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The following article was published by the Illinois State Bar Association’s Corporate Lawyer newsletter in January 2012.

PROTECTABLE INTERESTS IN RESTRICTIVE COVENANTS
CLARIFIED BY SUPREME COURT OF ILLINOIS

By Michael P. Tomlinson [1]

 

In the January 2011 issue of the Illinois State Bar Association’s Corporate Lawyer newsletter, I analyzed the opinion issued by the Second District Court of Appeal in Reliable Fire Equip. Co. v. Arredondo, 940 N.E.2d 153 (2d Dist. 2010). Michael P. Tomlinson, Protectable interests in restrictive covenants expanded, Ill. State Bar Ass’n Corporate Lawyer newsletter, Vol. 48 #5, Jan. 2011. In that opinion, the appellate court determined the restrictive covenant at issue was not enforceable, but did so in a fractured decision that appeared to expand the type of interests that could be protected by restrictive covenants. Exactly what would qualify as a protectable interest beyond near-permanent customer relationships and protecting against the misuse of trade secrets or confidential information was left unclear. My previous article predicted that “[i]n all likelihood, the answer ultimately will be that it will depend on the facts and circumstances of the case, including the nature of the business at issue.” Id. However, I also acknowledged that “only time and an Illinois Supreme Court decision will provide the complete framework for determining whether the scope of a restrictive covenant is reasonable.” Id. We now have that much-anticipated guidance from the Supreme Court of Illinois.

The Supreme Court’s Decision in Reliable Fire

On December 1, 2011, the Supreme Court of Illinois clarified Illinois law regarding the enforceability of restrictive covenants and affirmed the viability of the legitimate business interest test.Reliable Fire Equip. Co. v. Arredondo, 2011 IL 111871 (available at http://www.state.il.us/court/Opinions/SupremeCourt/2011/December/111871.pdf). Examining numerous previously-decided cases, the Court held that courts must employ a “three-prong rule of reason” to determine whether a restrictive covenant ancillary to a valid contract is enforceable, which requires that “(1) the restraint [is] necessary to protect the legitimate interest of the promisee; (2) the restraint [does] not impose a hardship on the promisor or the public; and (3) the extent or scope of the restraint [is] otherwise reasonable.”Id. ¶ 18.

The Court found that “[i]n the case of a postemployment restraint, where the employer-promisee exacts from the employee a promise not to compete after termination of the employment, the restraint is usually justified on the ground that the employer has a legitimate business interest in restraining the employee from appropriating the employer’s (1) confidential trade information, or (2) customer relationships.”Id. ¶ 34 (emphasis in original).

However, the Court also held that it is no longer valid for courts to use tests such as whether an employer has near-permanent relationships with its customers or whether the employee has acquired confidential information that he or she has used for his or her benefit as conclusive on the issue of whether a legitimate business interest exists. Id. ¶ 43. Rather, the Court held that “whether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case.”Id. The Court acknowledged that “[f]actors to be considered in this analysis include, but are not limited to, the near-permanence of customer relationships, the employee’s acquisition of confidential information through his employment, and time and place restrictions.”Id. However, “[n]o factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.”Id. The Court further stated that “[t]he same identical contract and restraint maybe reasonable and valid under one set of circumstances, and unreasonable and invalid under another set of circumstances.” Id. ¶ 42 (citations and internal quotations omitted) (further stating, “[w]e expressly observe that appellate court precedent for the past three decades remains intact, but only as nonconclusive examples of applying the promisee’s legitimate business interest, as a component of the three-prong rule of reason, and not as establishing inflexible rules beyond the general and established three-prong rule of reason.”).

The Court did not decide whether the covenant at issue in Reliable Fire was enforceable, but rather remanded the case for the circuit court to apply the proper legal standard and to provide the parties with an opportunity to provide additional evidence they feel should be considered pertaining to the totality of the circumstances.Id. ¶ 46.

What the Supreme Court’s Decision Means for Practitioners

The Court’s opinion has important implications for those wishing to enforce and defend against restrictive covenants. It eliminates the near-permanency of customer relationships (and the multi-factor criteria or nature of the business inquiries that are part of the near-permanent relationship test) and the receipt and use of confidential information as being determinative of the issue of whether a legitimate business interest exists. Instead, the legitimacy of every claimed business interest will be judged based on the totality of the circumstances, which may be informed by many different factors in each case. This will allow employers and those wishing to argue that a legitimate business interest exists to prove its existence in various ways. For example, legitimate business interests may exist even if near-permanent customer relationships do not exist and even where obtaining and using confidential information is not at issue. On the other hand, those seeking to defend against the existence of a legitimate business interest will be able to introduce evidence beyond simply seeking to rebut (1) that customer relationships were near-permanent and that but for the defendant’s employment, he or she would not have come into contact with the customers at issue and/or (2) that the defendant obtained confidential information through his or her employment that he or she attempted to use for his or her own benefit.See Dam, Snell & Taveirne, Ltd. v. Verchota, 324 Ill. App. 3d 146, 151-52 (2d Dist. 2001).

However, it is important to keep in mind another point that the Court was careful to emphasize – even if a legitimate business interest exists, the restrictive covenant must be no greater than necessary to protect that interest.Reliable Fire Equip. Co., 2011 IL 111871, ¶18. Further, the restraint also must not impose an undue hardship on the promisor or the public.Id. Finally, the extent or scope of the restraint must be otherwise reasonable.Id. As such, even if a legitimate business interest exists, to be enforceable, the restrictive covenant still must be reasonable in terms of time, geographic scope, and scope of activity restricted. These are all principles of which to be aware for practitioners and others drafting, seeking to enforce, or seeking to defend against restrictive covenants.


[1] Michael P. Tomlinson, of Tomlinson Law Office, P.C. (mtomlinson@tomlinson-law.com) maintains a practice in Chicago concentrating on business litigation, including litigation relating to the enforcement of restrictive covenants.  He also counsels clients regarding general business and transactional matters.

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