LawPulse

Rumors of the death of the legitimate-business-interest test as a measure for determining the legitimacy of restrictive covenants were greatly exaggerated, the supreme court says. 

Overruling recent case law from the Illinois Appellate Court that attempted to refine the law governing employer-employee cove­nants not to compete, the Illinois Supreme Court has restated and clarified the standards. The opinion, released December 1, 2011, is Reliable Fire Equipment Company v Arredondo, 2011 IL 111871.

The facts and lower court holdings

Reliable Fire Equipment sells, installs, and services portable fire extinguishers and fire suppression and alarm systems. In 1992, it hired defendant Rene Garcia as a systems technician, later promoting him to a sales position. In 1998, it hired Arnold Arredondo as a salesperson.

Both signed noncompetition agreements in which they promised not to compete with Reliable, either during their termination or for one year after ceasing to be employed, in Illinois, Indiana, or Wisconsin. They also promised not to solicit sales or referrals from Reliable's customers or referral sources or to solicit other employees to leave their employment with Reliable.

In the early part of 2004, while still employed by Reliable, Arredondo was forming a company to supply engineered fire alarm and related auxiliary systems throughout the Chicago metropoli­tan area, High Rise Security Systems, LLC. He and Garcia signed an operating agreement for High Rise in August of that year.

Also in August 2004, Reliable's founder and chairman got wind of Arredondo and Garcia's movements. He asked them whether they were going to start their own business. They denied it. The following month, Arredondo resigned. On October 1, 2004, Reliable fired Garcia on suspicion of competition. In December, Reliable filed a complaint against Garcia, Arredondo, and High Rise, alleging violations of the restrictive covenants.

The defendants counterclaimed, seeking a declaration that the restrictive covenants were unenforceable. After a bench trial, the court ruled that Reliable had failed to prove the existence of a legitimate business interest justifying enforcement of the covenants and granted defendants' counterclaim. The appellate court affirmed.

Misreading Mohanty

Reviewing the law and not the evidence, the supreme court said that restrictive covenants in employment agreements are enforceable as long as consideration supports the agreements and the restraints are reasonable. Citing prece­dent dating back to 1896, the court said that the question of reasonableness requires a three-pronged test: first, the restraint must be necessary to protect the legitimate business interest of the promisee; second, it must not impose an undue hardship on the promisor or the public; and third, the scope of the restraint must be otherwise reasonable.

In reiterating that test, the court corrected a divergence in the analysis of noncompete agreements suggested by two recent opinions of the appellate court. In Sunbelt Rentals, Inc v Ehlers, 394 Ill App 3d 421, 915 NE2d 862 (4th D 2009), one appellate court panel held that a court should evaluate only time and territory restrictions to determine the reasonableness of a restrictive covenant, saying that the supreme court had never accepted the legitimate business interest test. That statement, the supreme court said, was mistaken, commenting that the panel had misread its opinion in Mohanty v St. John Heart Clinic, SC, 225 Ill 2d 52, 866 NE2d 85 (2006) and other prior cases. In Steam Sales Corp v Summers, 405 Ill App 3d 442, 937 NE2d 715 (2d D 2010), the appellate panel repeated the error.

In the matter before it, the appellate panel rejected the reasoning of Sunbelt and Steam Sales. Approving, the supreme court overruled both Sunbelt and Steam Sales, saying that a promisee's legitimate business interest is a long-established component in the three-pronged test of whether a restrictive covenant is reasonable.

Totality of the circumstances

The court then clarified the proper standard for evaluating the legitimate business interest prong, correcting yet another appellate narrowing of the historic analysis of noncompete agreements. In Nationwide Advertising Service, Inc v Kolar, 28 Ill App 3d 671, 329 NE2d 300 (1st D 1975), the supreme court noted, the appellate court wrote that an employer will be considered to have a legitimate business interest subject to protection through noncompete agreements with its employees only if two factors are present: first, the employees must have acquired confidential information through their employment, and, second, customer relationships must be near-permanent as a result of the nature of the business.

The court rejected the Kolar court's framing of the issue. Acknowledging that those as well as other factors might be helpful in determining the question, the court suggested that any attempt to compile a complete list of relevant factors would be futile, for it would almost immediately become obsolete. Citing Justice Hudson's special concurrence in the matter before it with approval, the court held that whether a legitimate business interest exists will depend on the totality of the circumstances of the individual case.

Likewise, the court concluded, the ultimate test for enforceability, that is, whether the noncompete agreement is reasonable, will also turn upon the totality of the circumstances. The court reversed and remanded the matter for further proceedings.