The Year In Illinois Non-Competes Fittingly Concludes With Another Rule 23 Order

A few months ago, I wrote a post about a problem that I perceive with the way our appellate court of Illinois has been handling non-compete cases.

In short, the court can issue non-precedential Rule 23 orders, which constitute judgments rather than opinions. And they're not to be cited as precedent in future cases.

I have no problem with the concept of Rule 23 orders. They're meant to reduce the court's burden to crank out opinions that can later be cited back to them by lawyers as precedential and binding within an appellate district.

But in truth, they should be limited to two classes of cases: (1) review of criminal convictions; and (2) review of civil cases where there is a highly deferential standard of review. For instance, appellate review over a jury verdict under a manifest weight of the evidence standard is an ideal case for a limited, non-precedential opinion. Cases like that almost never announce some rule that future courts will point to as precedential.

But the non-compete cases that have come before the Appellate Court do not fall within these categories and address important issues of law, or interpretations of law, in the wake of the Supreme Court's Reliable Fire case late last year. My September post describes some of these rulings.

And so, with 2012 coming to a close, it seems only appropriate that our appellate court has done it again - issuing a Rule 23 order on a fairly significant question in a non-compete case.

The case of Saddlers Row, LLC v. Dainton (opinion contained below) arose out of a fairly common set of facts. The employee had a two-year, 75-mile general non-compete agreement, which he breached by going to work for a direct competitor a mere seven miles from his prior place of work. The employer acknowledged that customer relationships, not trade secrets, were the protectable interest. But the evidence showed that most of its customers were located within 40 miles of the employer's place of business - and that 75 miles stretched further than was necessary to protect the vast majority of its customer base.

The circuit court refused to impose an order of preliminary injunctive relief, finding the 75-mile scope overbroad. It then refused to blue-pencil the agreement and pare back the geographic scope by 25 or so miles.

The appellate court agreed that the geographic scope was unreasonable, but held that the circuit court abused its discretion by refusing to modify the covenant to make it enforceable.

The court looked at two critical factors in determining that circuit court should have modified the covenant:

1. The covenant's geographic scope, while overbroad, was close to reasonable. Since most of the employer's customers were within 40 miles or so of its place of business, a 75-mile restriction was hardly a major overreach. In fact, since the employer had customers out of state (apparently, very few), any line-drawing would be arbitrary. Put another way, the employer clearly made a good-faith effort at trying to draw a reasonable restriction.

2. The employee directly competed in close proximity to the employer. The court emphasized that this was not a case where the employee tried, in good faith, to compete in an area outside the employer's sweet spot, such that any competition would be minimal. This was an "in-your-face" breach. And because equitable considerations are paramount in any blue-penciling analysis, the appellate court deemed it important that the employee knew he was in blatant breach of the covenant.

The decision is obviously pro-employer, and it's rare to find cases like this where an appellate court finds that a refusal to blue-pencil is an abuse of the trial court's discretion. Off-hand, I can't think of many in Illinois like this. This demonstrates why the case should never have been a Rule 23 order. The court emphasized very specific considerations that come into play when determining whether blue-penciling is appropriate.

Of further interest is the court's omission of any analysis concerning why a customer non-solicitation covenant wasn't the proper type of contract to use in this case. When an employer is not trying to protect trade secrets, its need for a general non-compete is diminished. And in Saddlers Row, the employer admitted it wasn't trying to protect trade secrets. Its interest was in securing customers, and the more appropriate fit for that type of protectable interest would appear to be a common non-solicitation covenant. But this was not even discussed.


Saddlers Row v. Dainton

Post-Reliable Fire, Illinois Courts Are Really All Over the Place

When the Supreme Court of Illinois rendered its decision in Reliable Fire Equipment Co. v. Arredondo, I really didn't think much had changed. Though I suspected courts would be less susceptible to motions to dismiss, Reliable Fire really did not set forth any hard-and-fast rules - even if it did broaden the types of interest a company can protect through a non-compete agreement. In essence, I thought employers might have a slightly easier time enforcing contracts than in the past.

Less than a year later, courts continue to struggle with Reliable Fire in application. The problem continues to be that each judge views non-competes differently, and that very few generalist judges are in the position of reading the 150 or so Illinois decisions to try and reconcile cases all over the map. Further, there are very few areas of commercial litigation that call upon courts to make policy judgments and to resolve tensions with significant public interests at stake.

But non-compete litigation poses a number of challenges for litigants, attorneys, and judges. For instance, it's widely assumed - rightfully so - that only the most extreme non-competes will be tossed before discovery. This is what Judge Holderman held a week or so ago in Instant Technology, LLC v. DeFazio, 2012 U.S. Dist. LEXIS 90911 (N.D. Ill. June 26, 2011). That case involved a three-year non-solicitation covenant in the IT staffing business - one of my top three markets for non-compete litigation (insurance agents and medical device sales run a solid one and two). Citing Reliable Fire, Judge Holderman noted that the three-part reasonableness test requires a court to balance the totality of the circumstances to determine whether a covenant is enforceable.

But the Appellate Court of Illinois looked at the issue differently in Kairies v. All Line, Inc., 2012 IL App (2d) 111027-U, when it affirmed a circuit court's order granting judgment on the pleadings in a non-compete case. That dispute involved a declaratory judgment claim brought by an employee who was bound to a two-year non-solicitation/non-compete covenant. The court found that the non-solicitation covenant was unenforceable on its face because it extended to all of the company's customers - not just those the employee contacted or developed. The non-compete proved an easier analysis, because it was an outright prohibition on competition anywhere (though, for some reason, the court never notes the absence of a geographic term).

The really screwy part of this is that the Kairies court held Reliable Fire was of limited impact, since the "principles governing the determination" of the non-solicitation covenant's reasonableness were "well settled and predate Reliable Fire." Essentially, Kairies seems to suggest Reliable Fire only deals with determining the existence of a legitimate business interest, and that prior cases concerning reasonableness were undisturbed.

But this can't be right. If Reliable Fire requires consideration of the totality of the circumstances, and indeed says that the "identical contract and restraint may be reasonable and valid under one set of circumstances...and invalid under another set" then a court must look at the protectable interest and the covenant's language together, with the unique facts of each case.

As an example, a customer non-solicitation covenant may not have the necessary tie in to the employee, which the agreement in Kairies did not. But what if the facts show that the company was small and that all employees had access to, or worked on, all customers' accounts? Or what if the employee was a manager, such that he had indirect contact with (but extensive knowledge of) a wide range of customers?

This is not to say that some agreements are so patently overbroad that a pre-discovery motion is never a useful tool to dispose of a case. But there is no way that the Supreme Court intended for Reliable Fire to be interpreted so narrowly.

It's hard to say whether Kairies will be revisited on a motion to reconsider. It has a shaky foundation. At this point, it's non-precedential (why, I don't know...) under Rule 23. For lawyers, the case is a continuing reminder that they must be careful advising clients on enforceability. Courts just continue to miss significant legal issues.

A final word. I am not defending the contract provisions in Kairies. They weren't the greatest, and perhaps the employer deserved its fate. The policy rationale, and the potential impact, for future cases, though, is of real concern.

Assessing Reliable Fire and Non-Competes In Illinois

The Supreme Court's opinion in Reliable Fire Equipment was not much of a surprise. It seemed fairly clear the Court would establish that Sunbelt Rentals v. Ehlers was wrongly decided and that an employer needed to establish a legitimate business interest to support a reasonably drafted non-compete agreement.

The Court did just that, holding that the traditional three-part reasonableness framework holds and that courts must consider the totality of the circumstances in assessing whether the restraint is no greater than necessary for the employer's protection.

Though the decision left much to be decided and provided no real direction for future cases, a couple of principles were clarified.

First, the Court reaffirmed the long-held principle that total and general restraints of trade are void as against public policy. Therefore, an employer still must ensure that its non-compete agreements contain sensible limits in terms of activity, time, and territory. A complete ban on working in an industry will undoubtedly fall within Reliable Fire's purview of illegal "general" restraints.

Second, prior precedent in Illinois discussing legitimate business interests remain good law. Accordingly, employers may still rely on cases discussing the protectable interests of confidential information or customer relationships to demonstrate that a covenant is reasonable. They won't, however, be constrained by a rigid, formulaic test. Many cases, though, finding no protectable interest in ordinary customer relationships probably are of limited value.

Third, the Court stated that the three-part reasonableness test is "unstructured." In reality, this means trial courts will end up considering the following: (a) the language of the covenant; (b) its impact on the employee's livelihood; (c) whether non-parties or the public are harmed (this usually will involve a highly specialized service); and (d) whether the stated interest bears a nexus to the restrictions.

Employers will have some room to be creative in establishing a legitimate business interest. Such interests could include: (a) special training; (b) extraordinary or unique services (as in the case of a well-known CEO); (c) ability to influence critical vendor or supply chain relationships; or (d) disintermediation. In truth, employers have always asserted these interests, usually trying to bootstrap them into the categorical test, which is now just a guidepost rather than a dispositive inquiry. An article on the decision in Crain's can be found here.

Interestingly, last week the Supreme Court of Montana, in Wrigg v. Junkermier, Clark, Campanella, Stevens, P.C., addressed a very similar issue as that presented in Reliable Fire Equipment and held that an employer must "establish a legitimate business interest as a threshold step to [a court's] analysis of the reasonableness of the covenant." In that case, the Court held that an employer could not establish a protectable interest when the employee was involuntarily terminated. Prior decisions (of which there are few in Montana) did not come right out and discuss the protectable interest requirement, an issue similar to that in Illinois which led to the appellate district split.

I am not aware of any states which do not require courts to look at the protectable interest asserted.

Supreme Court of Illinois Grants Leave to Appeal in Reliable Fire Equipment

Today the Supreme Court of Illinois granted an employer's leave to appeal in Reliable Fire Equipment v. Arredondo, the Second District case last year which added new confusion to non-compete law in Illinois.

Following Reliable Fire Equipment, the five appellate courts in Illinois were left to apply three different "protectable interest" tests. The Court had little choice but to resolve this conflict among the appellate districts.

The case represents the Court's first true opportunity to enunciate a standard by which employment-based non-compete agreements will be judged. I believe the Court will adopt some variant of the traditional test widely used across many jurisdictions, which allows enforcement of non-compete agreements if: (a) the covenant is reasonable and not greater than is required for the protection of the employer; (b) the covenant does not impose an undue hardship on the employee; and (c) the covenant is not injurious to the public interest.

Element (a) is almost always an issue in litigation and encompasses traditional hot-button issues like a covenant that is too long, too extensive in geographic reach, or too broad in scope. It also would require a court to analyze the breadth of the covenant in relation to the interest an employer seeks to protect.

Also, it is element (a) where Illinois courts have gotten lost on a detour for the last, oh, 70 years or so. The Court is unlikely to issue an opinion in Reliable Fire Equipment until early 2012.

IBM Loses Preliminary Injunction Motion Over Executive's Departure to Hewlett Packard (IBM v. Visentin)

IBM has had some high-profile non-compete disputes the past couple of years, and it has found itself on both the winning and losing sides of those cases.

Just last week, IBM suffered a defeat in a preliminary injunction proceeding which concerned Giovanni Visentin's acceptance of employment with Hewlett Packard. Visentin was employed by IBM in numerous roles over the last several years. From 2007 through the end of his employment at IBM, he was General Manager of IBM's Integrated Technology Services (ITS) business segment. Visentin gave notice of his resignation in January and joined HP to be Senior Vice-President, General Manager, Americas for HP Enterprise Services.

A federal district court in New York denied IBM's motion for a preliminary injunction to enforce the non-compete agreement Visentin signed with IBM. The court found that IBM did not have a protectable interest in certain categories of business information Visentin had access to and which IBM contended were confidential or trade secret material. The court analyzed several of these categories and concluded, in large part, either that the information claimed to be confidential was not specifically identified or was already public knowledge.

The court further found the terms of the non-compete agreement to be overbroad and unenforceable. The primary reason for the overbreadth finding was the scope of the activity restraint. The court held that the agreement prohibited competition in areas where IBM had no presence, such as retail and laptop printer sales.

The opinion is fairly lengthy and detailed, and there is little point to summarizing all of the categories of information IBM asserted protection over and what the testimony was at trial. But there are two really important points to take away from this case, one an observation and one an opinion.

First, HP did exactly what an employer in a competitive hiring position should do. It clearly put a great deal of thought into what types of responsibilities Visentin had at IBM and was careful to ensure there was relatively little overlap with his new job at HP. It also required him not to use or disclose any IBM information in his new position. Combining this with the fact Visentin did not take anything with him after leaving IBM, the judge credited much of the defense testimony.

Second, this reasoning behind this decision is still somewhat shocking. The court noted on many occasions that Visentin was a very senior manager who was not a technological expert and who was not on the front lines dealing with clients. According to the court, he had little knowledge of how deals were priced and what metrics went into client proposals. Visentin's defense, effectively, was that he was too senior to know anything specific.

The way the court's opinion reads, it almost suggests that the higher up in the corporate food chain an employee is, the less likely that employee could potentially harm a legitimate business interest by competing. Taking the opinion to its next logical step, those employees who are much junior to Visentin are more likely to be restrained and have non-competes enforced against them. I don't understand this.

Most courts when dealing with this issue reach a fairly simple conclusion. The executive was provided access to a wide range of confidential business information. Whether he tries to take it with him and use it to the company's detriment is not dispositive. This case is the complete flip-side, buying the defense's (well-crafted) argument that nothing IBM identified as confidential was at risk for disclosure. The case points out the need for employers who are attempting to enforce non-competes to show with precision what threat exists from not having an injunction issued. It also illustrates why employers need to articulate clearly the legitimate interest underlying the covenant. In this case, I think IBM did the latter, but not the former.

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Court: United States District Court for the Southern District of New York

Opinion Date: 2/16/11

Cite: IBM Corp. v. Visentin, 2011 U.S. Dist. LEXIS 15342 (S.D.N.Y. Feb. 16, 2011)

Favors: Employee

Law: New York

Florida Case Demonstrates Limits of Legitimate Business Interest Test (Southern Wine v. Simpkins)

Florida is known as a highly pro-employer state, largely because of a comprehensive and detailed statute that makes enforcement of non-compete agreements by way of injunction substantially easier than in other jurisdictions.

Like most states, however, Florida's basic test for enforceability revolves around two basic concepts. First, the employer must present evidence of a legitimate business interest supporting the non-compete. Second, the restraint must be reasonably necessary to protect that interest.

Florida's statute contains a non-exhaustive list of potentially assertable business interests. The usual suspects, provision of confidential information and client relationships, are contained in that list. Another interest that many states recognize, specialized training, is also found within Florida's statute.

The case of Southern Wine and Spirits of America v. Simpkins discusses several of these interests in the context of a preliminary injunction hearing. In that case, Simpkins - a high level executive - resigned from Southern Wine and joined a direct competitor in the wholesale beverage distribution business.

Southern Wine's effort to enjoin Simpkins failed, in part due to the court's discussion of the types of interests Southern Wine was trying to protect through the restraint. The court found that Southern Wine was able to establish that Simpkins received confidential business information through his employment with Southern Wine - particularly information about strategy, marketing, and personnel. Importantly, the court found that the utility or usefulness of such information was likely to be stale in 2 to 6 months.

The court rejected Southern Wine's efforts to assert a protectable interest in its vendor relationships - an interest not mentioned in Florida's statute. As with all distributors, Southern Wine's business model depended on strong relationships both with customers (presumably retail outlets that sell alcoholic beverages) and vendors. The court refused to find that Southern Wine could demonstrate a legitimate business interest in its vendor relationships. Based on the case discussion, it does not appear that Simpkins either was instrumental in developing customer relationships or that Southern Wine believed his new employment posed such a threat.

Finally, the court dismissed Southern Wine's effort to show that Simpkins received specialized or extraordinary training as an employee. In Florida, this interest requires an employer to show that the training went "beyond what is usual, regular, common, or customary in the industry in which the employee is employed." Based on this test, it would seem an employer in Florida must present evidence not just of its own training but also what other firms in the industry offer to their employees. This likely would entail testimony from headhunters or expert witnesses, or perhaps other employees that have worked for several different companies.

As a result of the court's lengthy discussion over what Southern Wine was trying to protect, the court declined to issue a preliminary injunction in its favor. The court noted that the confidential information to which Simpkins had access likely was stale already since he had been absent from Southern Wine for over 6 months.

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Court: United States District Court for the Southern District of Florida

Opinion Date: 1/14/11

Cite: Southern Wine and Spirits of America, Inc. v. Simpkins, 2011 U.S. Dist. LEXIS 5762 (S.D. Fla. Jan. 14, 2011)

Favors: Employee

Law: Florida

Part III: The Concurring Opinion in Reliable Fire Equipment v. Arredondo

This is Part III in a series discussing the recent holding in Reliable Fire Equipment v. Arredondo. Please scroll down for prior posts and information about this case.

The concurring opinion in Reliable Fire Equipment clarifies a great deal about how to evaluate restrictive covenants in Illinois. The thrust of the concurrence is that there are no hard and fast rules about what qualifies as a "legitimate business interest" in terms of a non-compete's enforceability. Justice Hudson correctly noted that the cases have been less than clear on how rigid Illinois' two-part test was.

As it stands now, courts within the Second District will have to assess the employer's legitimate business interest under a "totality of the circumstances" test. This is more in line with the intensely fact-based nature of non-compete cases, departs from the two-part test used by courts, and expands the overall analysis to more than "time, territory and scope" as is currently used in the Fourth District.

As I have mentioned before, courts in many states look at an array of protectable interests, from customer contacts and access to confidential information to unique services and special training. In Illinois, the inquiry has been very narrow and many fact patterns just don't seem to fit the analysis at all.

On Wednesday, I will discuss this in more detail about what may be next after Reliable Fire Equipment, but for now, employers may take some comfort in the fact that other interests may be used to justify a restriction on competition. Just by way of example, an employer may now be able to enforce covenants against not only those employees who "attempt" to use confidential information against an ex-employer, but also against those whose employees whose position poses an inevitable risk of disclosure of confidential information.

Part II: Application of the Legitimate Business Interest Test in Reliable Fire Equipment

This is Part II in a series discussing the recent holding in Reliable Fire Equipment v. Arredondo. Please scroll down for further discussion of this case.

In Reliable Fire Equipment v. Arredondo, the Appellate Court found that the legitimate business interest test had to be applied to determine whether the non-compete agreement was enforceable. Though my prior post noted that the Appellate Court seemed to back away from a rigid two-factor test, it went ahead and applied the same historical test courts previously have used in Illinois. In that respect, the court analyzed whether Reliable Fire Equipment could show the presence of confidential information or near-permanent customer relationships that would allow it to enforce the non-compete.

The discussion on confidential information was fairly brief, and the Appellate Court accepted the trial court's conclusion that much of the relevant data available to the ex-employees - customer lists and pricing information - was easily findable and within the public domain. The Appellate Court was not willing to reverse this conclusion under an exacting standard of review.

The Appellate Court's discussion of customer relationships was more extensive. The court approved the two alternate tests courts have used to determine whether an employer has a legitimate interest in protecting its customer base. It discussed the "seven-factor" approach and the "nature of the business" test. Concluding that Reliable Fire Equipment's business was a sales-driven business, typified by common sales techniques and cross-purchasing by customers, the Appellate Court found that in such a circumstance a "near-permanent" relationship is generally absent. In the court's view, there continues to be a rather significant distinction between a professional services business (such as accounting, consulting, medical practice) and a sales-driven business.

Having concluded that, the court went on to discuss the seven-factor test, which applies various indicators to determine whether a true sales business still can have near-permanent relationships with its customers. The Appellate Court applied those factors and found the trial court's conclusion that Reliable Fire Equipment did not satisfy the test was not erroneous.

In particular, the court noted that buyers of fire alarm systems typically placed a project for bid and accepted the lowest quote. The court also noted that the sales staff had to supply their own computers and cell phones and had a limited entertainment budget. The court further stated that customers were well-known and could be located through access to public directories. Finally, the court determined that the business' relationship with customers was at-will and not exclusive.

The last point the Appellate Court made concerned the reasonableness of the employees' agreements with Reliable Fire Equipment. In particular, the court expressed concern as to the broad scope of the covenant, determining that the restriction prohibiting the employees from working with all customers of their ex-employer was too broad. Under Illinois law, the restriction really should extend to those customers with whom the employee developed a business relationship.

On Monday, I will discuss Justice Hudson's concurring opinion.

Part I: The Majority's Holding in Reliable Fire Equipment

This is Part I in a series discussing the recent case of Reliable Fire Equipment v. Arredondo. Please scroll down for my initial post concerning this case.

What is most notable about the majority opinion in Reliable Fire Equipment v. Arredondo is its length and depth of analysis. Keep in mind the backstory, here. Illinois Appellate Courts, for years, have failed to examine the precedents of the Supreme Court of Illinois when examining covenants not to compete.

This may sound unusual, and it its, but pick a random, garden-variety covenants case from the last 30 years and any citation to any Supreme Court precedent will be extremely difficult to find.

Lawyers have known this for quite sometime, that the two appellate branches of our courts seem to treat the other as if it does not exist. Because the Supreme Court has taken so few covenants cases - and almost no true employee cases - it was just assumed that you would cite to the appellate courts and nothing else.

That changed a few years ago when Justice Steigmann of the Fourth District had his ear bent by a well-known Chicago lawyer and began looking into historical precedent more carefully. He eventually unwound the legitimate business interest test in Sunbelt Rentals v. Ehlers, a case that focused the analysis of non-compete agreements on whether the time, territory and scope of the covenant was reasonable. Put another way, the gloss of whether a covenant supported a "legitimate business interest" was stripped away as being inconsistent with years of Supreme Court precedent. Justice Steigmann traced the Court history and commented that the interest test was created by Appellate Courts out of whole cloth.

After Sunbelt Rentals was decided, I noted that Justice Steigmann's holding was a bit incomplete because it failed to address one critical case, House of Vision v. Hiyane. In particular, House of Vision discussed an employer's interest in protecting customer relationships. While it is true the Court did not formulate the legitimate business interest test as the Appellate Courts have since classified it, it clearly recognized that reasonableness was not to be viewed in a "scope, time and territory" vacuum.

Reliable Fire Equipment takes much the same approach. After a careful analysis of the Supreme Court's prior cases - including a critical and extended discussion of House of Vision - the Appellate Court concluded that it was essential for the promisee (i.e., the employer or one receiving the benefit of the covenant) to demonstrate an interest worthy of protection.

Here's where the court's holding becomes more interesting and esoteric. It seems to portend a clear departure from what attorneys have always believed to be a two-part inquiry into what actually constitutes a "legitimate business interest." As readers of this blog know, in Illinois courts have recognized the following as protectable employer interests:

(1) "near-permanent" customer relationships the employee would not have had but for his or her relationship with the employer; and

(2) access to, and an attempt to use, confidential information or trade secrets of the employer.

The court is somewhat vague on whether the legitimate business interest test is so limited, obliquely saying that the test "need not be inflexible if broadly construed." I'm not sure what this means. Later, the court stated that "[o]ther criteria may exist that warrant protection under the law beyond those enumerated in the two traditional prongs of the...test."

More on this when I discuss the impact of Reliable Fire Equipment, but it is fair to say for now that lawyers have some room to argue that other interests worthy of protection - special training, unique services - may support a non-compete agreement.

On Monday, I'll discuss the application of the legitimate business interest test to the facts of Reliable Fire Equipment.

Second District of Illinois Appellate Court Reaffirms (Kind of ) Legitimate Business Interest Test (Reliable Fire Equipment v. Arredondo)

There is officially a true conflict within the Illinois Appellate Courts over how the enforceability of non-competition agreements will be determined.

In Reliable Fire Equipment Co. v. Arredondo, the Second District of the Illinois Appellate Court reaffirmed application of the "legitimate business interest" test, at least in some modified format, for employment restrictive covenants. The court engaged in a lengthy historical analysis of non-compete law, both in Illinois and under the common law. Because of the importance of this opinion, I will write five separate posts on this blog.

Part I: The Majority's Holding
Part II: Application of the Facts
Part III: The Special Concurrence
Part IV: The Dissent
Part V: What's Next

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Court: Appellate Court of Illinois, Second District
Opinion Date: 12/3/10
Cite: Reliable Fire Equipment Co. v. Arredondo, 405 Ill. App. 3d 708 (2d Dist. 2010)
Favors: Employee
Law: Illinois

Sunbelt Rentals Redux: The Same Argument Was Just Made In Michigan (Teachout Security v. Thomas)

Pardon my continued discussion of Sunbelt Rentals, but it's kind of important.

As readers know, the Appellate Courts in Illinois are in flux as to what an employer must prove to enforce a non-compete. To recap, the law in four appellate districts requires an employer to prove:

(a) that the covenant is reasonable in time, territory and scope; and
(b) that the covenant supports a recognized legitimate business information of either: (i) near-permanent customer relationships the employee would not have had access to but for his employment; or (ii) use of confidential business information.

The other appellate district dispenses with requirement (b). My point all along is that it is almost impossible to assess the notion of reasonableness without asking the employer to articulate what it is trying to protect. I think, as do many lawyers, that the legitimate business interest test is dated and incomplete. And I am fine with reformulating the test entirely, but at some point, an employer has to show what the protectable interest is for anyone to assess whether it's reasonable.

Illinois, it turns out, is not the only state to run into this precise issue. Michigan has the same dispute, though it doesn't appear to have been discussed much.

The case of Teachout Security Svcs., Inc. v. Thomas notes that Michigan courts have struggled to define the role of a legitimate business interest in the non-compete analysis. In that case, a security firm sought to enforce a non-compete agreement against its ex-employees. The employees prevailed on summary judgment, as the trial court found that the employer was trying to limit its employees' general skill and knowledge, not the use of anything proprietary.

The employer argued the trial court did not have to do anything more than analyze whether the covenants were reasonable. In support, the employer cited another Michigan court that bought into this argument - effectively the identical argument that the court in Sunbelt Rentals accepted. The Court of Appeals of Michigan, though, disagreed and held the trial court was correct in considering whether the employer had a "reasonable competitive business interest justifying the non-compete agreement."

The statutory framework in Michigan had to influence the court's decision and renders a Sunbelt Rentals-like analysis hard to fathom. For instance, Michigan's statute specifically states that "[a]n employer may obtain from an employee an agreement or covenant which protects an employer's reasonable competitive business interests..." Accordingly, the Legislature has conditioned enforcement on an affirmative showing of what the employer is trying to protect through a non-compete.

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Court: Court of Appeals of Michigan
Opinion Date: 10/19/10
Cite: Teachout Security Services, Inc. v. Thomas, 2010 Mich. App. LEXIS 2011 (Mich. Ct. App. Oct. 19, 2010)
Favors: Employee
Law: Michigan

An Illinois Court Finally Address Sunbelt Rentals (Steam Sales v. Summers)

It took a while...but we finally have a follow-up to the important Sunbelt Rentals case that the Appellate Court of Illinois issued in 2009. As readers may recall, that decision by the Fourth District held that employers need not demonstrate that a restrictive covenant be supported by a "legitimate business interest". Rather, the employer only needed to establish the reasonableness of the covenant in terms of time, territory and scope.

In the intervening months, commentators - including this one - had a lot to say about Sunbelt Rentals, but few courts even addressed the decision. The few that did were federal district court opinions that dealt with Sunbelt Rentals in an oblique way - acknowledging its existence, but treating it as an interesting anomaly.

My take on Sunbelt Rentals was, I think, fairly reasonable. I indicated that I was not sure how a court could assess the "reasonableness" of a non-compete restriction without identifying what it is the employer sought to protect - that is, the so-called "legitimate business interest." Here is a fragment of what I wrote when Sunbelt Rentals was decided:

"It's hard to see, though, how a court can determine whether a covenant is "no greater than is necessary for its protection" without analyzing what business interest it seeks to protect in the first place. The legitimate business interest test fills that vacuum and allows a court to fashion an appropriate restraint, or strike one entirely if the employer can't articulate the need for a restriction."

In that sense, I thought Sunbelt Rentals was interesting and somewhat well-reasoned - I still do - but perhaps a bit narrow and incomplete. I was looking for some acknowledgment that a court can't entirely divorce the reason for the covenant from its terms.

The Second District case of Steam Sales Corp. v. Summers discusses Sunbelt Rentals but is careful not to adopt or reject the rationale of that case. It leaves us wanting a bit more clarification, but the gist of what the Second District held is right in line with the issue I noted after Sunbelt Rentals came out.

Steam Sales acknowledges a tension that exists in that if an employer does not satisfy Illinois' wounded "legitimate business interest" test by showing that the covenant protects either near-permanent customer relationships or confidential business information, then the employer cannot enforce a perfectly drafted covenant. To try and resolve the tension, Steam Sales states that the "reasonableness of time and territory should still be evaluated in relation to a protectable interest." Note the court did not use the term "legitimate business interest", but rather a broader term - "protectable interest." The court does not adopt or reject Sunbelt Rentals, but it tries to build upon its strengths and correct its limitations.

The court does not come out and say what I would like it to - that there are other protectable interests out there (think goodwill and special training for starters) which can support a covenant. But it comes quite close and certainly hints at it. By suggesting that reasonableness must be examined in light of what it is the employer is trying to protect, the court seems open to a more modern, malleable definition of "protectable interest" that can fit the facts of a particular covenant case.

In my opinion, courts here are ready to dispatch the legitimate business interest test that was created out of whole cloth by the appellate courts and just adopted wholesale throughout the state for decades. I think it is almost inevitable that courts build upon Steam Sales and hold that reasonableness must be examined in light of an asserted protectable interest. That there is no particular limitation on what that means seems inevitable.

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Court: Appellate Court of Illinois, Second District
Opinion Date: 10/4/10
Cite: Steam Sales Corp. v. Summers, 405 Ill. App. 3d 442 (1st Dist. 2010)
Favors: Employer
Law: Illinois

Are You Ready for Another Motorola Non-Compete Lawsuit?

From Crain's Chicago Business today comes another story about Motorola feeling jilted by a former employee. This time, Motorla sued David Aderhold, a former wireless network sales executive, after he took a job with Ericsson. By way of background, Ericsson and Alcatel Lucent beat out Motorola a year ago on a bid to become a supplier of fourth-generation network equipment to Verizon. After Motorola lost the bid, Aderhold claims Motorola consented to his new job, first through co-CEO Greg Brown and again through Fred Wright, a senior vice-president.

Motorola may have a difficult time preventing Aderhold from working on the Verizon account, as its loss of the account prior to the time Aderhold left would seem to militate against a finding that the non-compete supports a legitimate business interest. Under Illinois law, that test is rather exacting, and only near-permanent customer relationships and breach of confidentiality can support a restraint. By definition, there is no customer relationship between Motorola and Verizon (through no fault of Aderhold) and use of confidential information also would seem to be a non-issue. What Aderhold would have to gain from disclosing information of a jettisoned supplier like Motorola is an utter mystery. If anything, it seems Aderhold would want to distance himself as much as possible from anything her learned at Motorola.

First Circuit Affirms Denial of Preliminary Injunction In Non-Compete Dispute (ANSYS, Inc. v. Computational Dynamics North Am.)

Last year, I wrote about a decision from a federal district court in New Hampshire, which denied an employer's attempt to enjoin an employee, Dr. Doru Caraeni, from violating a non-compete agreement. That case, ANSYS, Inc. v. Computational Dynamics, served as a nice illustration of the difficulty in applying the legitimate business interest test to employees who are not in a client-facing position. In particular, the situation in the ANSYS case involved a source code developer who went to work for a direct competitor.

The First Circuit, in affirming the district court's order denying injunctive relief, did not provide a whole lot of clarification for what New Hampshire law might say regarding the protectable interest claimed by ANSYS in seeking to enforce the non-competition covenant. It effectively punted back to the district court's findings that ANSYS had not proven at a preliminary injunction hearing that Dr. Caraeni actually used, or threatened to use, anything proprietary during the course of his new employment.

For its part, ANSYS claimed that it only needed to show two facts for the non-compete to be enforceable: (a) that Dr. Caraeni had access to certain proprietary information; and (b) that he was employed in a position to use this knowledge or information for a competitor. Though the circuit court was not overwhelmingly persuaded by this logic - calling it "not irrational" - it was careful to note that New Hampshire had never adopted this standard as the prevailing law.

ANSYS' theory sounds an awful lot like the "inevitable disclosure" theory of trade secrets misappropriation. This doctrine, which can be used in certain circumstances to create an enforceable non-compete or even create a de facto restraint in the absence of a contract, is narrowly applied and by no means universally adopted.

For employees who have deep proprietary knowledge, but have little ability by themselves to cultivate client goodwill, the risk associated with enforcing general non-competes is quite high. Other types of restraints can achieve the same goal, with lower risk of non-enforcement. ANSYS may have been better off having Dr. Caraeni sign a garden-leave clause or paying him to sit on the sidelines for a short period of time.

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Court: United States Court of Appeals for the First Circuit
Opinion Date: 2/12/10
Cite: ANSYS, Inc. v. Computational Dynamics North America, Ltd., 2010 U.S. App. LEXIS 2858 (1st Cir. Feb. 12, 2010)
Favors: Employee
Law: New Hampshire

Broadcast Employees Frequently Exempt From Non-Compete Agreements

Jason Shinn, author of Defending the Digital Workplace, was kind enough to e-mail me this week about a fairly new Arizona statute that prohibits broadcast employers from requiring certain employees to sign non-compete agreements. Many readers may be aware that competitive and contractual concerns were front and center in the negotiations between Conan O'Brien and NBC over his departure from the network. (No copy of Conan's agreement appears online, and since he worked in California, a non-compete likely would not be enforceable under California law. Conan's dispute really was not about the terms of a non-compete anyway, but rather an exclusive services provision for walking away from NBC.)

Arizona is certainly not alone in exempting broadcast employees from non-compete restrictions. In 2008, New York passed a similar statute. Other states which have enacted legislation concerning non-compete agreements and broadcast employees include Illinois, Maine, Massachusetts and Connecticut. Michigan introduced legislation in 2007 that would have made broadcast industry non-competes presumptively unreasonable.

Many of these statutory provisions do not apply to broadcast executives or sales managers. The clear intent is for the exemption to govern on-air talent. Why the distinction? It has to do with the test most states apply in determining whether a non-compete is valid or an illegal restraint of trade.

Applying the legitimate business interest test to on-air talent is a little different. The interest to be protected, presumably, is goodwill in audience and network sponsorship retention. That appears to be more than a valid interest for an employer to assert. One can certainly imagine a ratings decline (with correspondent economic losses) if a high-profile anchor defects to a cross-town competitor.

Because most news anchors or sportscasters do not go out and solicit clients (i.e., the viewers themselves), applying the legitimate business interest test as courts have traditionally formulated it can be a little tricky. It is for this reason that the broadcast employees' trade association, the American Federation of Television and Radio Artists, has been aggressive in pushing for legislative non-compete exemptions.

Illinois Courts Still Torn Over Sunbelt Rentals (Aspen Marketing Svcs v. Russell)

Illinois may not get a resolution any time soon to whether an employer is required to prove that a non-compete covenant must support a recognized, legitimate business interest. By now, lawyers and commentators are fully aware of the Fourth District's ruling in Sunbelt Rentals, Inc. v. Ehlers and its repudiation of a decades-long test used to determine the validity of non-competes. Though that test had a somewhat bizarre development, courts throughout Illinois recognized it.

Applying the test in practice perversely has made litigation more expensive for employees, as cases frequently devolved into lengthy discovery disputes over the so-called protectable interest and whether it was threatened. Often times the concept of "reasonableness" gets lost in the shuffle. Still, many employers lost cases after failing to prove a legitimate business interest was at stake.

But Ehlers settled his case with Sunbelt Rentals, and so there won't be a decision from the Illinois Supreme Court any time soon on the inter-district conflict. For now, that means that outside of the Fourth District, courts are still applying the legitimate business interest test. District Judge Gettleman recognized as such this week in Aspen Marketing Services v. Russell, when he denied a motion to dismiss a non-compete suit. Gettleman expressly noted the ruling in Sunbelt Rentals and declined to apply it, noting that the Illinois Supreme Court and other Illinois courts outside the Fourth District haven't weighed in.

On a separate note, the idea of challenging the validity of a non-compete on a motion to dismiss is rarely a good one. Almost invariably, this results in an early loss for the defendant, since the concept of "reasonableness" cannot be examined under the pleadings alone. Unless there is some obvious defect (such as a nationwide covenant when the contract specifies a very limited area of responsibility), lawyers ought not to count on dismissal of a non-compete claim until at least summary judgment.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 12/3/09
Cite: Aspen Marketing Svcs., Inc. v. Russell, 2009 U.S. Dist. LEXIS 112982 (N.D. Ill. Dec. 3, 2009)
Favors: Employer
Law: Illinois

Confusion Over Protectable Interest Creates Enforcement Problems (ANSYS, Inc. v. Computational Dynamics North Am.)

Most states require that a non-compete agreement protect a legitimate business interest. Illinois may be moving away from this requirement, as evidenced by the recent Sunbelt Rentals case. However, any attorney analyzing a non-compete dispute must ask what interest the restriction purports to serve.

In theory, this may sound reasonable, but in practice the analysis can lead to weird results, particular if the restrained employee is not one that has extensive client contact. The case of ANSYS, Inc. v. Computational Dynamics North America is a good example of how a court may analyze an employer's interest in "trade secrets" or "confidential information."

Specifically, what must a court do when an employer proves that an employee had access to certain confidential information (in ANSYS, it was source code) but its proofs are less clear as to the employee's attempts or threats to use it?

In ANSYS, the result was employee-friendly; the court held the employer did not prove the employee was likely to use any protected information in the course of his new employment with a competitor. In Illinois (at least assuming Sunbelt Rentals won't be adopted elsewhere), that result is probably correct: an employer must demonstrate an employee attempted "to use" confidential information learned during his or her employment with the former employer.

But Judge Easterbrook in a federal case some years back disagreed with this proposition, effectively noting that no such threatened use must be shown. This is related to the idea that confidentiality agreements are really too hard to enforce; non-competes, though clearly a restraint of trade, carry with it an easier enforcement mechanism. The better analysis would seem to focus on access, not use. If an employer can introduce evidence about the type of confidential information to which the employee had access, then the inquiry should devolve to reasonableness and not get hung up over whether a legitimate interest is at stake.

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Court: United States District Court for the District of New Hampshire
Opinion Date: 11/25/09
Cite: ANSYS, Inc. v. Computational Dynamics North America, Ltd., 2009 U.S. Dist. LEXIS 111021 (D. N.H. Nov. 25, 2009)
Favors: Employee
Law: New Hampshire

Defection At Citadel's High-Frequency Trading Unit Warrants Injunction - To A Degree (Citadel Investment Group v. Teza Tech.)

One of the most high-profile non-compete disputes in the Chicago area has resulted in a victory for Citadel Investment Group and a set-back for two executives who defected to start their own high-frequency trading firm.

In a 36-page memorandum opinion and order Judge Mary K. Rochford enjoined Mikhail Malyshev and Jace Kohlmeier from violating non-compete restrictions contained in their Citadel employment agreements for the balance of the nine-month term. Effectively, this means that both Malyshev and Kohlmeier may be free to compete as soon as February of 2010, since the court refused to extend the non-compete term on an equitable basis for the period in which the defendants were in breach.

The case involves a shadowy, but highly profitable business known as high-frequency trading (HFT). In essence, HFT relies on powerful computers to enter trade orders (often without human intervention), with algorithms deciding on specific aspects of the trade such as how much to buy, when, and at what price. HFT is a relatively new phenomenon, but it yields enormous profits. A disproportionate amount of equity trading volume is conducted by HFT firms.

Citadel itself invested heavily in HFT. It paid off - Citadel's HFT unit reaped earnings of $1.15 billion in 2008. Malyshev and Kohlmeier were instrumental, key employees for Citadel's HFT group. Neither had HFT experience prior to joining Citadel. For quite some time, each considered leaving to start his own proprietary trading firm. And each had a non-compete agreement, barring employment with a "Competitive Enterprise" for a period to be selected by Citadel upon departure, ranging from 0 to 9 months.

Upon their departure, Citadel elected the maximum 9-month period and paid Malyshev and Kohlmeier to sit on the sidelines. No surprise, there, given their access to proprietary information and involvement in recruiting R&D talent to Citadel. However, both ex-employees formed Teza Technologies and hired 15 employees, essentially daring Citadel to file suit.

It did.

Citadel pursued each aggressively and sought preliminary injunctive relief. The court dispatched with a number of the arguments raised by the defense. Given that one of the defendants deleted a fair amount of Citadel information (despite a court order not to do so), the court really did not have to address whether a legitimate business interest supported the non-compete. The adverse inference it could draw about the document deletion was more than enough to demonstrate the defendants had access to and attempted to use Citadel's confidential information.

The defendants also seemed to challenge the non-compete due to the fact that they really weren't actively trading, but merely preparing the firm's trading infrastructure to compete eventually. However, nothing in the non-compete allowed the defendants to wash their hands of liability based on this "preparing to compete" theory, and the theory itself ignored the fact that HFT firms depend heavily on building infrastructure. By getting a headstart in developing a trading platform, the defendants were essentially entering the market much faster than they agreed to under their employment contracts.

The most important feature of the decision, though, concerned the length of the injunction. And it is here where the defendants probably were able to take some solace in defeat. The court refused to extend, or equitably toll, the non-compete period for the time in which the defendants were in breach. The court looked at the Second District Appellate Court's decision from two years ago to hold that, under Illinois law, a contract must specifically provide for an equitable tolling, or extension, remedy. Otherwise, the court will not imply the term under the contract.

This, of course, does nothing to mitigate the defendants' damages during the non-compete period. But it does serve as a cautionary tale for counsel in drafting non-compete clauses. Unless an equitable tolling remedy is clearly contained in the contract, the court will not agree to extend it even if the defendants were in breach leading up to the injunction order.

UPDATE X1: Both parties have filed a notice of appeal with the Circuit Court.

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Court: Circuit Court of Cook County, Chancery Division
Opinion Date: 10/16/09
Cite: Citadel Investment Group, LLC v. Teza Technologies, LLC, 09 CH 22478 (Cook Cty. 2009)
Favors: Employer
Law: Illinois

Supreme Court of Wisconsin Rules on Several Important Restrictive Covenant Issues (Star Direct v. Dal Pra)

Wisconsin has long been known as an employee-friendly state when it comes to interpreting non-compete agreements. One of the primary reasons involved a previous construction of that state's governing statute, which leaned heavily against enforcement of any part of a non-compete clause if even one part was deemed unreasonable or overbroad. Without the ability to sever part of a non-compete covenant, employers often lost the balance of their case because of the strict rule on divisibility.

That will now change, given the Supreme Court of Wisconsin's decision in Star Direct v. Dal Pra. The case arose out of dispute between Star Direct, a seller of novelties and sundries to gas stations and convenience stores, and one of its former route salesmen, Eugene Dal Pra. As is often the case, Dal Pra began looking for other employment opportunities when his former employer was sold. In this case, Star Direct took over the business from CB Distributors. Eventually, Dal Pra went off and started his own business, exploiting many relationships he had developed as a CB Distributors (and later Star Direct) employee.

Dal Pra won in the circuit court, successfully challenging three separate restrictive covenants - an industry non-compete extending 50 miles from Rockford, Illinois; a customer non-solicitation clause; and a confidentiality clause. The court of appeals affirmed. In the Supreme Court, Dal Pra did not achieve the same success.

The Court concluded the industry-wide non-compete was invalid, but upheld the other two covenants. Most interestingly, the Court discussed the overbreadth of the non-compete clause, as well as Wisconsin's severability rule.

First, the Court found that the non-compete was too broad since it prohibited Dal Pra from engaging in any business "which is substantially similar to or in competition with the business of the Employer." The phrase "substantially similar to" ultimately invalidated the provision. The Court held that, by definition, the clause extended to businesses not in competition with Star Direct, because to hold otherwise would virtually ignore the terms "substantially similar to." The only logical interpretation was that Star Direct intended the capture more than just competitors, and a clause this broad served no protectable interest. Because of Wisconsin's statutory prohibition, the Court could not blue-pencil or strike the offending words, and the entire clause was invalid as an overbroad restraint of trade.

The second issue is related to this last point. Previous cases sanctioned a broad interpretation of Wisconsin's statute and suggested that contract provisions were indivisible if they governed similar types of activities. In practice, this would mean that a customer non-solicitation clause in another paragraph often would fall if the industry non-compete were held invalid. Additionally, confidentiality agreements met a similar fate, despite the fact they are not true restraints of trade. The end result is that employers who ended up drafting an enforceable agreement in all but one respect lost the entire benefit of the bargain.

The Court has now changed that rule. The contract in Dal Pra contained separate paragraphs governing the non-compete, non-solicit and non-disclosure clauses. They were not textually linked in any way and could operate independently of one another. So for instance, if the non-compete were simply taken out entirely, the non-solicit could stand on its own without any cross-reference or dependence on the non-compete clause. In view of this, the Court found the otherwise valid confidentiality and customer non-solicitation covenants could stand.

For practitioners in Wisconsin, covenants should be separately labeled and contained in different paragraphs. Defined terms, such as "Competing Business" or "Restricted Territory", should be in their own contract section and not contained in the same paragraph as any restrictive covenant. Failure to separate these terms out could jeopardize otherwise enforceable restrictions.

The decision in Dal Pra, at least pertaining to severability, injects some common sense into Wisconsin law. Business attorneys can at least draft agreements with some modicum of confidence that they will be upheld and not struck down on a technicality.

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Court: Supreme Court of Wisconsin
Opinion Date: 7/14/09
Cite: Star Direct, Inc. v. Dal Pra, 767 N.W.2d 898 (Wis. 2009)
Favors: Neutral
Law: Wisconsin

Fourth District in Illinois Rejects "Legitimate Business Interest" Test for Non-Compete Cases (Sunbelt Rentals, Inc. v. Ehlers)

The Fourth District Appellate Court of Illinois may have just made it substantially more difficult for employees to break their non-compete agreements - at least in some parts of the state.

Justice Steigmann authored an opinion that built upon his special concurrence two years ago in Lifetec, Inc. v. Edwards, a case where he called into question the applicability of the so-called "legitimate business interest" test used by Illinois courts to analyze restrictive covenants. This time around, Steigmann succeeded in convincing his robed colleagues to abandon the test altogether, overturning a number of Fourth District cases in the process. The decision does nothing to alter the test in other districts, and each of those still uses the test which is widely believed to be employee friendly.

By way of brief background, Illinois courts have essentially used a two-part analysis to determine whether a non-compete agreement is valid. First, it must be reasonable in scope. Second, it must protect a legitimate business interest. The second part of the test demanded an employer show that it had an interest in misuse of confidential information or near-permanent customer relationships acquired through the employee's association with the employer. This is not a marked departure from what other states require, though some would argue Illinois is fairly narrow in not recognizing other types of business interests, such as special training. However, Justice Steigmann could not find Illinois Supreme Court authority for part two of the test.

By reviewing Supreme Court precedent, Steigmann is correct in that the Court never formally adopted the test which has been used for years by all five district appellate courts. He casually neglects to mention that in the past 60 years, the Court has taken on a grand total of six non-compete cases, and several of those looked at covenants outside the employment context. His analysis is not entirely accurate because his discussion also neglects to confront one of the Court's leading precedents, House of Vision v. Hiyane. That case was authored by Justice Schaefer, probably Illinois' most famous jurist.

In House of Vision, the Court specifically discussed at length the interest of a business in protecting customer relationships. It even distinguished prior precedents (also cited by Justice Steigmann) where the Court noted that in a sale-of-business non-compete, the legitimate interest to be protected concerned intangible goodwill. Covenants ancillary to a sale of a business are always easier to uphold, and it may well be true that a legitimate business interest is virtually presumed in such circumstances. But it seems illogical that the Court would discuss a legitimate business interest in connection with a sale-of-business covenant, and then deem the test inapplicable to more problematic employment covenants. Steigmann has assured us the Court will have to take an employment non-compete case soon to resolve the tension between the Fourth District and the rest of the state's appellate courts.

Justice Steigmann's analysis defaults to the reasonablenes test he cites from what he considers binding precedent: an employer must show that the covenant is no greater than is necessary for its protection. As applied to the facts involving Sunbelt Rentals and Neil Ehlers, the court concluded the 50-mile non-compete was reasonable even though the employment agreement also contained a well-drafted client non-solicitation clause.

It's hard to see, though, how a court can determine whether a covenant is "no greater than is necessary for its protection" without analyzing what business interest it seeks to protect in the first place. The legitimate business interest test fills that vacuum and allows a court to fashion an appropriate restraint, or strike one entirely if the employer can't articulate the need for a restriction.

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Court: Appellate Court of Illinois, Fourth District
Opinion Date: 9/23/09
Cite: Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (4th Dist. 2009)
Favors: Employer
Law: Illinois