Monday, December 5, 2011

Two Important Noncompete Cases

Two recent cases, one out of the federal court here in Chicago and one of out Illinois Supreme Court, highlight some important considerations for drafting and enforcing noncompete agreements. The federal decision is important because it highlights the necessity of careful planning in the sale or purchase of a business, while the Illinois Supreme Court case rewrites some fundamental rules for consideration of noncompete agreements in Illinois.

In the federal case the former employee, Harris, originally formed a company that distributed prelit Christmas trees and other seasonal material. He ultimately sold his business to New England Pottery, a holiday decor distributor and agreed to stay on as an employee subject to a 5-year employment agreement. In his capacity as an employee, Harris continued to interact with the suppliers and customers he developed for his own company.

NEP was ultimately sold to Central Garden and Pet company some 5 years later. Harris did not participate in the negotiations between Central and NEP and was not a signatory or party to their asset purchase agreement. Harris signed an employment agreement with Central on the date of the sale and on the date the sale closed he signed a noncompete agreement that prohibited him from working in the holiday decor industry or in any other industry in which Central operated for 5 years following the end of his employment with Central. During the course of Harris' employment with Central, there were no exclusive relationships between Central and its overseas suppliers--Central's suppliers were not prohibited from sharing information about orders placed by Central or other customers, and only Harris, of all the employees privy to Central's cost and pricing information, was required to sign a confidential information agreement relating to this information.

Harris ultimately left Central, and filed a lawsuit seeking to void his noncompete with Central. He also immediately started working in competition with his former employer.

The federal court first had to determine what standard to use in determining the viability of the noncompete. Harris claimed he was simply an employee when he signed his noncompete, but Central claimed that Harris' noncompete was part of its acquisition of NEP. Unfortunately for Central, its asset purchase agreement did not incorporate or even mention Harris' noncompete agreement or identify the noncompete as essential to the closing of the deal. As the court noted, once Central executed the asset purchase agreement, it became obligated to complete the purchase of any of these assets, regardless of whether Harris agreed to a noncompete. Accordingly, the court measured the noncompete under the far more restrictive (and less favorable for Central) "employee" standard, meaning that the agreement had to protect a legitimate business interest and be reasonable as to time, place, and scope of restricted activity.

Central claimed that it was seeking to protect a legitimate business interest--confidential information--in prohibiting Harris' employment with competitors (note that the standard used by the federal court changed about three months later, see below). Again , the court quickly disposed of this argument, noting that neither Central's customers nor any other Central employee, save Harris, was prohibited from discussing customer or pricing information. Under these facts, there was no confidential information because the company had not taken the adequate steps to safeguard it. The court found that the noncompete was therefore not protecting a valid business interest, and found for Harris.

Interesting aside - the company tried to rely on the confidentiality provision included in its employee handbook as evidence of its efforts to prevent disclosure of business information by its work force as a whole. The handbook provided no description of what information the company considered confidential with respect to this specific lighting business at issue, and the company admitted that it provided no guidance to the employees about the business information it considered confidential. Instead, Central hoped that its employees would use common "business etiquette" to keep its business information confidential. This argument barely passes the straight face test for me, but just so that there is no doubt, I give you the words of the court: "Relying on good manners to prevent disclosure of information will not do in creating a protectable interest in confidentiality". Good manners notwithstanding, get it in writing.

And, when you are in the process of negotiating a business transaction and you want the noncompete of a potential competitor to be a factor, put it in the agreement.

The Illinois Supreme Court case is more significant. The facts of the case are not as important as the court's analysis, which basically brings Illinois into conformance with a number of other states with respect to what can be used to justify the imposition of a noncompete on a former employee.
Under previous Illinois precedent, an employer can establish a legitimate business interest to preclude an employee from competing with it only when there was either a permanent customer relationship at issue or confidential business information. That was the analysis used by the federal court in the case above.

In this new case, the Illinois Supreme court considerably broadened the considerations an employer case use to justify preventing a former employee from competing with it. Now courts and employers must make their analysis using a legitimate business interest test that is far more flexible. A legitimate business interest is now judged on the totality of the facts and circumstances of each case. Factors 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 employment, and time and place restrictions. The court specifically noted that none of these factors carry any more weight than any other, but that their importance will depend on specific facts and circumstances of the individual case.

As someone who has litigated noncompete cases in several states, I think that the court's decision is absolutely correct, and far closer to what is being used in states that have allowed their noncompete jurisdiction to evolve over the last few years. In fact, geographic restrictions have become less important, while the nature of what comprises protectable confidential business information has become far more flexible and time sensitive.

So, for employers in Illinois, the drafting of a noncompete should be undertaken with significant care and forethought. The restrictions cannot be too broad, especially in regard to the activities the company is trying to prohibit post employment. The best course of action is to carefully assess the role of the employee and what elements of that role the company can legitimately claim as proprietary. Then the company should determine how long and to what degree it can protect those business interests by always keeping in mind that for noncompete cases, less is more.

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