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On December 1, 2011, the Illinois Supreme Court issued its opinion in Reliable Fire Equipment Company v. Arredondo, et al., which resolved several years of confusion over the appropriate standard for enforcing non-compete agreements in Illinois.

The Confusion

For years, Illinois courts consistently explained that they would only enforce a non-compete agreement if: it was no more restrictive than necessary to protect an employer’s legitimate business interests; enforcement would not impose an undue burden on the employee; and enforcement would not injure the public. As a result, substantial case law focused on what would, and what would not, constitute a legitimate business interest sufficient to support the enforcement of a non-compete agreement.

In 2009, however, the Illinois Fourth District Appellate Court issued its opinion Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (2009). In that case, the court dismissed the requirement of a legitimate business interest as “judicial gloss” and explained that a non-compete agreement simply should be enforceable where its time and territory restrictions are reasonable. (According to the court, that analysis included consideration of whether enforcement would create an undue hardship on the employee or hurt the public.) The next year, the Illinois Second District Appellate Court issued its opinion in Steam Sales Corp. v. Summers, 405 Ill. App. 3d 442 (2010). While declining to directly address whether the Fourth District was correct in Sunbelt Rentals, the court nevertheless intimated that a 2006 Illinois Supreme Court case had imposed a standard different than the commonly used legitimate business interest test. Because Illinois courts generally follow the appellate courts in the jurisdiction in which they are located, after Steam Sales, the five appellate districts in Illinois were using at least three different approaches to analyze the enforceability of non-compete agreements.

The Fix

In May 2011, the Illinois Supreme Court agreed to hear an appeal in the case of Reliable Fire Equipment Company v. Arredondo, et al. to resolve this confusion.

On December 1, 2011, the Illinois Supreme Court issued its decision in Reliable Fire. In that decision, the court rejected the analyses of Sunbelt Rentals and Steam Sales Corp. and reaffirmed that a non-compete agreement is enforceable in Illinois only if: it is no greater than required to protect a legitimate business interest; it does not impose undue hardship on the employee; and it does not injure the public. The court also explained that whether or not an employer has a legitimate business interest depends on the totality of the facts and circumstances in each case. Some of the factors to be considered include the near-permanence of customer relationships, the employee’s acquisition of confidential information through employment, and the time and territory restrictions. However, the court also explained that those factors are merely some of the considerations, that they are not meant to be an exhaustive list of considerations, and that none of those factors carries any more weight than any other. Additionally, the court expressly stated that appellate court precedent concerning what will, and what will not, constitute a legitimate business interest remains intact, but that those cases should only be considered non-conclusive guidance.

The Practical Implications

While the Reliable Fire decision puts to rest any confusion caused by Sunbelt Rentals and Steam Sales, it provides little guidance to employers who are trying to craft or enforce non-compete agreements. Accordingly, employers will still need to pay close attention to the responsibilities of each position in crafting appropriate non-compete agreements, and pay close attention to the facts and circumstances of each potential violation to determine whether and how to enforce their non-compete agreements.

In October of 2009, the Illinois Court of Appeals for the Fourth District decided Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421 (4th Dist. 2009). In that opinion, the Court rejected the requirement that an employer must have a legitimate business interest in order to enforce a non-compete agreement -- a requirement in Illinois Courts for decades. According to the Court in Sunbelt Rentals, an employer need only show that a non-compete agreement has a reasonable geographic limitation and lasts for a reasonable period of time in order to enforce that agreement. Since that decision, few courts have cited to Sunbelt Rentals and those that have cited to it have declined to squarely address whether it was correctly decided.

In December of 2010, however, the Illinois Court of Appeals for the Second District decided Reliable Fire Equipment Company v. Arredondo, et al., ___ Ill. App. 3d ____ (2d Dist. 2010). In that case, the Court directly addressed Sunbelt Rentals and ultimately rejected its analysis. According to the Court in Reliable Fire, restraints on trade have long been disfavored by the Courts and the "legitimate business interest test" remains an important "threshold question" which allows the Court to analyze "whether the employer has an interest other than suppression of ordinary competition."

Additionally, the Court's lead opinion acknowledged that prior decisions had generally recognized legitimate business interests in only two situations: 1) where the employer had near-permanent customer relationships and the employee would not have had contact with those customers but for his or her employment; or 2) where an employee was exposed to the employer's confidential or trade secret information during his or her employment. However, that opinion went on to explain that limiting the analysis to whether the employer's interest fell into one of those two categories "may be unduly restrictive. Other criteria may exist that warrant protection under the law beyond those enumerated in the two traditional prongs of the legitimate-business-interest test." Consequently, the Court left the door open to recognize legitimate business interests beyond the two traditional situations.

Unfortunately, the significance of the lead opinion in Reliable Fire is muddled by a special concurrence and a dissent – both of which are more critical of the traditional formulation of the legitimate business interest test and both of which are open to a more flexible analysis of what constitutes a protectable business interest sufficient to warrant a non-compete. Indeed, as stated by the dissent, the decision in Reliable Fire “will serve only to confuse bench and bar and the employers and employees of Illinois.”

Illinois Courts follow the Appellate Courts in their district. As a result, now more than ever, employers must be cognizant of the different standards for enforcing non-compete agreements; they now differ from Chicago, to Chicago's suburbs, to down-state Illinois.
 

Readers of this blog know that, in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant (i.e., before an Illinois court will address the reasonableness of a restrictive covenant, the employer must first establish that it is supported by a “legitimate business interest” – a tall order given how that term is defined in Illinois).

Since then, we have been closely following Illinois state and federal no-compete cases to monitor the impact of Sunbelt Rentals. To date, its holding remains limited to Illinois’ Fourth District Court of Appeals (i.e., central Illinois, but not Chicago or any of its suburbs) as no court in Illinois has followed its reasoning in a published decision. (One federal district court in Indiana did apply Sunbelt Rentals, in CDW LLC et al. v. Netech Corporation, 2010 WL 2710626 at * 7 (S.D.Ind. July 7, 2010), but it did so without acknowledging or analyzing the split of authority on the issue.)

Last week, in Steam Sales Corporation v. Brian Summers, the first Illinois Appellate District other than the Fourth District re-visited the issue of whether the “legitimate business interest” still applied. While the Court in Steam Sales noted that Sunbelt Rentals’ “rejection of [the “legitimate business interest”] test does merit some consideration,” the Court did not rule on the issue because even under the “legitimate business interest” test, the restrictive covenant at issue was enforceable.

Notwithstanding its failure to address the crux of Sunbelt Rentals, certain aspects of Steam Sales may signal a thawing of judicial attitudes in Illinois toward no-competes.

First, the Court held that the reason why the employer had a legitimate business interest sufficient to support the no-compete was because it has “near permanent customer relationships.” Showing that an employer has “near permanent customer relationships” is one of the two established means in Illinois of establishing a legitimate business interest, but it “is generally absent from businesses engaged in sales.” Lawrence and Allen, Inc. v. Cambridge Human Resource Group, Inc., 292 Ill.App.3d 131, 142 (Ill. App. Ct. 1997). Rather, “near permanent customer relationships” are more typically found in professional services businesses. The employer in Steam Sales sold and maintained boilers. Because boilers are a long-term investment and because long-standing relationships are required to service the equipment and sell new equipment, the Court held that even though the employer was engaged in sales, it had “near permanent customer relationships” and therefore had a legitimate business interest sufficient to support the no-compete at issue.

Second, in Steam Sales, the Court upheld a two-year no-compete. While there is precedent to support a no-compete of such length, many employers today shy away from two-year restrictions out of concern that a Court will find them too long.

Finally, while Illinois courts have sometimes been seen as somewhat hostile to no-competes in employment contracts, the Steam Sales opinion is notably unsympathetic to the employee. Indeed, the Court stated that “[r]egardless of which party initiated the agreement, [the employee] had the option of either not signing it or asking [the employer] to modify the terms of the restrictive covenant. . . . As in Sunbelt Rentals, [the employee] risked the enforcement of the restrictive covenant after he chose to sign it.”

Hence, while Steam Sales did not follow the holding of Sunbelt Rentals with respect to the continuing validity of the “legitimate business interest test,” it nevertheless may signal a thaw in judicial attitudes toward no-competes in Illinois.

As for the long-term impact of Sunbelt Rentals . . . stay tuned.
 

As we noted in a blog post in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant. At the time, we noted that the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

As of early December 2009, only one other court had cited to the Sunbelt decision. In that decision (which we discussed in an earlier blog post), federal district court judge Robert Gettleman declined to follow Sunbelt, noting that “[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the applications of the legitimate business interest test.”

Since that time, there has been only one other published decision citing Sunbelt. In Rayco Management, Inc. v. Lancaster, No. 09 CH 18611, 2009 WL 6521389 (Cir. Ct. Cook Ct. Dec. 9, 2009), a trial judge in the Circuit Court of Cook County similarly declined to follow Sunbelt, concluding that he was bound by the precedent of the First District Appellate Court which still applies the “legitimate business interest” test.

Approximately nine months after Sunbelt was decided, no appellate court has issued a published decision addressing the holding of that decision and both lower courts that have been presented with a Sunbelt argument have declined to follow that decision absent direction from the appropriate appellate or higher level court. We will continue to monitor this issue, as it has significant ramifications on the enforceability of restrictive covenants in Illinois.
 

*Co-authored with Jake Schmidt.

As we noted in a blog post in October 2009, in Sunbelt Rentals, Inc. v. Ehlers, 333 Ill.Dec. 791, 915 N.E.2d 862 (Ill. App. Ct. 2009), an Illinois appellate court reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. Specifically, it rejected the “legitimate business interest” test long applied as a threshold issue by Illinois courts when deciding the enforceability of a restrictive covenant. At the time, we noted that the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

Although we expect that the reasoning of Sunbelt will be at issue in virtually every lawsuit seeking to enforce or invalidate an Illinois restrictive covenant, to date only one published decision, Aspen Marketing Services, Inc. v. Russell, No. 09 C 2864, 2009 WL 4674061 (N.D. Ill. Dec. 3, 2009), has cited Sunbelt. In that case, federal district court judge Robert Gettleman noted his awareness of Sunbelt and its rejection of the legitimate business interest test, but he applied the test anyway, noting that “[t]he Illinois Supreme Court, the United States Court of Appeals for the Seventh Circuit, and this court, however, have not rejected the applications of the legitimate business interest test.” Judge Gettleman did not otherwise elaborate on his decision to apply the legitimate business interest test.

We will continue to monitor this issue, as it has significant ramifications on the enforceability of restrictive covenants in Illinois.
 

The following article by Peter A. Steinmeyer and Jake Schmidt appeared in Law360 on October 23, 2009. 

In advising against the blind application of legal doctrines, Justice Oliver Wendell Holmes wrote that “[i]t is revolting to have no better reason for a rule of law than that so it was laid down in the time of Henry IV.” O.W. Holmes, The Path of the Law, 10 Harv. L. Rev. 457, 469 (1897). In this spirit, an Illinois appellate court recently reexamined and rejected over thirty years of well-established precedent regarding the enforceability of restrictive covenants. In doing so, the court either isolated itself from every other Illinois appellate court or took the first step in decreasing the traditional hostility with which Illinois courts treat restrictive covenants.

From the mid-1970s until a few weeks ago, Illinois law in this area was clear: employers seeking to enforce a restrictive covenant first had to establish that the covenant was necessary to protect either confidential information or a near permanent customer relationship – the two recognized “legitimate business interests” sufficient to support a restrictive covenant under Illinois law. During the last three decades this rule has been recognized and applied by every appellate court in Illinois.

In late September 2009, the Fourth District Court of Appeal in Sunbelt Rentals, Inc. v. Ehlers, No. 4-09-0290, 2009 WL 3052369, __ Ill. App. 3d __, __ N.E.2d __, (Ill. App. Ct. Sept. 23, 2009), determined that the “legitimate business interest” test was not supported by any decision of the Illinois Supreme Court. Accordingly, the Sunbelt court held that, in determining whether a restrictive covenant is enforceable under Illinois law, “[a court] should evaluate only the time-and-territory restrictions contained therein.” Id. at *8. In doing so, the Fourth District Court of Appeals departed from the clearly established case law of all appellate courts in Illinois (and also previous decisions of the Fourth District).

Barring further action by the Illinois Supreme Court, the Sunbelt court’s rejection of the “legitimate business interest” test will be one of the primary issues argued in all future restrictive covenant cases in Illinois. This circuit split within the Illinois appellate court system is emblematic of the flux nationally regarding the enforceability of restrictive covenants, with states moving in different directions. Practitioners on either side of the issue, whether practicing in Illinois or elsewhere, should review the Sunbelt decision and evaluate the potential applicability of such an argument or similar arguments to their cases.

The Sunbelt Decision

As noted above, for the last thirty-plus years, every Illinois appellate court agreed that a threshold inquiry when evaluating the enforceability of a restrictive covenant is whether it is necessary to protect a “legitimate business interest.” Such an interest “exists where: (1) because of the nature of the business, the customers’ relationships with the employer are near permanent and the employee would not have had contact with the customers absent the employee’s employment; and (2) the employee gained confidential information through his employment that he attempted to use for his own benefit.” Hanchett Paper Co. v. Melchiorre, 341 Ill. App. 3d 345, 351, 792 N.E.2d 395, 400 (Ill. App. Ct. 2003). This has become known as the “legitimate business interest” test.

The Sunbelt court analyzed Illinois Supreme Court case law from 1896 to the present and concluded that “the Supreme Court of Illinois has never embraced the ‘legitimate-business-interest’ test[.]” Id. at *5.

The Sunbelt court also concluded that the “legitimate business interest” test is inconsistent with recent Illinois Supreme Court decisions concerning restrictive covenants – specifically, Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85 (Ill. 2006). According to the Sunbelt court, the Illinois Supreme Court determined that the restrictive covenants at issue in Mohanty were enforceable solely by analyzing the reasonableness of the time and territory restrictions contained therein. Sunbelt, 2009 WL 3052369, at *6 (noting that “the [Illinois] [S]upreme [C]ourt made no mention of the ‘legitimate-business-interest’ test, despite over three decades of its use by the appellate court.”).

Based on its review of the law in this area and its conclusion that the Illinois Supreme Court has never endorsed the “legitimate business interest” test, the Sunbelt court held as follows:

[Illinois] courts at any level, when presented with the issue of whether a restrictive covenant should be enforced, should evaluate only the time-and-territory restrictions contained therein. If the court determines that they are not unreasonable, then the restrictive covenant should be enforced. Thus, this court need not engage in an additional discussion regarding the application of the “legitimate-business-interest” test because that test constitutes nothing more than a judicial gloss incorrectly applied to this area of law by the appellate court.

Id. at *8.

Are Cases Involving Medical Professionals Different From Other Cases?

Except for one case from 1896 involving an undertaker, Hursen v. Gavin, 162 Ill. 377, 44 N.E.2d 735 (Ill. 1896), all of the Illinois Supreme Court decisions discussed by the Sunbelt court concern the enforceability of restrictive convenants in the medical professional context. Mohanty v. St. John Heart Clinic, S.C., 225 Ill. 2d 52, 866 N.E.2d 85 (Ill. 2006) (group of doctors); Cockerill v. Wilson, 51 Ill. 2d 179, 281 N.E.2d 648 (Ill. 1972) (veterinarian); Canfield v. Spear, 44 Ill. 2d 49, 254 N.E.2d 433 (Ill. 1969) (group of doctors); Bauer v. Sawyer, 8 Ill. 2d 351, 134 N.E.2d 329 (Ill. 1956) (doctor); Ryan v. Hamilton, 205 Ill. 191, 68 N.E.2d 781 (Ill. 1903) (doctor). Other courts that have reviewed these same cases have concluded that the Illinois Supreme Court simply assumes the presence of a legitimate business interest in cases involving medical professionals. For example, the First District Court of Appeal has held that “the Illinois Supreme Court’s consistent enforcement of such covenants in the medical professional field, where the duration and geography scope is reasonable, demonstrates its recognition that a professional medical practice is a protectable business interest.” Retina Services, Ltd. v. Garoon, 182 Ill. App. 3d 851, 856, 538 N.E.2d 651, 653 (Ill. App. Ct. 1989).

Justice Steigmann’s unanimous opinion in Sunbelt does not address whether restrictive covenants in the medical professional context are treated differently. However, in his dissenting opinion in Lifetec (an opinion that reaches the same conclusion as the majority opinion in Sunbelt), Justice Steigmann rejected this notion:

It makes no sense to place a greater burden on employers of salespeople than on employers of physicians when the enforceability of noncompete covenants is at issue. Surely the physician-patient relationship and access to medical care are more societally significant concerns than any concerns related to the relationship between a retailer of medical products and its sales force. I find support in this view in Justice Freeman’s partial concurrence in Mohanty, where he wrote, “a strong case exists for abolishing all physician restrictive covenants as being against public policy. However, I agree that this decision is for the General Assembly to make.”

Lifetec, Inc. v. Edwards, 377 Ill. App. 3d 260, 280, 880 N.E.2d 188, 204 (Ill. App. Ct. 2007) (Steigmann, J. dissenting) (internal citation omitted).

Going forward, whether or not other appellate courts follow Sunbelt may turn on whether those courts agree with Retina Services or Justice Steigmann’s dissenting opinion in Lifetec.

Restrictive Covenant Litigation Post-Sunbelt

Like many attorneys who practice in this area, we often advise clients regarding the enforceability of restrictive covenants. Regardless of whether a client wishes to enforce or invalidate a restrictive covenant, our analysis always starts with the same question: does the client have a legitimate business interest in need of protection? After addressing that question and analyzing the reasonableness of the applicable time and territory restrictions, we advise the client regarding the likelihood that a court would enforce the covenant. The Sunbelt decision, however, has injected significant uncertainty into this analysis. Any company or individual seeking to enforce or invalidate a restrictive covenant in Illinois must now ask additional questions: Is the employer or the employee located within the Fourth District (i.e., central Illinois, including the state capital, Springfield)? If you are seeking to invalidate a covenant, how will you respond to an argument that the court should adopt the holding of Sunbelt? In arguing this point, you will most likely have to address whether or not a legitimate business interest is presumed to exist in the medical professional context, and whether such a presumption is the reason for the Illinois Supreme Court’s silence on this issue. If the court rejects the “legitimate business interest” test, how confident are you staking your entire case on the reasonableness (or unreasonableness) of the time, activity, and territory restrictions contained in the restrictive covenants?

The Sunbelt decision is also instructive for those practicing in other jurisdictions. Whether a restrictive covenant is supported by a legitimate business interest is a threshold inquiry in many jurisdictions. Are such tests and rules subject to a Sunbelt-style attack? Another lesson of Sunbelt is the need to stay on top of the law in this area. For example, there are bills pending in the Massachusetts legislature which would significantly alter the legal rules for restrictive covenants in that state and make the enforcement of such agreements more difficult. In contrast, in the November 2010 general election in Georgia, voters will decide on a proposed amendment to the Georgia Constitution that would make it much easier to enforce restrictive covenants.

The bottom line is that any court that follows Sunbelt is much more likely to enforce a restrictive covenant, because that case eliminates one of the main tools used to invalidate such agreements in Illinois. If other Illinois appellate courts or the Illinois Supreme Court follow this precedent, Illinois will change from a state traditionally somewhat hostile to restrictive covenants to a state that is much more accepting of them.

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