insurance business from clients whose
accounts she serviced within two years
preceding the termination of her
employment.
 During her tenure at ABC, Marsha developed
relationships with several longstanding clients.
Marsha is the “go to” person for all issues and
questions relating to these accounts. She has
entertained clients (at ABC’s expense) and has
socialized with them on non-business occasions.
All of her clients have Marsha’s cell phone
number.
 Marsha has decided to accept an offer from
one of ABC’s competitors. In an exit
interview, she affirms her understanding of
her restrictive covenant and indicates her
intention to honor it.
 On her last day, Marsha sends the following
email to each of her ABC clients:
 “After 10 rewarding years at ABC, I have
decided to accept another opportunity in the
insurance industry. I have derived great
professional satisfaction from the business
you have entrusted to me and I value my
relationship with both you and your
employees on a professional and personal
level.
 “My contract with ABC prohibits me, for a
period of one year, from soliciting or
accepting business from ABC clients that I
have serviced in the past two years and I
intend to honor that agreement. I hope again
to be in a position to meet your insurance
needs in the not-too-distant future.”
 Marsha does not send a copy of her email to
anyone at ABC.
 Following Marsha’s departure, several large ABC
clients whose accounts Marsha serviced move
their business to Marsha’s new agency. When
ABC’s president calls one of the clients to
introduce ABC’s new salesperson, that client
provides him with a copy of the email.
Has Marsha violated her restrictive covenant?
A. Yes
B. No
C. Maybe
0%
A.
0%
B.
0%
C.
 Does it make a difference if the evidence
shows that when contacted on her cell
phone, Marsha informed clients that she
could not give them her new office contact
information and reiterated her intention to
honor her non-compete?
 Does it make a difference if the
evidence shows that when contacted on
her cell phone, Marsha informed clients
of her new office contact information,
but that she intended to honor her noncompete?
 Does it make a difference if at the new
agency:
 Marsha is screened from contact with
her former clients, but shares in the
revenue generated by their business?
 What if Marsha is screened from contact
with former clients, does not share in
the revenue generated by their
business, but is paid a higher base salary
by the new firm for a period of one
year?
 Does is make a difference if Marsha’s
new firm already had accounts with
several of the clients for other lines of
insurance (but not commercial lines)?
“How To” Analysis
 Q # 1: Is the restrictive covenant
ancillary to either the sale of a business
or a valid employment relationship?
 If No, the ex-employee wins.
 If Yes, then go to the next question.
 Q # 2: Is there valid consideration for
the restrictive covenant?
 If No, the ex-employee wins.
 If Yes, then go to the next question.
 Q #3: Is the covenant injurious to the public?
 Example: Injurious to the public when there’s a
limited source of product or services and
enforcement of the restrictive covenant would
inhibit the public’s access to the product or
service.
 Q # 4: Does the covenant impose undue
hardship on the employee?
 Example: If the employee gained knowledge
and experience in a particular segment of the
industry, but the covenant precludes the
employee from working in any capacity, then
undue hardship may result.
Totality of the Circumstances
 Q # 5: Is the covenant greater than is required
for the protection of a legitimate business
interest of the employer?
 In making these arguments
Keep in mind the factors espoused by the
reviewing courts over the years and use
them as non-conclusive aids
 Q. 5 continued
Consider the type of activity being
restrained and the temporal and geographic
restrictions
The standard is “totality of the
circumstances”—no one factor carries any
more weight than the others, but its
importance will depend on the specific facts
and circumstances of the individual case
 “If it were possible to make a complete list
today [to define an employer’s legitimate
business interest], human ingenuity would
render the list obsolete tomorrow.”
 Reliable Fire, 2011 IL 111871 at ¶ 40, quoting
Arthur Murray, 105 N.E.2d at 695.
Burning Question for a Spring Day
 Is the decision in Reliable Fire probusiness or pro-ex-employee?
 Safe answer: It depends.
The following opinion is that of the
presenter and not necessarily that of the
producer of Reliable Fire
 The opinion makes it:
 More difficult for a plaintiff to get a TRO
 More difficult for a defendant to win a
Motion to Dismiss
 More difficult for either side to win at the
summary judgment stage
Cont.
 Almost a certainty the case is going to
trial unless:
One side feels a “chill wind” coming
from the bench after a preliminary
injunction hearing.
New Developments
 “Garden Leave” covenants
 Require an at-will employee to provide 90-180 days’
notice of intent to leave
 During notice period, employer continues to pay
employee salary and benefits but employee
performs little or no services
 During notice period, employee still owes employer
duty of loyalty and cannot work for another firm
 Garden leave provisions are pure noncompete
 Courts have been divided on their
enforceability
1. Bear Stearns & Co. v. Sharon, 550 F.
Supp.2d 174 (D. Mass. 2008) Court
refused to enforce provision against
department managing director
reasoning that the employee was forced
to remain with the firm despite his “atwill” status
2. Bear Stearns & Co. v. Arnone, No.
103187 (Sup. Ct. N.Y. 2008) Court
enjoined broker from communications
with clients where she contacted her
clients during notice period to tell
them where she could be contacted
after the period expired.
Illinois Trade Secrets Act
 The ITSA defines a “trade secret” as:
 Information, including but not limited to:
 Technical or non-technical data
 A formula
 Pattern
 Compilation
 Program
 Device
 Method
 Technique
 Drawing
 Process
 Financial data
 List of actual or potential customers or suppliers
That
 Is sufficiently secret to derive economic
value, actual or potential, from not being
generally known to other persons who can
obtain economic value from its disclosure
or use
 AND
 Is the subject of efforts that are
reasonable under the circumstances
to maintain its secrecy or
confidentiality
 Rustbucket alleges that Larry, the
salesperson, stole its trade secrets by
downloading a copy of its customer list onto
a thumb drive before quitting. The customer
list was maintained on a computer and was
password protected. The list took a long
time to compile and was extremely valuable.
Has the Plaintiff alleged sufficient facts to survive
a 2-615 motion to dismiss for failure to state a
cause of action?
A. Yes
B. No
0%
A.
0%
B.
 Customer lists and other customer-related
information are confidential if:
 The information has been developed by the
employer over a number of years at great expense
AND
 Kept under tight security
A.J. Dralle, Inc. v. Air Technologies, Inc., 255 Ill. App.3d
982 (2d Dist. 1994).
 However, where customer information
is readily available to competitors
through normal competitive means, no
protectable interest exists.
 Office Mates 5, North Shore, Inc. v. Hazen,
234 Ill. App.3d 557, 575-76 (1st Dist. 1992).
Scenario
 Plaintiff restaurant owner/chef alleges that
defendant, her ex-sous chef, stole her recipe for
Southern-style biscuits. Plaintiff inherited the recipe
from her grandmother twenty years ago, does not
share it with anyone, and was the only one at her
restaurant who would prepare the the biscuits.
Plaintiff kept the recipe in a safe in her office and
Plaintiff was the only one with the key to the office
and the combination to the safe. Plaintiff’s restaurant
is known for its biscuits.
 Does the biscuit recipe meet the
definition of a “trade secret”?
 Chef Lagasse would say that the correct
answer is “Yes”
 There is a difference between a recipe for
baking a casserole and a recipe for baking a
cake. Essentially, one is a guideline to be
followed generally and the other is a formula,
that is, “a prescription of ingredients in fixed
proportion”.
Moral of the Story
 Don’t be too quick to argue your client's
case without knowing something about
the industry at issue.
Tips for the TRO
 Focus on where the the Verified Complaint is
lacking in detail e.g.
 How much did the defendant earn?
(particularly important in a Trade Secrets
Act case)
TRO Tips (cont.)
 How long has the plaintiff-employer
been in business?
 How long does it take the plaintiff to
develop the clientele?
 How much money is invested in
developing the clientele?
 How are the plaintiff’s trade secrets secured? Telling
you that the secrets are “password-protected” tells
you nothing as everyone needs a password to log
onto his or her employer’s site.
 Who has access to the plaintiff’s trade secrets?
 How long did the defendant work for the plaintiff?
 What is the geographic area in which the plaintiffcompany operates?
Money Damages
 Assume Marsha's been enjoined from
soliciting/accepting business from other ABC clients.
 ABC Corp. now seeks money damages for the loss of
business that “walked out the door” after she left,
but before the injunction was entered.
 The lost business consists of 5 major clients,
accounting for annual revenues of $1 million. These
clients are now clients of Marsha’s new employer.
 ABC requests entry of a money judgment in the
amount of $1 million because Marsha’s restrictive
covenant prohibited her from soliciting or accepting
business from these clients.
 Marsha and her new employer argue that these
clients were longtime, loyal clients who were serviced
exclusively by Marsha and would have left ABC in any
event, even if they could not have followed Marsha to
her new firm.
 Several (but not all) of the 5 clients
testified to this at trial.
 What judgment is ABC entitled to?
 1. Judgment in the amount of $1 million.
 2. $0. Judgment for Marsha and her new
employer on the ground that ABC’s
damages were not caused by Marsha’s
breach.
 3. Who the heck knows?
Relevant Considerations
 The purpose of damages is to place the
injured party in the same position (but not
a better position) at the time of judgment
than it would have been had the contract
been honored.
 Nilsson v. NBD Bank, 313 Ill. App.3d 751, 760
(1st Dist. 1999).
 Arguably, had Marsha simply left ABC and done
nothing to violate her restrictive covenant, the
clients that form the basis of ABC’s damages claim
would have left anyway.
 However, notwithstanding the client’s testimony at
trial, the fact is that Marsha’s conduct in accepting
the business from them has rendered it difficult, if
not impossible, to reconstruct what would have
happened had she not breached.
 A countervailing consideration to the notion that
breach of contract damages should not place the
injured party in a better position than if the breach
never occurred, is the principle that a breaching
party who, by their conduct, renders the calculation
of damages difficult or uncertain, should not
benefit from that fact.
 Belleville Toyota v. Toyota Motor Sales, U.S.A., 199
Ill.2d 325, 361 (2002).
 “Breaking Up Is Hard To Do”
 Starring:
Justice Mary Anne Mason
Judge Nancy Arnold (Ret.)
Judge Erica Reddick
Please complete the evaluations.