May employers prospectively restrict employees from “competing” – that is, from obtaining future employment that could harm their current employers - such as in terms of sales, market share, and other measurable organizational success? Less so now than before, per recent changes in Illinois employment law, as non-compete provisions must be carefully and narrowly circumscribed to be enforceable. Employers with employees in other states should note too the more generally applicable legal principles.
Available legal protections have long generally favored employees, allowing “covenants not to compete” only if such employment contract provisions are “reasonably” restricted in duration, particular geographic area, and type of work. Additionally under some states (and as a matter of public policy), courts have held them legally unenforceable as a restraint against commerce in cases of involuntary employment termination or other circumstances warranting leniency.
For nonprofit employers, non-compete contract provisions may be quite rare since technically nonprofits do not “compete” for business. But they crop up in nonprofit work relationships along with non-solicitation agreements, which may preclude employees from soliciting a charity’s donors for other fundraising, recruiting staff, or soliciting (for purposes of selling services) any of the charity’s current or potential clients, vendors, or suppliers after the employee’s termination; and they are otherwise somewhat common in certain business industries (e.g., sales).
Illinois’ recently amended its Freedom to Work Act (the Act) to increase constrains on employers seeking to utilize both non-compete and non-solicitation restrictions with their employees. Effective January 1, 2022, the amended Act contains broader compensation-related restrictions, limits the use of non-solicitation restrictions, and adds a disclosure requirement and consideration period along with significant potential penalties for violations.[1]
Non-Competes and Non-Solicitation Restrictions Generally
Legally, non-competes and non-solicitation agreements are expressed as contract rights. To the extent they last more than one year, such contractual obligations must be in writing under state “statute of fraud” laws. Within the employment context, they might be included in an initial employment agreement, whether an at-will employment relationship or not. More commonly, a separation agreement may provide for severance money paid in exchange for the employee’s willingness to refrain from certain activity and to waive claims against the employer.
To be legally valid, a non-compete clause (aka covenant not to compete) must generally contain three limiting elements. Under long established court decisions, failure to satisfy all three elements defeats the restriction’s legal enforceability. First and of key importance, the non-compete must describe the scope of work that the employee may not perform (e.g., as a dentist, violin teacher, or fundraiser). Second, the non-compete must specify an applicable time period (e.g., three months, six months, or perhaps one year). Third, the restriction must be limited to a definite geographical area (e.g., within a certain city or region). Courts and others have grappled with this third element, and they likely will continue to do so particularly given the advent of more remote work arrangements. Overall, courts disfavor such “restraints on trade,” or restraints which preclude a worker from pursuing her occupation and thus prevent from supporting herself and her family. Thus, the more limited the term, the better!
A non-solicitation agreement provides a less restrictive arrangement, by which an employee may not solicit for employment the employer’s employees or the employer’s donors, clients, vendors, or suppliers. A non-solicitation agreement thus may prove helpful for nonprofits seeking to protect its donor relationships as well as other aspects of its operations.
Illinois’ New Law – More Freedom for Employees, Less for Employers
The new Illinois law follows a recent trend toward significant restrictions on the use of non-compete and non-solicitation clauses. The apparent public policy under the newly amended Freedom to Work Act is to protect lower-wage workers through compensation considerations, notice requirements, and civil penalties for employer violations. The Act contains the following key aspects.
First, the amended Act provides compensation thresholds. If a non-compete agreement applies to an employee who earns $75,000 or less, it will be legally unenforceable. Additionally, non-solicitation agreements involving employees who make $45,000 or less per year are likewise legally invalid. Note that since the law only applies to agreements made on or after January 1, 2022, these compensation thresholds must be considered for new hires. Additionally, with respect to each kind of restrictive agreement, the compensation cap increases by $5,000 and $2,500 respectively every five years through January 2037. Applying such periodic increases to non-compete restrictions, employees who earn $80,000 or less as of January 2027, $85,000 or less as of January 2032, and $90,000 or less as of January 2037 may not be legally bound by a non-compete agreement. Likewise, any employees who earn $47,500 or less as of January 2027, $50,000 or less as of January 2032, and $52,500 or less as of January 2037 may not be legally bound by non-solicit agreements.
Second, the amended Act prohibits employers from requiring employees to sign a non-compete and non-solicitation agreements if they have been terminated or furloughed “as a result of business circumstances or governmental orders related to the COVID-19 pandemic or under circumstances that are similar to the COVID-19 pandemic unless enforcement of the covenant…includes compensation equivalent to the employee’s base salary at the time of termination of the period of enforcement minus compensation earned through subsequent employment during the period of enforcement.”[2] Basically, for such a restrictive covenant to be valid under these circumstances, employers must ensure that the terminated/furloughed employee experiences no drop in pay during the subsequent period of restricted activity.
Third, the amended Act further identifies the legal criteria required to support legal enforceability of both types of restrictive covenants. More specifically, such arrangements are legally enforceable only if five criteria are met. The first two criteria are logical, that is, the employee must receive “adequate consideration” (i.e., compensation payments, and perhaps related employee benefits) and the restriction must be “ancillary to a valid employment relationship.” The latter three criteria are consistent with the long-established criteria for non-competes, as identified above: the restriction must be “no greater than is required for the protection of a legitimate business interest of the employer”; the restriction must not “impose undue hardship on the employee”; and the covenant must not be “injurious to the public.”[3]
Significantly, the amended Act affords a court discretion to “reform or sever provisions of a covenant not to compete or a covenant not to solicit rather than hold such covenant unenforceable.”[4] This means where a court may have otherwise declared an insufficiently restricted agreement null and void, the reviewing court may now preserve the agreement with modifications that meet the five legal criteria described above. Relevant factors for exercising such discretion include “the fairness of the restraints as originally written, whether the original restriction reflects a good-faith effort to protect a legitimate business interest of the employer, the extent of such reformation, and whether the parties included a clause authorizing such modifications in their agreement.”[5] Such statutory provision is itself a modification of the long established “blue-pencil” judicial prohibition on reforming restrictive covenants. Under such legal doctrine, courts have traditionally refused to hold certain contract portions valid and other portions invalid, and instead have struck down the entire covenant as defective. Employers thus may enjoy a proverbial silver lining in this otherwise restrictive new law, for restrictive covenants that fail to satisfy all the required criteria.
Fourth, the amended Act includes a disclosure requirement, rendering a non-compete or non-solicitation agreement otherwise enforceable only if the employer (a) advises the employee in writing to consult with an attorney before signing and (b) provides the employee with 14 days to review the agreement. Notably, the 14-day review period may be waived by the employee.
Importance of Compliance
Employers need not wonder whether the Illinois legislature is serious about limiting the use of restrictive covenants. The amended Act includes a mandatory attorneys’ fees provision in the employee’s favor, upon prevailing in litigation. Additionally, the new law grants the Attorney General authority to sue employers alleged to be engaged in a pattern or practice of entering illegal restrictive covenants for damages and civil penalties up to $5,000 for each violation or $10,000 for each repeat violation within a 5-year period.
Key Takeaways
If an employer seeks to impose a non-compete or non-solicitation restriction on an employee, it should carefully consider the following next steps. Such matters may apply at the commencement of an employee’s relationship with the employer or as part of employment separation discussions.
First, evaluate how important one or both restrictions are to the employer’s activities. As noted above, such considerations may not apply at all to a nonprofit setting. Further, perhaps other more important goals may be to protect confidentiality of information (e.g., donor information), to clarify ownership and authorized usage of creative works that may be developed (such as under copyright law), or to address how information may be shared with others (e.g., use of social media). Such matters would be more appropriately addressed through confidentiality, creative works, or disclosure provisions.
Second, put it in writing! For current employees, an employee handbook may provide the best method for addressing confidentiality, intellectual property, or social media requirements may be best addressed through, and preferably accompanied by the employee’s written acknowledgement to comply with such employer requirements. For departing employees, a written severance agreement is critical – and with the required attorney review advisory and 14-day waivable evaluation period for employees working in Illinois.
Third, make sure that any restrictive covenants meet all the established criteria. Courts have historically been quite harsh with non-compete restrictions, favoring employees and their ability to engage in new work after leaving current jobs. With this in mind and as the new Illinois law requires, think hard about employees’ freedom to work, make sure any restrictive covenants make sense, factor in any applicable compensation thresholds, and clearly communicate applicable expectations and requirements to employees.
[1] See 820 ILCS 90/1 et al.
[2] See 820 ILCS 90/10(c)
[3] See 820 ILCS 90/15
[4] See 820 ILCS 90/35(b)
[5] See 820 ILCS 90/35(b)
