There are countless reasons that small businesses fail or end up in disputes involving non-competition agreements in the context of a business divorce. A “non-competition agreement” precludes a business’ employees, officers, or equity owners (i.e., partners) from being involved in a competitive business. Non-competes are just one type of restrictive covenant, along with others that restrict solicitation of employees, customers, or prospects of a business or limit the use and disclosure of confidential information, such as intellectual property (IP).
Often, it is disputes and disagreements between owners and partners that signal the imminent demise of a once-promising enterprise. For example, a business heavily dependent on proprietary technology may run into issues if its IP has not been properly protected and/or is improperly exploited, often in contravention of what is viewed by the business as a valid non-competition agreement. But business owners aren’t the only folks on the team who can lay a company low. Sometimes, it is a key employee who, upon their departure, pulls the rug out from their former employer by taking clients, customers, IP, and/or colleagues with them.
That is why so many small businesses require employees to sign “non-competition agreements” as a condition of employment. For decades, however, courts have looked at these restrictive covenants with a very skeptical eye; skepticism that continues to grow as reflected in court rulings and other laws around the country. Judges have not hesitated to strike down such clauses and hold them void and unenforceable, especially if they are overly broad in geographic scope or duration, are unsupported by adequate consideration, or involve lower-wage workers. Courts have, historically, provided more latitude to non-competition agreements involving owners, partners, and key operations who attempt to violate them – especially when they take IP or significantly damage the good will of the business.
Illinois’ recently passed amendments to its Illinois Freedom to Work Act, codifies the trends above, and further limit the availability and enforceability of non-competition agreements for small business owners. This is only one example of what small businesses seeking to protect their business can expect in every state in the Union. SB672, which Gov. JB Pritzker signed into law on August 13, 2021, dramatically transforms the landscape for non-competition provisions. These new restrictions on restrictive covenants will apply to all agreements dated on or after January 1, 2022, meaning that business owners who count on these clauses to protect their business interests may need to reconsider their arrangements or approaches.
Here is what small business owners need to know about the future of non-competition and non-solicitation agreements in Illinois (and likely elsewhere in the near future)):
Perhaps the most impactful aspect of the new law is that it completely prohibits any non-competition agreement for employees whose earnings fall below a specific threshold. Specifically:
- Non-competition agreements are void and unenforceable for employees who have expected annual earnings of less than $75,000.
- Customer/employee non-solicitation agreements are void and unenforceable for employees with expected annual earnings of less than $45,000.
These baseline income amounts are set to increase in 2027 and every five years thereafter.
“Legitimate Business Interest” and Consideration of the “Totality of Circumstances” Required for Enforceability
One of the fundamental principles Illinois judges have used when evaluating the enforceability of restrictive covenants is to examine the circumstances surrounding the specific agreement and determine whether the limitations are narrowly tailored to protect a company’s “legitimate business interests.”
The new amendments to Illinois law reflect this case-by-case approach, explicitly stating that ‘the same identical contract and restraint may be reasonable and valid under one set of circumstances and unreasonable and invalid under another set of circumstances.” The amendments set forth several factors that a court should consider when determining whether the employer has a legitimate business interest, including:
- The employee’s exposure to the company’s customer relationships or fellow employees.
- The near permanence of the business’s customer relationships.
- The employee’s acquisition, use, or knowledge of confidential information (including through the employee’s employment).
- The time restrictions, place restrictions, and scope of the activity restrictions.
In this regard, every restriction on “post-employment” activities related to competition requires that the business have a protectible interest to support a non-competition covenant, which often is the businesses’ confidential, proprietary, or trade secret information (or protectible IP). As such, agreements with these covenants must address IP rights and ownership – assignment of inventions, work-for-hire clauses and non-disclosure provisions as to confidential information. Failure to do so can be a recipe for disaster when “partners” with IP access split and are at each other’s throat.
Adequate, Independent Consideration Needed
All enforceable contracts, including restrictive covenants, must be supported by adequate consideration. For purposes of non-competition covenants, “adequate consideration” under the new Illinois law (and most other state laws) means:
- The employee worked for the company for at least two years after signing an agreement containing a restrictive covenant.
- The employer otherwise provided the employee with adequate consideration, such as a period of employment plus additional professional or financial benefits.
Opportunity to Review and Cool Off
The new Illinois statutory amendments will require businesses to provide an employee with 14 days to review any non-competition agreement and advise them in writing that they should consult an attorney before signing it. This gives the signatory time to consider the choice presented – including with counsel.
Judges Reserve the Right to Modify – Rather Than Strike – Revise Restrictive Covenants
The new Illinois’ law codifies the discretion judges currently have to modify overly broad or otherwise legally deficient restrictive covenants – a practice known as “blue penciling” – rather than holding the entire covenant unenforceable. While a codification of a principle embedded in many states’ law on non-competition agreements, this discretion is critical to the drafting of any proper non-competition covenant.
Under Illinois’ new law, an employer will not be able to enforce an otherwise valid non-compete if they terminated, furloughed, or laid off the employee as the result of the COVID-19 pandemic unless enforcement of the covenant includes compensation equivalent to the employee’s base salary at the time of termination for the period of enforcement minus compensation earned through subsequent employment during the period of enforcement.
Agreements Involving Sale of Business or Trade Secrets Unaffected
SB672 does not apply to restrictive covenants executed in the following contexts:
- Sale of business. The new law does not place limits on restrictive covenants entered by a person buying or selling the goodwill of a company or otherwise acquiring or disposing of an ownership interest in a business.
- Confidential information and trade secrets. Companies can still have employees enter into agreements that contain confidentiality provisions, prohibitions on the use or disclosure of inventions or trade secrets, and the assignment of inventions – which, as noted above, must be addressed up front in any business venture.
As noted, the Illinois’ amendments will not be effective until January 1, 2022, so they will not apply to existing restrictive covenants. But small business owners who regularly use any type of non-competition agreement should consult with an experienced business attorney who can review such provisions considering the new law. Should you have questions about these new limits on non-competes in Illinois, or the state law applicable to your business, or would like a review of your existing agreements to ensure compliance with such laws, please contact me at 312-840-7004 or firstname.lastname@example.org