Page 5 - John Hundley 2012

Sharp Thinking

No. 58 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. February 2012

Non-Compete Covenants Must Be Supported By

Legitimate Business Interest, High Court Says

By John T. Hundley, Jhundley@lotsharp.com, 618-242-0246

Covenants not to compete must be supported by a legitimate business interest whether made in
connection with employment or with a sale of a business, the Illinois Supreme Court reiterated recently.

Absent a legitimate business interest, such covenants fail the reasonableness test
of RESTATEMENT (2D) OF CONTRACTS §§ 187-88, which the high court approved as
stating long-standing Illinois law. Under that test, a restrictive covenant, if ancillary to
a valid employment relationship, is reasonable only if the covenant: (1) is no greater
than is required for the projection of a legitimate business interest of the employer-
promisee; (2) does not impose undue hardship on the employee-promisor; and (3) is
not injurious to the public. Reliable Fire Equip. Co. v. Arredondo, 2011 IL 111871.

However, the court said that three-prong test imposes “no inflexible formula” and calls for ad
hoc considerations in which “[p]recedents are of less than usual value.” Whether there is a
legitimate business interest is to be determined “based on the totality of the facts and circumstances of
the individual case,” the court said, rejecting the two-factor test created in Nationwide Adv. Serv., Inc. v.
Kolar, 14 Ill.App.3d 522 (1973). Also rejected were other Appellate Court decisions to the extent they
implied that employment covenants need not be supported by a legitimate business purpose.

Factors to be considered under the “totality of circumstances” approach 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, the court said. Moreover, it said, “[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.”

Kolar had focused solely on the near-permanence of customer relations and the employee’s
acquisition of confidential information, and while those factors remain relevant, the exclusive focus “is no
longer valid,” the court said.

Several observations may be offered in light of Reliable. First, its implications for restrictive covenants
in the sale-of-business context are unclear, but should not be ignored. Though Reliable involved
restraints on employees, in imposing the “legitimate business interest” requirement the court
relied on cases arising in the business-acquisition context, without attempting to distinguish that
context. Presumably its imposition of the “totality of the circumstances” test applies to that context also.

Second, the “totality of circumstances” approach seems to make enforceability of restrictive covenants
much more the province of the finder of fact – making appellate review more difficult. The decision seems
to invite trial courts to “let everything in” and see what sticks.

Third, the “totality of circumstances” approach encourages the mixing of apples and oranges. The
acquisition of confidential information and the permanence of customer relations speak to the legitimacy

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