by Joshua R. Rich
McDonnell Boehen Hulbert & Berghoff LLP is an IMA Member
Employers have a number of tools they can use to protect against their employees walking off with trade secrets; among them, restrictive covenants or non-compete agreements can be extremely powerful. Such agreements avoid the threat of trade secret misappropriation by prohibiting a former employee from working for a competitor (and thereby potentially using the employer’s trade secrets against it) for some period after his or her employment ends. But they can be too powerful, locking unhappy employees into their current jobs, and courts generally refuse to enforce them if the geographic or temporal scope is too great. Many businesses – and lawyers – are aware of that threat and pay close attention to the limitations they place on departed employees. But few pay attention to another aspect of restrictive covenants that can be just as fatal to enforcement: whether the employer has provided adequate consideration in exchange for the agreement.
In most contract cases, courts do not pay attention to the consideration provided by the parties. Rather, they give parties the latitude to strike any lawful deal they desire and will not look at the fairness of the deal. Restrictive covenants are one of the few exceptions in which courts will look to the bargain and weigh the adequacy of consideration. They do so because restrictive covenants can give employers overwhelming negotiating power and prevent employee mobility; thus, many courts will look at the quid pro quo that the employer provides in exchange for the employee agreeing not to compete. The consideration necessary can vary widely, depending on which state’s law governs, when the deal is struck, and even which court is asked to enforce the agreement.
Illinois may be the most notable state where the adequacy of consideration may depend on which court is asked. The difference is stark: while the State courts of Illinois have adopted a bright line rule regarding the term of at will employment required for a restrictive covenant to be enforced, the U.S. District Court for the Northern District of Illinois has concluded that there is no such bright line rule and, potentially, a shorter term of at will employment may suffice. Thus, the enforceability of a non-compete agreement may very well hinge upon the Court in which the case is heard.
The Illinois Court of Appeals for the First District, the appellate court that considers all appeals from the Circuit Court of Cook County (which includes Chicago), has established a rule that adequate consideration requires at least two years of at-will employment or some other form of compensation. In Fifield v. Premier Dealer Services, Inc., the declaratory judgment plaintiff had been employed by the defendant’s predecessor-in-interest. As the business was transitioned from one owner to the next, the new owner required Fifield to sign an employment agreement (with a non-compete provision) in order to stay in his job. Although Fifield negotiated that the non-compete would not apply if he was terminated without cause within one year, he received no additional compensation for signing the agreement. He then voluntarily left his employment after less than four months and filed a lawsuit to have the non-compete provision found unenforceable, especially because he never had access to confidential information.
Because restrictive covenants are restraints on trade, they are carefully considered by Illinois courts. The terms therefore must be reasonable, but even before considering the terms, a court must make two required findings: (1) that the restrictive covenant is “ancillary to a valid contract;” and (2) that “the restrictive covenant is supported by adequate consideration.” With regard to the second finding, Illinois courts have long held that continued at-will employment for a substantial period of time can constitute adequate consideration. Surveying the cases (especially the Brown & Brown, Inc. v. Mudron case from the downstate Illinois Court of Appeals for the Third District), the Fifield trial court found that two years of continued employment was considered adequate. It also found no distinction in the required consideration between restrictive covenants entered into prior to beginning employment and those entered into after employment had begun. And because it found no consideration had been provided to Fifield beyond continued employment for less than four months, it held the non-compete provision in the employment agreement unenforceable. The Court of Appeals agreed with the trial court’s analysis, holding that “Illinois courts have repeatedly held that there must be at least two years or more of continued employment to constitute adequate consideration in support of a restrictive covenant,” even if the employee cuts the term of employment short by resigning before the two year threshold. Since that time, the Illinois Court of Appeals has repeatedly applied the two year bright line rule to determine whether consideration for a restrictive covenant is adequate.
After initially appearing to agree with the state courts’ bright line rule, the U.S. District Court for the Northern District of Illinois has more recently rejected it for a test based on the totality of the circumstances. Other Federal district courts in Illinois have also rejected the bright line two year standard. Under the Erie doctrine, a Federal court sitting in its diversity jurisdiction and applying state substantive law – as the district courts were doing here – must apply the law as it believes the state supreme court would see it. And the judges of the Northern District of Illinois (and those from the Central and Southern Districts who have faced the issue) have believed that the Illinois Supreme Court would reject the Illinois Appellate Court’s bright line rule in favor of consideration of the totality of the circumstances.
The differences between the approaches of the Illinois State and Federal courts suggests that an employer should consider the choice of forum carefully before it brings suit to enforce a restrictive covenant against a former employee. If the former employee had worked for at least two years after having signed an employment agreement, State court might be the best choice of venue to enforce a non-compete agreement. If the former employee had not worked for at least two years and there is no other consideration, Federal court would be a better venue. Of course, there must be a basis for subject matter jurisdiction in the Federal court. But even if the parties are not diverse and the facts would support such a claim, Federal court venue might still be available if a breach of a non-compete agreement can be coupled with a trade secret misappropriation claim under the Federal Defend Trade Secrets Act.
In addition, a careful employer may wish to provide some form of consideration beyond at will employment in exchange for the signing of a non-compete agreement. As the McInnis court indicated, any additional consideration may be considered even in State courts. Thus, a signing bonus, new bonus plan, or even a change in employment conditions may allow a restrictive covenant to satisfy the consideration requirement in State court. In Federal court, any such additional consideration would go onto the scales of the totality of the circumstances to support enforcement of the restrictive covenant as well. Thus, if an employer is concerned that its employment agreement will not be fully enforced, it would do well to provide something to the employee beyond at will employment and call that additional consideration out in the agreement itself.
To view the original article, click here.