Third Party Enforcement of A Non-Compete and Trade Secret Pre-emption – IL Law

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In Cronimet Holdings v. Keywell Metals, LLC, 2014 WL 580414 (N.D.Ill. 2014), the Northern District of Illinois considers whether a non-compete contract is enforceable by a stranger to that contract as well as trade secret pre-emption of other claims.

Facts and Procedural History

Plaintiff, who previously signed a non-disclosure agreement with a defunct metal company (the “Target Company”) it was considering buying, filed a declaratory action against a competitor (“Competitor”) requesting a ruling that the non-disclosure agreement and separate non-competes signed by the Target Company’s employees were not enforceable by the competitor who bought  the Target Company’s assets. The NDA and non-competes spanned 24 months.

The plaintiff moved to dismiss eight of the ten counterclaims filed by the Competitor.  It argued the Competitor lacked standing to enforce the non-competes and that its trade secrets counterclaim (based on the Illinois Trade Secrets Act, 765 ILCS 1065/1 (“ITSA”)) pre-empted several of the tort counterclaims.

In gutting most (8 out of 10) of the counterclaims, the court applied the operative rules governing when non-competes can be enforced by third parties:

 Illinois would likely permit the assignment of a non-compete to a third party;

Enforcing a non-compete presupposes a legitimate business interest to be protected;

– A legitimate business interest is a fact-based inquiry that focuses on whether there is (i) a “near-permanence” in a customer relationship, (ii) the company’s interest in a stable work force , (iii) whether a former employee acquired confidential information and (iv) whether a given non-compete has valid time and space restrictions;

A successor corporation can enforce confidentiality agreements signed by a predecessor (acquired) corporation where the acquired corporation merges into the acquiring one;

– A successor in interest is one who follows an original owner in control of property and who retains the same rights as the original owner;

– The ITSA pre-empts (displaces) conflicting or redundant tort claims that are based on a defendant’s misappropriation of trade secrets;

– Claims for unjust enrichment, quasi-contract relief or unfair competition are displaced by the ITSA where the claims essentially allege a trade secrets violation;

– The ITSA supplants claims that involve information that doesn’t rise to the level of a trade secret (e.g. not known to others and kept under ‘lock-and-key’);

(**4-5).

The court found that since a bankruptcy court (in the Target Company’s bankruptcy) previously ruled that the Competitor didn’t purchase the non-competes, and wasn’t the Target Company’s successor, the Competitor lacked standing to enforce the non-competes.

The Court also held that once the Target Company stopped doing business, its non-competes automatically lapsed since it no longer had any secret data or customers to protect.

The Court also agreed that the Company’s ITSA claim pre-empted its claims that asserted plaintiff was wrongfully using the Target Company’s secret data.  The court even applied ITSA pre-emption to non-trade secret information.  It held that so long as the information sought to be protected in a claim was allegedly secret, any non-ITSA claims based on that information were pre-empted.

Afterwords:

(1) A non-compete can likely be assigned to a third party;

(2) Where the party assigning a non-compete goes out of business, the assignor no longer has a legitimate business interest to protect; making it hard for the assignee to enforce the non-compete;

(3) ITSA, the Illinois trade secrets statute, will displace (pre-empt) causes of action or equitable remedies (unjust enrichment, unfair competition, etc.) that are based on a defendant’s improper use of confidential information – even where that information  doesn’t rise to the level of a trade secret.

Homeowners’ Operation of Home-Based Daycare Business Doesn’t Violate Restrictive Covenant Requiring Residence Use – IL Third Dist.

The plaintiff homeowner’s association in Neufairfield Homeonwers Ass’n v. Wagner, 2015 IL App (3d) 140775, filed suit against two sets of homeowners claiming they violated restrictive covenants in the development’s declaration by operating daycare businesses from their homes.

The association based their suit on a declaration covenant that required all lots to be used for “Single Family Dwellings.”

The declaration allowed an exception for home-based businesses but only if they were operated in conformance with City ordinances and if there were no vehicles with business markings parked overnight in the development.  A further qualification to the home-based business rule prohibited activities that encouraged customers or members of the public to “frequent” the development.

The association sued when several homeowners complained that the daycare businesses resulted in increased vehicular traffic in the development and was a nuisance to the residents.

The association supported their case with an affidavit from the property manager and a homeowner – both of whom testified that the two daycares resulted in multiple non-residents entering and exiting the subdivision on a daily basis and that several residents had similar complaints.

Affirming summary judgment for the homeowner defendants, the appeals court provides a primer on the enforceability of restrictive covenants and the governing contract interpretation principles affecting them. It wrote:

-Restrictive covenants affecting land rights will be enforced according to their (the covenants) plain and unambiguous language;

–  In interpreting a restrictive covenant, the court’s objective is to give effect to the parties’ actual intent when the covenant was made;

– A condominium declaration is strong evidence of a developer’s intent and it will be construed against the developer where the declaration’s text is unclear;

– Undefined words in a declaration are given their “ordinary and commonly understood meanings” and a court will freely use a dictionary as a resource to decipher a word’s ordinary and popular meaning.

(¶¶ 16-20).

Here, the key declaration word was “frequent” – that is, did the defendants’ daycare businesses result in customers or members of the public “frequenting” the subdivision?

The declaration didn’t define the verb “frequent” but the dictionary did as to do something “habitually” or “persistently.”  Webster’s Third New International Dictionary 909 (1981); (¶ 20).

The plaintiff’s supporting affidavit established that, at most, 7 or 8 cars entered and exited the subdivision on a daily basis – supposedly to patronize the daycare businesses.  The court viewed this amount of traffic wasn’t persistent or habitual enough to meet the dictionary definition of “frequent” under the declaration.

As a result, the association’s declaratory judgment suit failed and the court affirmed summary judgment for the property owners.

Afterwords:

1/ Courts will construe declarations and restrictive covenants as written and will do so under standard contract interpretation rules (e.g. unambiguous language will be construed under plain language test and without resort to outside evidence).

2/ Where a term isn’t defined, a court can look to dictionary to inform a word’s ordinary and popular meaning.

3/ A court will construe a restrictive covenant in favor of free use of residential property and where a declaration specifically allows home-based businesses, a court will scrutinize association attempts to curtail a property owner’s use of his property.

 

 

Two-Year Continuous Employment Rule to Support Non-Compete Validated by Illinois Appeals Court

Fifield v. Premier, 2013 IL App (1st) 120327 is rightly regarded as a watershed case in Illinois employment and non-compete law circles for squarely stating that two years of continuous employment is the required consideration to support a non-compete agreement in an at-will setting.

Prairie Rheumatology Associates, SC v. Francis, 2014 IL App (3d) 140338 represents an appeals court’s recent validation of the two-year rule in the context of a medical practice suing to prevent one of its former physician employees from competing against it.

The plaintiff medical company and the doctor defendant entered into an at-will employment contract (it could be terminated by either side at any time) that contained a 2-year and 14-mile non-compete term. The defendant agreed not to perform competing medical services for 2 years and within 14 miles of the plaintiff’s office measured from the date defendant’s employment ceased and the physical office location.

19 months into her tenure, defendant quit and went to work for a medical services firm located nine miles from plaintiff’s office. Plaintiff sought a preliminary injunction to enforce the non-compete. The trial court entered an injunction that prevented the defendant from treating plaintiff’s current patients but allowed defendant to treat patients that belonged to her before she started working for the plaintiff. The defendant appealed.

Held: reversed. Non-compete lacks consideration and is not enforceable.

Reasons:

In Illinois, a post-employment restrictive covenant (like a non-compete agreement) is enforceable only where it is reasonable in geographic and temporal scope (“space and time”) and necessary to protect a legitimate employer interest.  A restrictive covenant is reasonable where (1) it’s no greater than necessary to protect the employer’s legitimate business interest, (2) it doesn’t impose an undue hardship on the employee, and (3) isn’t injurious to the public. (¶ 12).  But before the court analyzes these three factors, it must first determine whether the restrictive covenant is supported by consideration.

The reason for the consideration rule is because an employer’s promise of continued employment is often illusory in an at-will relationship since the employer can fire the employee at any time without warning.  Two years or more of continued employment constitutes adequate consideration in the non-compete setting and the two-year rule applies even where the employee resigns on his own instead of where he is fired.  (¶¶ 14-15).

Here, the defendant resigned 19 months after her employment commenced – five months short of the required two-year consideration period. As a result, the court declined to enforce the non-compete.

The court rejected plaintiff’s argument that it gave the defendant “additional consideration” in the form of marketing support and facilitating defendant’s hospital privileges. Looking at the evidence, the court found plaintiff gave defendant minimal assistance in obtaining hospital privileges and failed to introduce defendant to any referral sources as was promised. At the injunction hearing, plaintiff’s principal couldn’t name a single doctor to whom she introduced defendant during defendant’s time practicing at plaintiff’s office.  (¶¶ 18-19).

Afterwords:

This case cements rule that two years of continuous employment is required for there to be adequate consideration to enforce a post-employment non-compete term.  An employer can possibly get around this by offering additional consideration (i.e., something the employee is otherwise not entitled to).  But where the employer cannot offer evidence of the additional consideration, the two-year rule controls and will bar enforcement of the non-compete.