Limitation on Restrictive Employment Covenants
On August 13, 2021, Illinois Governor J.B. Pritzker signed into law an amendment to the Illinois Freedom to Work Act (820 ILCS § 90), governing restrictive covenants. The law – which takes effect on January 1, 2022 and only applies to restrictive covenants entered into after January 1, 2022 – imposes stricter restrictions on the use of non-compete and non-solicit covenants for Illinois employers.
The new law defines a “covenant not to compete” as an agreement between an employer and a low-wage employee that restricts such low-wage employee from performing: (A) any work for another employer for a specified period of time; (B) any work in a specified geographical area; or (C) work for another employer that is similar to such low-wage employee’s work for the employer included as a party to the agreement.
A covenant not to solicit is defined as an agreement between employer and employee that restricts the employee from: (1) soliciting for employment the employer’s employees, or (2) soliciting (for the purpose of selling products or services of any kind) or interfering with the employer’s relationship with clients, vendors and suppliers (or prospective clients, vendors and suppliers).
A “low-wage employee” is defined as an employee whose earnings do not exceed the greater of (1) the hourly rate equal to the minimum wage required by the applicable federal, state, or local minimum wage law, or (2) $13.00 per hour.
The new law does not apply to: (1) non-disclosure agreements covering an employer’s confidential and trade secret information; (2) covenants related to independent contractors; (3) invention assignments; (4) covenants not to compete associated with the sale of a business or business interest; (5) clauses requiring notice before termination, so long as the employee is employed by the employer and paid during the notice period; and (6) agreements to not reapply for employment with the employer after termination.
Under the newly signed law, employers in Illinois are prevented from entering into non-compete covenants with employees who earn an actual or expected annualized rate of earnings of $75,000 per year or less. The law also prohibits employers from entering into non-solicit covenants with employees who earn an actual or expected annualized rate of earnings of $45,000 per year or less. For the purpose of determining an employee’s rate of earnings, their compensation includes earned bonuses, commissions, tips, and other compensation such as employee contributions to a 401(k) plan, an FSA or an HSA, and commuter-benefit deductions.
For non-compete covenants, the earnings threshold amounts will increase by $5,000 every five years until January 1, 2037, at which time the amount will equal $90,000. For non-solicit covenants, the earnings threshold amounts will increase by $2,500 every five years until January 1, 2037, at which time the amount will equal $52,500.
In addition, the new law discourages, but does not absolutely prohibit, “blue-penciling” or judicial reformation of restrictive covenants. “Blue-penciling” occurs where courts revise restrictive covenants to comply with what is deemed reasonable. Under the new law, courts have limited discretion to “blue-pencil.” They may do so if the original constraints are deemed to be fair as written and reflect a good faith effort to establish reasonable restrictions. “Blue-penciling” is also available by explicit agreement of the parties.
ADEQUACY OF CONSIDERATION
The adequacy of “consideration” for a restrictive covenant has long been a matter of Illinois case law. In 2013, the First District Appellate Court, in Fifield v. Premier Dealer Services, decided that for at-will employees, mere employment (or, for current employees, continued employment) is not adequate consideration to support a restrictive covenant, unless the employee remains employed with that employer for at least two years after signing the restrictive covenant.
However, under the new law, a restrictive covenant is supported by “adequate consideration” if (1) the employee has worked for the employer for at least two years after signing a restrictive covenant, or (2) the employer has provided the employee with “professional or financial benefits” that may constitute independent consideration for entering into a restrictive covenant. The law does not define precisely what amount of “professional or financial” benefits shall constitute adequate consideration, leaving the door open for interpretation by Illinois courts. Presumably, these “benefits” include promotions, bonuses, or other financial benefits.
In addition to adequate consideration, a non-compete or non-solicit covenant must satisfy an employer’s “legitimate business interest.” This phrase is not defined under the new law but is determined by the totality of the circumstances of the individual case, including: (1) the employee’s exposure to the employer’s customer relationships or employees; (2) the near-permanence of the customer relationship; (3) the employee’s knowledge or use of confidential information; (4) the length of the proposed restriction; (5) the geography of the proposed restriction; and (6) the scope of the proposed restriction.
ATTORNEY REVIEW PERIOD
Under the new law, Illinois employers will be required to advise newly hired employees – in writing – that they have the right to consult with an independent attorney before entering into a non-compete or non-solicit covenant. In addition, employers must provide the employee with at least 14-days to review the proposed restrictive covenant. Employees have the option of signing the covenant before that 14-day period has ended.
If an employee prevails in a civil action or arbitration filed by an employer seeking to enforce a non-compete or non-solicit covenant, the employee can recover reasonable attorneys’ fees and costs from the employer regarding such claim.
ATTORNEY GENERAL AUTHORITY
The Illinois Attorney General has broad authority to investigate employer conduct when there is “reasonable cause” to believe that an employer is engaged in a pattern or practice prohibited by the Illinois Freedom to Work Act. The Illinois Attorney General is permitted to seek compensatory damages and equitable remedies against employers, including monetary penalties of $5,000 per violation or $10,000 for each repeat violation within a five-year period.
Employers will be prohibited from entering into restrictive covenants with employees who have lost their jobs due to the COVID-19 pandemic or under “circumstances that are similar to the COVID-19 pandemic.” However, these restrictions are not included if enforcement of the non-compete 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.
COLLECTIVE BARGAINING AGREEMENTS
Non-compete covenants will be illegal and unenforceable with respect to employees covered by collective bargaining agreements, as well as individuals “employed in construction,” except for individuals primarily performing management, engineering, architectural, design, or sales functions, as well as individuals who are shareholders, partners, or owners of the business. Employers cannot enter into non-compete covenants with individuals covered under the Illinois Public Labor Relations Act or the Illinois Educational Labor Relations Act.
RECOMMENDED NEXT STEPS FOR EMPLOYERS
As noted, the new law does not apply to restrictive covenants entered into prior to January 1, 2022. Thus, employers who have entered into non-compete or non-solicit covenants with employees do not need to retroactively update or amend their restrictive covenants.
However, employers should begin to review their existing restrictive covenants to ensure that they will remain enforceable under the new – more restrictive – legal standards beginning January 1, 2022. Due to the lack of bright-line rules, this new legislation allows significant leeway for Illinois courts in determining the validity and enforceability of restrictive covenants.
If you have any questions related to this guidance, please contact your attorney at Pedersen & Houpt or the attorneys below and we will answer your questions.
|Lawrence W. Byrne |
Attorney at Law
161 North Clark Street, Suite 2700
Chicago, Illinois 60601
|Matthew D. Wilson |
Attorney at Law
161 North Clark Street, Suite 2700
Chicago, Illinois 60601