Illinois Legislator Introduces Covenants Not to Compete Act

Yesterday, Rep. Rosemary Mulligan filed HB 4040 concerning employment covenants not to compete. The proposed legislation is comprehensive, with the following highlights:

(a) it limits non-compete agreements to "key employees" as defined by the act, but does not impact non-solicitation, no-hire or non-disclosure covenants;

(b) blue-penciling of unreasonable terms is discretionary, but will not allow an employer to obtain damages for any breach occurring before an order of modification;

(c) requires 2 weeks notice before an employee is asked to sign a non-compete (unless there is a bona fide advancement or promotion);

(d) defines legitimate business interests;

(e) creates rebuttable presumptions as to reasonableness regarding time (1 year), geography and type of activity;

(f) addresses attorneys' fees in the context of one-sided agreements or declaratory judgment claims.

The proposed act does not apply to stock forfeiture agreements, confidentiality agreements, restrictions among partners, or activity restraints.

Garden-Leave Provision Strictly Construed Against Employer (Bannister v. Bemis Co.)

Garden-leave clauses, which essentially pay an employee for a post-termination non-compete, originated in the United Kingdom and are becoming increasingly popular in the United States. The reason is obvious: employers face uncertainty when seeking injunctive relief to enforce a non-compete claim against an ex-employee. Though relatively few cases have addressed garden-leave provisions, they have been met with favorable opinions.

In Bannister v. Bemis Co., Inc., a variant of a garden-leave clause was at issue. Roger Bannister served as director of technical and product development for Bemis. In 2000, he signed a non-compete agreement which contained an 18-month post-employment restriction against working for a competing entity. However, Bannister's contract provided he could receive his continued base-salary from Bemis if he was "unable to obtain employment consistent with his abilities and education solely because of the [non-compete clause."

Four years later, Bannister requested a release from his non-compete clause so he could join Mondi, a Bemis competitor. Apparently, Bannister was not the only employee seeking to leave Bemis for Mondi; around the same time, Bemis sued Mondi and ex-Bemis employees who accepted positions with Mondi. That suit (to which Bannister was not a party) settled with a covenant providing Mondi would not hire for 18 months any Bemis employees who were subject to non-compete agreements.

After refusing severance, Bannister was terminated a few months after the Mondi-Bemis suit was settled.

Bannister then sought his garden-leave pay from Bemis, claiming he could not find a suitable position because of his non-compete. He provided monthly statements to Bemis regarding his efforts to find work. Bemis resisted, arguing Bannister could not work for Mondi anyway because of the settlement agreement in the lawsuit. Bemis offered to release Bannister from his non-compete for all other companies except Mondi.

The Eighth Circuit had little trouble affirming a damages judgment in favor of Bannister for the nine months in which he could not find comparable work. The court rejected Bemis' arguments that the Mondi settlement had any impact on Bannister's rights: "To the extent that the Mondi settlement is relevant, the only reason it prevented Mondi from hiring Bannister is because of Bannister's [non-compete] with Bemis. Thus, even considering the settlement agreement, the [non-compete] was still the sole cause of Bannister's ability to be hired by Mondi."

Garden-leave provisions are likely to be considered by employers as more and more employees are severed without cause. Courts may have more sympathy for workers subject to restrictions who are involuntarily terminated, reasoning the application of a covenant imposes an undue hardship on the employee. Further, a garden-leave provision can yield more certainty than a non-compete clause, because the latter always carries with it some risk for the employer that its covenant will be declared invalid.

If such provisions are drafted and because garden-leave is still a new concept in American courts, counsel should still consider drafting restraints narrowly and pay careful attention to those jurisdictions like Virginia, Wisconsin and Georgia where a strict blue-pencil rule can threaten an entire agreement.

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Court: United States District Court for the Eighth Circuit
Opinion Date: 2/25/09
Cite: Bannister v. Bemis Co., Inc., 2009 U.S. App. LEXIS 3648 (8th Cir. Feb. 25, 2009)
Favors: Employee
Law: Arkansas

Connecticut Court Allows Non-Compete Agreement to Extend to Potential Customers (Webster Financial v. McDonald)

Non-compete agreements which contain activity restrictions - usually termed non-solicitation clauses - generally are viewed more favorably by courts than outright bans on employment with a competitor. I have previously written that for salespersons and those employees whose primary responsibility is client service, employers should consider utilizing a non-solicitation provision rather than a general non-compete clause.

Despite the fact these restrictions are inherently less problematic, a non-solicitation covenant still is a restraint on trade and must protect the employer's legitimate business interest rather than prevent competition. To that end, courts have taken widely different approaches in assessing the concept of reasonableness when a non-solicitation clause is challenged in court.

For starters, a geographic limit frequently does not work with non-solicitation clauses. Unless a salesperson is assigned a specific territory, a geographic restriction can appear arbitrary. In this respect, courts generally will uphold a non-solicitation clause without a geographic term. In Illinois, the rules are fairly strict - if there is no geographic term tied to a non-solicitation clause, then it must be narrowly drawn to prevent the employee only from contacting those customers with whom he or she developed a relationship during the course of employment. Other states permit non-solicitation clauses that capture a broader range of clients.

In Webster Financial v. McDonald, a Connecticut trial court had occasion to consider this issue when an employee tried to dismiss a non-compete claim at the initial pleading stage. The court refused to do so, holding that the clause, which barred the defendant from soliciting even "potential clients" of his ex-employer, could be reasonable. In Illinois, this would be too broad because the term "potential client" is vague and does not fall within the ambit of protectable relationships.

However, the court in Connecticut held that the case could not be dismissed - at least not without some discovery as to the agreement's reasonableness. The court gave the employer the benefit of the doubt on the contract language, relying on the fact that geographic-based restrictions would logically preclude contact with even potential clients. Because courts have always upheld geographic restrictions that are reasonable, there was nothing wrong with a non-solicitation covenant covering potential clients.

Again, because the was rendered in response to a motion to dismiss, the court had to take all facts as true and was left determining whether the covenant was per se unreasonable. At least at this stage, it could not make such a finding.

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Court: Superior Court of Connecticut, Judicial District of Waterbury
Opinion Date: 1/27/09
Cite: Webster Financial Corp. v. McDonald, 2009 Conn. Super. LEXIS 169 (Conn. Super. Ct. Jan. 27, 2009)
Favors: Employer
Law: Connecticut

Unclear Territorial Restriction Renders Non-Compete Invalid (Asheboro Paper and Packaging v. Dickinson)

In virtually all states, non-compete agreements are subject to the rule of reasonableness. Reduced to its essentials, the rule requires that post-employment covenants be reasonable as to time, geography, and scope of activity. It is the last two elements that are frequently the subject of reasonableness challenges by departing employees.

Such was the case in Asheboro Paper and Packaging v. Dickinson. Asheboro Paper is a distributor of packaging products and hired Dickinson as a sales representative. His post-employment non-compete prevented him from working for one year in any capacity for a competing organization within 150 miles of Asheboro Paper's "branch offices in North Carolina and Virginia."

It was undisputed the parties intended for Dickinson - who previously worked at Unisource Worldwide - to establish and grow a branch office in Richmond, Virginia. However, at the time of hiring, Asheboro Paper had no office or physical presence of any kind in Virginia. In fact, Asheboro Paper contracted with a logistics company to rent a distribution and warehouse center for the purpose of storing inventory. Dickinson did not have unfettered access to the facility.

About two years after he started, Dickinson quit and went back to Unisource in Richmond. Asheboro Paper sued to enforce the non-compete and prevent Dickinson from working for Unisource within 150 miles of Richmond.

The court denied Asheboro Paper's motion for preliminary injunction on the grounds the non-compete was overbroad (both in terms of geography and scope of activity), and that Asheboro Paper was unlikely to succeed on the merits. The most interesting part of the opinion dealt with the territorial restriction in the non-compete.

Asheboro Paper failed to demonstrate the existence of a "branch office" in Virginia. Though it was clearly the parties' intent for Dickinson to help establish one, it never materialized. Further, the court held that Dickinson's home - where he worked and made sales calles - did not constitute a branch office. The court also remarked that Asheboro Paper failed to introduce in evidence any customer lists to justify the 150-mile radius. That radius would nominally prevent Dickinson from working in parts of Delaware, Maryland, the District of Columbia and West Virginia. Yet, Asheboro Paper conceded it had no clients in those locations.

The case presents an example of why employers should be wary of requiring salespersons to sign general non-compete agreements with bright-line territorial restrictions. A good defense attorney will generally be able to demonstrate the overbreadth of such a restriction. The better practice is to include a separate, narrowly tailored customer non-solicitation provision (either as a substitute for the non-compete or a back-up), so that questions about where an employer does or does not conduct business become moot. In Asheboro Paper, the agreement did not contain a severable non-solicitation provision, so the entire covenant failed.

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Court: United States District Court for the Middle District of North Carolina
Opinion Date: 2/19/09
Cite: Asheboro Paper and Packaging, Inc. v. Dickinson, 599 F. Supp. 2d 664 (M.D.N.C. 2009)
Favors: Employee
Law: North Carolina

Georgia Case Highlights Strict Application of Blue-Pencil Rule (Global Link Logistics v. Briles)

Legal practitioners in Georgia may not see non-compete rulings like this for much longer. As reported extensively in Seyfarth Shaw’s blog, Trading Secrets, the Georgia legislature may be on the move with respect to recasting employee non-compete law.

The pro-employee bent to Georgia’s law deals with the blue-pencil rule; any overbroad provision can kill a non-compete agreement. From this practitioner’s viewpoint, some of the handwringing over the blue-pencil rule is way overblown. Lawyers responsible for drafting these contracts ought to be more pragmatic. If an employee has an overbroad contract, at least he or she has a predictable result should the agreement be challenged. The fluidity associated with the blue-pencil rule yields uncertainty.

In Global Link Logistics v. Briles, the employee's non-compete barred him from working for a competitive business for two years in any capacity whatsoever. It was this last part - the lack of any activity restriction whatsoever – that doomed his former employer.

In Georgia, like Illinois and many other states, a non-compete must be reasonable in terms of (a) time, (b) geography, and (c) scope of activity. As to the third reasonableness component, the non-compete should put some parameter on the type of work that is off-limits. Generally, if there is a reasonable nexus between the employee's actual job function and the restricted job classification in the non-compete, a court is likely to find it reasonable. Patently overbroad clauses that bar a wide range of job activities or a complete ban on working in an industry, however, won’t cut it under Georgia law or the law of many jurisdictions.

So Briles’ non-compete failed. The result was obviously correct. The better analysis for non-compete agreements is to put the employer under an obligation to draft it reasonably and suffer the consequences for shoddy work. If a blue-pencil rule is sanctioned by a court, it at least ought to have some bite - such as foreclosing the opportunity for damages or fee-shifting to the employer.

Conducting an analysis based on the rule of reason (itself an antitrust derivative) is more preferable than having have courts get wrapped up in the fact-intensive, expensive process of determining whether a legitimate business interest supports the covenant. That rule has led to inconsistent and, frankly, bizarre results.

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Court: Court of Appeals of Georgia, First Division
Opinion Date: 2/18/09
Cite: Global Link Logistics, Inc. v. Briles, 674 S.E. 2d 52 (Ga. Ct. App. 2009)
Favors: Employee
Law: Georgia

Termination of Employment Will Not Constitute "Abandonment" of Non-Compete (EBI Holdings v. Butler)

The impact of involuntary termination of employment on the enforceability of a non-compete is not amenable to a quick summary. I wrote an article in the DePaul Business & Commercial Law Journal in 2002 canvassing the law on this subject, and it took me over 40 pages of dense analysis to opine that there is no real clear-cut answer. In Illinois, a 1994 case seems to hold that a non-compete agreement cannot be enforced if an employee is discharged without cause. But since that time, no cases have explained this holding or if it in fact means what it says.

In EBI Holdings v. Butler, an Illinois federal district court this week got close to addressing the issue, but ultimately declined. Since the employee's non-compete agreement was governed by New Jersey law, perhaps Butler is not a good test case on the interpretation of an Illinois case now 15 years old.

However, the plaintiff - a discharged medical products salesman - made an interesting argument. He claimed that his termination from a distributor amounted to abandonment of a post-employment covenant. The court struck his affirmative defense and noted that the agreement contemplated termination of his employment, so that abandonment under New Jersey law could not be a viable defense. It's not clear the employee raised a defense that the non-compete was unenforceable by reason of his discharge.

The case also did not address a circumstance where a discharge was inconsistent with the terms of the employment agreement. In such a case, an employee may have a viable claim that the non-compete is not enforceable because his termination was not valid or proper under the governing contract.

In a separate opinion, the court in Butler clarified the preemption doctrine in a trade secrets case. Often times, an employer will include common law claims arising out of the same operative facts as trade secrets misappropriation, such as conversion, unjust enrichment, tortious interference with contract, or civil conspiracy. The court clarified that the Seventh Circuit's decision in Hecny Transp., Inc. v. Chu limits the preemption theory to claims which rest on trade secrets theft. The test is "whether the plaintiff's claim would lie if the information at issue were non-confidential." Old district court cases taking a much broader view of preemption, and dismissing a lot of common law claims, are no longer reliable precedents.

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Court: United States District Court for the Central District of Illinois
Opinion Date: 2/17/09
Cite: EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11558 (C.D. Ill. Feb. 17, 2009) and EBI Holdings, Inc. v. Butler, 2009 U.S. Dist. LEXIS 11535 (C.D. Ill. Feb. 17, 2009)
Favors: Employer
Law: New Jersey, Illinois

Strict Construction Rule Prevents Enforcement of Non-Compete Agreement in Washington Case (Fluke Corp. v. Milwaukee Electric Tool)

Employers should always be aware that non-compete agreements will be strictly construed against it as the party in charge of drafting the contract; presumptions regarding ambiguities almost always devolve in favor of an employee. It is here where lawyers need to be particularly scrupulous in drafting agreements that reflect the intentions of the employer and guard against potential loopholes.

A recent Washington appellate case illustrates what happens when the precise contract language renders a non-compete totally ineffectual, such that traditional notions of reasonableness and protectable interests never even get addressed.

Fluke Corp. v. Milwaukee Electric Tool involves a dispute over the termination of Jonathan Morrow, who left Fluke to begin work for Milwaukee Electric in its Test and Measurement Field. But Morrow was initially hired by Jacobs Chuck Manufacturing, a subsidiary of Danaher Corporation. Fluke was a separate subsidiary of Danaher.

Morrow's two-year, broad non-compete restriction was contained in a contract with Jacbos Chuck; Fluke was not a party to it and the definition of "Company" in the preamble to the agreement referenced only Jacobs Chuck as a division of Danaher.

The non-compete clause broadened the definition of Company to include any affiliate of Danaher, but the expanded definition of Company was limited just to the non-compete term. Morrow was transferred to Fluke after he signed the non-compete contract, and he never signed a new agreement with Fluke.

Fluke balked when Morrow quit to join a competitor. Reversing the trial court's order of injunctive relief, the appellate court held that the unambiguous contract language rendered the non-compete unenforceable by Fluke against Morrow.

The reasoning: Morrow's transfer to another subsidiary - Fluke - constituted a termination of the employment agreement. It was critical that other contract provisions not at issue stated that a transfer of Morrow to another affiliate of Danaher would not constitute a termination of the agreement. However, by limiting the effect of transfer to just a few paragraphs, the fact the non-compete section was silent on this issue meant Morrow's transfer to Fluke was a termination for purposes of the non-compete covenant.

Finally, the agreement did not provide for automatic assignment to a subsidiary in the case of a transfer. Had it, the outcome may have been different - or at least the court would have been forced to address the substance of the non-compete.

The decision is an example of how employers must be careful in analyzing when the non-compete purports to operate, either in terms of an inter-company transfer, a termination or an assignment following an acquisition. It is critical that terms in one paragraph match up with another so that employees cannot argue that the strict construction rule releases them from any post-employment obligations.

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Court: Court of Appeals of Washington, Division One
Opinion Date: 2/17/09
Cite: Fluke Corp. v. Milwaukee Electric Tool Corp., 2009 Wash. App. LEXIS 364 (Wash. Ct. App. Feb. 17, 2009)
Favors: Employee
Law: South Carolina

Illinois Decision Demonstrates Difficulty of Proving Protectable Interest in Customer Relationships (Brown & Brown v. Ali)

One of the most nebulous areas of non-compete law concerns the scope of a protectable business interests. While many states recognize similar interests that support a restrictive covenant, the devil always lies in the details.

In Illinois, only two protectable interests will validate an otherwise enforceable non-compete agreement: (1) confidential information an employee has attempted to use for his own benefit; and (2) near-permanent relationships with customers that the employee would not have had but for his affiliation with the employer.

Attorneys representing employers should exhaust every avenue to invoke the first protectable interest - use of confidential information. This rather undefined term gives an attorney the flexibility to be creative and make his or her case for why a departed employee has purloined information and tried to use it for his own self-interest. No physical taking of documents is necessary; use of confidential information can come from one's memory.

The second business interest is harder to justify, and a recent federal district court bench-trial confirms why this is so. In Brown & Brown v. Ali, the defendant was a highly paid, highly regarded executive for a wholesale insurance broker, specializing in the placement of insurance for public entities and non-profit insurance pools or trusts. His two-year client non-solicitation agreement prohibited him from contacting all of Brown & Brown's customers after his departure.

Despite the fact insurance brokerage is a highly competitive, relationship-driven business, the court found Brown & Brown could not establish a protectable interest in near-permanent customer relationships. The court relied on a number of Illinois decisions holding that, ordinarily, an employer engaged in sales has no protectable interest in its customer relationships because business is highly mobile and fluid.

Ultimately, the issue was of little consequence, and perhaps Brown & Brown's proof that Ali misused and took its business information impacted its presentation of evidence on customer relationships. Still, the ruling serves as a cautionary tale for employers relying on near-permanency to support its non-compete.

Additionally, the court again invalidated a choice-of-law provision - this time one favoring application of Florida law. The court relied on another state court decision involving the same employer and same agreement to conclude that public policy mandated application of Illinois law, rather than the chosen law by contract. Florida law prohibits consideration of whether a non-compete will impose a hardship on an employee, while Illinois courts have long considered this issue under the rubric of reasonableness.

The choice-of-law ruling demonstrates courts in Illinois will take a close look at an out-of-state's substantive law to determine whether applying it would be consistent with public policy in Illinois.

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Court: United States District Court for the Northern District of Illinois
Opinion Date: 1/7/09
Cite: Brown & Brown, Inc. v. Ali, 2009 U.S. Dist. LEXIS 10252 (N.D. Ill. Jan. 7, 2009)
Favors: Employee
Law: Illinois

Texas Strictly Construes Forfeiture-for-Competition Clause (Valley Diagnostic Clinic v. Dougherty)

Not all restraints of trade are treated equally. In virtually all jurisdictions, covenants ancillary to an employment contract are subject to strict scrutiny for reasonableness and undue hardship. On the other hand, courts readily enforce sale-of-business covenants. And non-compete clauses which are ancillary to other relationships, such as distributorship agreements, can fall into either category depending on the facts and the bargaining position of the parties involved.

Another category of covenants has received comparatively little judicial scrutiny over the years. Forfeiture-for-competition clauses do not, technically, restrain an employee from working in a particularly industry, but they exact a price for doing so. A typical forfeiture covenant arises when an employer provides an incentive to an employee to stay with the company for a period of time. The incentive typically is some form of deferred compensation or stock options. Agreements are written to grant an employer the ability to not only forfeit unpaid compensation or vested options, but also to clawback income paid out pursuant to the incentive plan for, say, the year preceding termination.

Courts have taken two general approaches to resolving the validity or enforceability of these restraints. The majority view does not view a forfeiture provision as a restrictive covenant, and in jurisdictions adopting this view, the forfeiture clause will not be subject to a reasonableness inquiry. Courts in Missouri, Indiana and New York follow this line of reasoning.

A second, and minority, line of cases will examine the forfeiture clause as a restrictive covenant, reasoning that the intent of the arrangement is to restrain competition - if not in language, then certainly in impact. Nebraska, Wisconsin and Connecticut take a more dim view of forfeiture provisions. In Illinois, the cases cut both ways.

Add Texas to the minority. In Valley Diagnostic Clinic v. Dougherty, the Court of Appeals of Texas held that a forfeiture-for-competition clause within a medical practice's bylaws will be construed under Texas' Covenants Not to Compete Act because the intent was clearly to restrain competition with the medical practice by a departing shareholder. Under the facts of the case, the forfeiture provision was invalid because it was not designed to enforce any return promise on the part of the shareholder. The precise holding was based on an antiquated and confusing line of Texas cases interpreting its ancillarity requirement for non-competes.

The decision holding that a forfeiture clause is subject to strict non-compete scrutiny arguably contravenes a 1975 Texas case, Dollgener v. Robinson Fleet Services. That case clearly held that a forfeiture provision within a non-contributory profit-sharing plan was not subject to a restrictive covenants analysis because it was not a negative employment covenant. Though the court did not discuss Dollgener, it is possible the Texas legislature's enactment of the Covenants Not to Compete Act abrogated the older line of cases. Still, had it done so, the court should have discussed the ruling and clarified the law in this regard.

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Court: Court of Appeals of Texas, Thirteenth District
Opinion Date: 2/12/09
Cite: Valley Diagnostic Clinic, P.A. v. Dougherty, 287 S.W.3d 151 (Tex. App. 2009)
Favors: Employee
Law: Texas

Drafting Oversight Voids Employee's Non-Compete Agreement in Sale of Business (Herring Gas v. Pine Belt Gas)

Most non-compete are ancillary either to an employment relationship or a sale-of-business transaction. Regarding the latter, a party seeking to escape any competitive restrictions usually meets with little success if its effort is based on protectable business interests or reasonableness as to the contract's scope. A fair number of sale-of-business cases, therefore, turn on the contract language and whether a restrictive covenant survives an acquisition.

The Supreme Court of Mississippi recently held that an employee's non-compete agreement was not enforceable when the governing asset purchase agreement made no reference to existing non-compete agreements as a "purchased asset." In Herring Gas Co., Inc. v. Pine Belt Gas, Inc., the buyer sought to enforce a non-compete covenant against Jimmy Rutland, an employee of Broome LP Gas, the entity which sold its assets to Herring Gas. The deal closed on April 19, 2006, and Rutland quit to join a competitor five days afterwards. A few weeks later, Broome assigned Rutland's non-compete agreement to Herring Gas.

About a month after the closing, Herring Gas wrote a cease and desist letter to Rutland challenging his decision to work for another purveyor of propane gas within the restricted territory (75 miles from Purvis, Mississippi). Herring Gas chose not to file suit for another six months.

The trial court held that Herring Gas, as the entity acquiring Broome's assets, could not enforce the covenant against Rutland. The Supreme Court affirmed for two reasons: (1) the language of the asset purchase agreement precluded enforcement by Herring Gas; and (2) the assignment failed because Rutland had already quit.

The first issue demonstrates the care with which counsel should approach employee non-compete agreements during the due diligence and closing phases of a transaction. The definition of purchased assets mentioned nothing about employment contracts or non-competes, and there was a specific exclusion of all other assets not identified in the contract of sale. Moreover, the parties failed to effectuate any assignment of the employment agreements at the time of closing. These facts ultimately precluded enforcement by Herring Gas.

In most jurisdictions, when a key employee signs a restrictive covenant concurrent with the sale of assets, that contract - even though styled as an employment agreement - will be examined in accordance with the more lenient enforceability standard where a protectable interest is virtually presumed.

However, this rule will not apply when the non-compete is an existing obligation that arose well before the sale date. The problem with Rutland's contract could have been avoided had the issue been addressed specifically in the closing documents.

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Court: Supreme Court of Mississippi
Opinion Date: 2/12/09
Cite: Herring Gas Co., Inc. v. Pine Belt Gas, Inc., 2009 Miss. LEXIS 65 (Miss. Feb. 12, 2009)
Favors: Employee
Law: Mississippi