Featured on Employment Law This Week: An employer cannot waive its own non-compete agreement to avoid payment, unless the agreement specifically grants it the right to do so.

An employee of a financial services firm in Illinois signed an agreement that required a six-month post-employment non-competition period in exchange for $1 million from his employer. When the worker resigned, the employer sent a notice waiving the agreement and telling the employee that it would not pay him the $1 million. After waiting out the six months, the employee filed suit against his former employer. The Illinois Court of Appeals found that there was no provision in the agreement that allowed the employer to change the terms without consent from the worker, and because the employee upheld his end of the contract, the employer must pay him what is due.

Watch the segment below and see our previous post on this topic.

Our colleagues Peter Steinmeyer and Scarlett Freeman of Epstein Becker Green authored an article in Workforce Magazine titled “Courts Take Closer Look at Noncompete Clauses.”

Following is an excerpt:

In the past few years, courts have been re-examining what constitutes adequate consideration for a restrictive covenant. In 2013, the Illinois Court of Appeals held, contrary to longstanding precedent, that in the absence of other considerations, mere employment constitutes adequate consideration for a restrictive covenant only if the employee remains employed for at least two years after signing the restrictive covenant.

This two-year rule applies regardless of whether the employee signed the restrictive covenant as a new or existing employee and regardless of whether the employee voluntarily resigned or was fired. Notably, multiple federal district courts in Illinois subsequently declined to apply the bright-line rule, instead considering other factors such as compensation, raises and bonuses, and the terms of the employee’s termination. …

As courts increasingly address challenges to the adequacy of consideration in restrictive covenants, employers can take measures to ensure that a restrictive covenant will be enforced. By simply remaining aware of fluctuating state laws, employers can structure employment agreements to incorporate adequate consideration under applicable state law.

Read the full article here.

In a decision issued in late October, AssuredPartners, Inc. et al. v. William Schmitt, 2015 IL  App. (1st) 141863 (Ill. App. 2015),  the Illinois Appellate Court struck down as overbroad and unreasonable, the noncompete, nonsolicit and confidentiality provisions in an employment agreement.  The Court then refused to judicially modify or “blue pencil” these provisions because the Court deemed their deficiencies “too great to permit modification.”  This decision is essentially a primer on current Illinois law regarding restrictive covenants and confidentiality agreements.

Starting with the noncompetition provision at issue, the Court held that it was overbroad because it restricted the former employee, a wholesale insurance broker of lawyers’ professional liability insurance, from a broader scope of activities than those he engaged in during his employment (i.e., it prohibited him from working with all types of professional liability insurance, not just the type that he actually brokered).

Additionally, the Court held that the geographic scope of the noncompetition agreement (i.e., all 50 states and the territories of the United States) clearly exceeded “that which is necessary to protect ProAccess and Jamison from threats against its business interest” and that such geographic overbreadth imposed “an undue burden” on the employee “by forcing him to work in another country if he wishes to continue earning a living as a wholesale broker specializing in LPLI or any other type of professional liability insurance.”

Finally, the Court noted that the length of the restriction – 28 months – was a “significant period to impose on an employee whose effective term of employment . . . lasted only 20 months.”

Accordingly, the Court held that the noncompetition provision failed to meet the requirements of reasonableness set out in the Illinois Supreme Court’s most recent pronouncement in this area, Reliable Fire Equip. Co. v. Arredondo, 2011 IL 111871 (2011).

Turning next to the post-employment, customer non-solicitation provision, the Court likewise found it to be unreasonably overbroad, as it applied to actual and potential customers of the plaintiff entities and of their subsidiaries, regardless of whether they were involved in the same activities as the former employee – and regardless of whether the former employee ever had contact with them while working for ProAccess.

Finally, the Court turned to the contractual confidentiality provision, which “prohibit[ed] the use or disclosure of any ‘information, observations and data (including trade secrets) obtained by [Schmitt] during the course of [his] employment with [Jamison/ProAccess] concerning the business or affairs of [plaintiffs] and their respective Subsidiaries and Affiliates.”  The Court held that this clause was broad enough to cover “ virtually every fact, plan, proposal, data, and opinion that he became aware of during the time he was employed by ProAccess – without regard as to whether such information was in any way proprietary or confidential in nature, or whether he in fact obtained the information through a source outside of his work.  It is patently overbroad.”

Additionally, the Court noted that it “cannot assume that the information Schmitt acquired during his employment with ProAccess resulted solely from plaintiffs’ businesses, as opposed to the customer relationships that he had established prior to his employment.”  The Court emphasized that this confidentiality provision “does not merely restrict the dissemination of confidential information; it drastically limits Schmitt’s ability to work in the insurance industry by preventing him from using any knowledge that he gained while in plaintiffs’ employ, regardless of whether he gained such knowledge, directly or indirectly, as a result of his employment” (emphasis in original).

For good measure, the Court further explained that the confidentiality clause is not saved because of its exception for confidential information that “becomes generally known to and available for use by the public.”  The Court explained that “[t]here is a great deal of information that is not ‘generally’ known to the public; not all of it merits protection under a confidentiality provision.”

Because the Court found these deficiencies to be so significant, it held that they were “too great to permit modification.”  Accordingly, rather than judicially modify or “blue pencil” any of these provisions, the Court struck them down.

Over all, the notion that permeates throughout AssuredPartners is that the restrictions at issue were fundamentally unfair to the individual former employee.

Coming on the heels of the Illinois Appellate Court’s blockbuster decision in Fifield v. Premier Dealer Services, Inc. (in which the same court held that, absent other consideration, two years of employment is required for a restrictive covenant to be deemed supported by adequate consideration – even where the employee signed the restrictive covenant as a condition to his employment offer – and even where the employee voluntarily resigned), AssuredPartners is a reiteration of the degree of judicial scrutiny currently being applied to restrictive covenants in Illinois.

In light of these decisions, Illinois employers are advised to draft as narrowly as possible, to pay particular heed to the consideration provided, to carefully consider choice of law and forum selection provisions, and to review existing restrictive covenants in light of the degree of judicial scrutiny currently being applied.

A couple years ago, the Illinois First District Appellate Court decided the case of Fifield v. Premier Dealer Services, 2013 IL App. 120327.  There, the Court held that, absent other consideration, two years of employment are required to constitute adequate consideration for a restrictive covenant, regardless of whether the covenant was signed at the outset of employment or after, and regardless of whether the employee quit or was fired.  Since then, some Judges in the United States District Court for the Northern District of Illinois have applied Fifield, and others have declined to do so.

Earlier this week, the United States Court of Appeals for the Seventh Circuit issued its first opinion reviewing a decision in which the District Court applied, or refused to apply, FifieldInstant Technology LLC v. DeFazio, (Case Nos. 14-2132 & 14-2243).  In the District Court, Judge Holderman applied FifieldIn its opinion, however, the Seventh Circuit simply reviewed the District Court’s factual determinations, determined that they were not clearly erroneous, and did not discuss Fifield or its application by the District Court at all.  The Court did, though, spend some time discussing an anti-raiding clause that was also at issue.  The Seventh Circuit explained that, because Instant Technology had such high workforce turnover (77% of the people who worked there two years before the trial left in the interim), it could not argue that its interest in maintaining the stability of its workforce was a legitimate business interest sufficient to support an anti-raiding clause that prohibited former employees from soliciting Instant Technology employees to join competing companies.

Readers of this blog know that long settled understandings regarding what constitutes adequate consideration for a restrictive covenant in Illinois were turned upside down when the First District Appellate Court in Illinois held in Fifield v. Premier Dealer Services, 2013 IL App. (1st) 120327  that, absent other consideration, two years of employment are required for a restrictive covenant to be supported by adequate consideration, regardless of whether the covenant was signed at the outset of employment or after, and regardless of whether the employee quit or was fired.

The Illinois Supreme Court declined to hear Fifield, and three federal judges in Illinois have declined to apply it.  However, the only other Illinois appellate court decision to address Fifield applied it without dissent.

Last week, the First District Appellate Court issued another decision applying Fifield, holding in McInnis v. Oag Motorcycle Ventures, Inc., 2015 IL (1st) 13097 that, in the absence of other consideration, 18 months of employment was not sufficient consideration for a restrictive covenant.  By itself, this ruling was not particularly noteworthy, except to the extent that the court confirmed that other consideration, combined with employment of less than 24 months, can constitute adequate consideration for a restrictive covenant.

What is noteworthy about this ruling, however, is the dissenting opinion by Justice Ellis, in which he wrote as follows:

I do not believe that a per se rule exists in Illinois, requiring that an at-will employee remain employed for at least two years – not one day less – after signing a restrictive covenant before sufficient consideration is found to exist.  Nor do I believe that a bright-line, two-year rule is warranted.  I also believe that the circumstances under which plaintiff left employment – whether he left voluntarily or was fired – are relevant to the determination.  Cases like these are inherently fact-specific, and I do not believe that this area of the law is the place for bright-line rules that remove relevant facts from consideration.

While a dissent carries no weight by itself, it may foretell a continued judicial discussion on this issue, particularly given that three different federal judges in Illinois have declined to follow Fifield based on their prediction that the Illinois Supreme Court would likely disagree with it.

Given that state supreme courts in Wisconsin and Kentucky both recently weighed in on whether mere continued employment is sufficient consideration for a non-compete (“yes” in Wisconsin, “no” in Kentucky) and given that the Pennsylvania Supreme Court recently heard oral argument on this issue, the question of what is adequate consideration for a restrictive covenant is one of the hottest topics in non-compete law.   Employers should continue to monitor this issue.

Last week, Chicago district judge Charles Kocoras dismissed a declaratory judgment action challenging the enforceability of a facially broad form non-compete agreement signed by all employees of the Jimmy John’s sandwich chain.  Judge Kocoras held that the dispute was not judiciable because the plaintiffs lacked the requisite “reasonable apprehension” of litigation against them and because they failed to allege that they had actually engaged in conduct that would violate the non-compete.  (Judge Kocoras’ memorandum opinion also addressed significant joint employer, franchisor/franchisee, and FLSA issues which are beyond the scope of this blog.)

As an initial matter, Judge Kocoras noted that “[t]he Seventh Circuit has not addressed whether a claim for declaratory relief is judiciable in the context of non-compete provisions.”  Nevertheless, borrowing from an analogous Seventh Circuit decision involving a patent infringement/declaratory judgment action, Judge Kocoras held that in order to establish the existence of an actual case or controversy sufficient to support a claim for declaratory relief in the non-compete context, the plaintiffs must clear two threshold procedural hurdles.  “First, the Plaintiffs must have a ‘reasonable apprehension’ that the Defendants are going to file a lawsuit against them for violating the Non-Competition Agreement. Second, the Plaintiffs must allege that they were preparing to engage or had engaged in conduct that would compete with the Defendants.”

In his Jimmy John’s decision, Judge Kocoras held that the Plaintiffs did not satisfy either requirement.  As for whether the Plaintiffs had a “reasonable apprehension” that the Defendants might sue them, Judge Kocoras noted that “Jimmy John’s and the Franchisee Defendants have submitted two affidavits attesting to their intention not to enforce the Confidentiality and Non-Competition Agreements against the Plaintiffs ‘in the future.’”  In light of these affidavits and the fact that the Defendants had not taken any prior action to enforce the non-compete agreements against the Plaintiffs in the past, Judge Kocoras held that the Defendants “satisfied their burden of establishing that the challenged conduct will not ‘reappear in the future.’”

As for the second requirement, Judge Kocoras held that the Plaintiffs did not allege with sufficient specificity that they had prepared to engage or had engaged in prohibited activities.  For example, Judge Kocoras explained that one of the Plaintiffs “fail[ed] to specify if she applied, was interviewed, or was offered a position [with a prohibited competitor]” and that a mere “litany of possibilities does not amount to a violation of the terms of the Confidentiality or Non-Competition Agreement.”

So, from a strategic perspective, what does this case mean for future declaratory judgment actions regarding non-compete agreements?

Non-compete law remains a creature of state law and most non-compete cases are brought in state court.  Hence, the precedential impact of this decision may be limited.

That being said, the decision does provide strategic lessons to both sides in the non-compete declaratory judgment setting.  First, the standard for getting a declaratory judgment in federal court may be stricter than that in a particular state court.  Defendants may want to consider removing such cases to federal court, if possible, and plaintiffs may be wise to plead in a manner intended to minimize the risk of a successful removal.  Second, a federal court plaintiff seeking a declaration that a seemingly overbroad non-compete is unenforceable must plead sufficient facts to show a reasonable apprehension of enforcement litigation.  Third, when attempting to defend (or enforce) an otherwise facially overbroad non-compete, it may be prudent to expressly disclaim enforcement of the maximum limitations of the agreement (i.e., to effectively “self modify” the agreement before a court has an opportunity to rule on its enforceability).

U.S. Attorneys in many jurisdictions are more willingly stepping into the fray between financial services firms and their former employees who have misappropriated trade secret information. In a recently reported case out of the Northern District of Illinois, two former employees of Citadel LLC, a Chicago based premier hedge fund in the high frequency trading space, pled guilty and received three-year sentences for their participation in a scheme to steal source code from Citadel and a prior employer in order to create their own trading strategy for their personal future use. This continues a trend begun in earnest in 2013 after the Department of Justice issued the Administration’s Strategy On Mitigating The Theft Of U.S. Trade Secrets. Since that time, federal criminal enforcement efforts in trade secret matters have been on the upswing in the financial services industry as well as other areas.

In this matter in Illinois, the former employees eventually admitted their guilt and were sentenced. While Yihao Pu admitted stealing the code from Citadel and his prior employer and received a sentence of three years in prison, Sahil Uppal admitted he provided some of the code to Pu in violation of his confidentiality agreement with Citadel and then assisted Pu in hiding his computer and stolen data, thus obstructing justice for which he received a three-year sentence and probation. The two were also ordered to make restitution of $759,000 to Citadel.

The moral of this story is that proprietary software code related to particular strategies used by you and your employer should never be taken or shared without the employer’s express consent. If already taken, it must be returned rather than removed and hidden from the employer or authorities. Employers in financial services and other industries appear more inclined to report such conduct to governmental enforcement agencies than in the past. While there is always a balance of judgment employers must make when involving Federal or State law enforcement authorities in their employment-related matters, there certainly appears to be an emerging trend for such authorities to actively investigate and thoroughly prosecute cases against employees who steal trade secrets.

The cases referred to above are U.S. v. Pu, 1:11cr-00699 and U.S. v. Uppal, 1:11cr-00699-2 in the United States District Court for the Northern District of Illinois.

Readers of this blog know that in the summer of 2013, long held beliefs about the required consideration for a restrictive covenant under Illinois law were thrown a curve when the Illinois Appellate Court for the First District (i.e., Cook County) held in Fifield v. Premier Dealer Services, Inc., 2013 IL App (1st) 120327, that, absent other consideration, two years of employment is required for a restrictive covenant to be deemed supported by adequate consideration—even where the employee signed the restrictive covenant as a condition to his employment offer and even where the employee voluntarily resigned.

Since then, two Federal district judges in Chicago split over whether to follow Fifield and the Illinois Supreme Court chose not to weigh in. Now, the first Illinois appellate court to address Fifield has done so – and it strictly adhered to it.

In Prairie Rheumatology Associates, S.C. v. Maria Francis, D.O., 2014 IL App (3d) 140338, Dr. Francis entered into an employment agreement with a two year post-employment non-compete. She tendered her resignation after 15 months of employment and resigned after 19 months of employment. When her former employer Prairie Rheumatology Associates (“PRA”) sought to enjoin her from competing in violation of her non-compete, Dr. Francis challenged the enforceability of her non-compete, arguing that it was not supported by adequate consideration because she was not employed for 24 months after entering in to it.

The Illinois Appellate Court for the Third District agreed, holding that because Dr. Francis was not employed for 24 months after entering into the non-compete, and because Dr. Francis “received little or no additional benefit from PRA in exchange for her agreement not to compete,” it was not supported by adequate consideration.

In an effort to show that Dr. Francis had received consideration in addition to the 19 months of employment, PRA argued that Dr. Francis had “received PRA’s assistance in obtaining hospital membership and staff privileges, access to previously unknown referral sources and opportunities for expedited advancement.” However, the Appellate Court found “that PRA failed to assist Dr. Francis in obtaining her hospital credentials and neglected to introduce Dr. Francis to referral sources.” Additionally, the Appellate Court found that PRA did not provide access to previously unknown referral sources, and that purported “expedited advancement and partnership opportunities” were “illusory” because “[e]ven though the employment agreement provided that PRA would consider Dr. Francis for partnership after 18 months, there was no guarantee she would become a partner and make shareholder.”

Accordingly, the Appellate Court held that PRA failed to provide adequate consideration and the non-compete was unenforceable.

We will continue to monitor developments regarding Fifield. In the meantime, Illinois employers hoping to enforce restrictive covenants within two years after the signing date should be prepared to distinguish Fifield factually or legally.

 

In determining what is an impermissible “solicitation” by a current employee, the Illinois Appellate Court recently drew a distinction between officers and non-officers. See Xylem Dewatering Solutions, Inc., d/b/a Godwin Pumps of America et al. v. Szablewski et al., Case No. 5-14-0080 (Ill. App. 5th  Dist. 2014).

In Xylem Dewatering Solutions, the defendants were accused by their former employer of wrongfully soliciting customers and suppliers on behalf of a competitive business that they were planning to launch. According to the Appellate Court’s decision, while still employed by their former employer, the defendants “asked customers and suppliers what they ‘thought’ about” the defendants’ formation of a new, competitive business. However, the defendants never “actually solicited any business or sold goods and services” to their then-employer’s customers on behalf of their new business until they had resigned and started the new business.

Although the defendants “agreed that those conversations were intended to persuade” customers and suppliers “to eventually do business with” their new business, the Appellate Court held that it was not an abuse of discretion for the trial court to conclude that these conversations were merely “preliminary actions” that did “not rise to the level of a breach of an ordinary employee’s duty of loyalty.” (emphasis added).

In reaching this conclusion, the Appellate Court drew a distinction between the duty of loyalty owed by ordinary employees (who are permitted “to plan and outfit a competing corporation so long as they do not commence competition”) and the “heightened duty of loyalty owed by corporate officers” (who are prohibited from “actively exploit[ing] their positions within a corporation for their own personal benefit” or “hinder[ing] the ability of a corporation to continue the business for which it was developed”).

Given the nature of these communications and their admitted purpose, their legality was not a foregone conclusion. Indeed, the Appellate Court may have reached a different conclusion if it was reviewing the trial court’s determination de novo, rather than merely reviewing it to determine if it was an abuse of discretion.

That being said, the Appellate Court’s decision makes clear that while all Illinois employees owe a duty of loyalty to their employer, corporate officers owe a heightened duty. Both they, and their employers and prospective employers, should be very aware of this distinction.

It should be noted that an employee’s duty of loyalty is governed by state common law. Accordingly, what passes muster in one state may not in another, and employers and employees should be aware of what is and is not permissible conduct in their own state.

Federal district judges in Chicago are now split over whether to follow the Illinois appellate court’s landmark non-compete decision, Fifield v. Premier Dealer Services, Inc., 373 Ill. Dec. 379, 993 N.E. 2d 938 (Ill. App. 1st Dist. 2013).

In the summer of 2013, long held beliefs about the required consideration for a restrictive covenant under Illinois law were thrown a curve when the Illinois Appellate Court for the First District (i.e., Cook County) held in Fifield that, absent other consideration, two years of employment is required for a restrictive covenant to be deemed supported by adequate consideration—even where the employee signed the restrictive covenant as a condition to his employment offer and even where the employee voluntarily resigned.

Earlier this year, in Montel Aetnastak, Inc. and Montel Inc. v. Kristine Miessen et al., No 13 C 3801, 2014 U.S. Dist. LEXIS 11889 (N.D. Ill. Jan. 28, 2014), Judge Ruben Castillo, the Chief Judge for the United States District Court for the Northern District of Illinois, declined to follow Fifield, holding that “[g]iven the contradictory holdings of the lower Illinois courts and the lack of a clear direction from the Illinois Supreme Court, this Court does not find it appropriate to apply a bright line rule” regarding what constitutes sufficient consideration for a non-compete. Instead, Judge Castillo chose to employ “the fact-specific approach employed by some Illinois courts.”

Judge Castillo’s immediate predecessor as Chief Judge for the United States District Court for the Northern District of Illinois, James F. Holderman, has now come down exactly the opposite way on this issue, and specifically applied Fifield and specifically rejected Judge Castillo’s holding in Montel. Instant Technology, LLC v. DeFazio et al., No. 12 C 491, 2014 U.S. Dist. LEXIS 61232 (N.D. Ill. May 2, 2014).
We are not aware of any other published federal court decisions or any published Illinois appellate court decisions to address this issue. However, at least two Cook County, Illinois judges have acknowledged and applied Fifield.

We will continue to monitor developments regarding Fifield. In the meantime, Illinois employers hoping to enforce restrictive covenants within two years after the signing date should be prepared to distinguish Fifield factually or legally.