The Battle to Boost Competition: Illinois Becomes the Latest State to Limit Restrictive Covenants

Sweeping changes are coming to Illinois regarding the legality and enforceability of restrictive covenants. Just this month, Governor J.B. Pritzker approved a bill that dramatically alters how restrictive covenants work in Illinois, which will soon join a growing trend of states restricting the use of non-competition and non-solicitation covenants.

What does the bill do?

The bill amends the Freedom to Work Act, which restricts the use of non-compete agreements for low wage workers. The bill significantly expands the Act, setting forth, for the first time in Illinois, statutory requirements for mandatory review periods, definitions of adequate consideration and legitimate business interests, and specific earnings thresholds for employees subject to restrictive covenants. In short, it does a lot.

When will this new law take effect?

The law goes into effect January 1, 2022. So, as we’ll discuss below, you have time to plan.

Will the law apply retroactively?

No, it will apply only to covenants signed on or after January 1, 2022.

What type of covenants will it apply to?

The law will apply to covenants not to compete and covenants not to solicit employees and customers. Notably, the new law does not apply to agreements covering an employer’s confidential and proprietary information, protection of trade secrets, or inventions assignment agreements. The law also does not address covenants for independent contractors.

The amended act also will not apply to non-compete covenants in the context of the sale of a business, as it expressly excludes covenants and agreements entered into by a person purchasing or selling the goodwill of a business or otherwise acquiring or disposing of an ownership interest.

You mentioned a mandatory review period. What is that about?

Savvy employment lawyers have long counseled clients to not spring restrictive covenant agreements on a new or current employee without time to review (for example, as part of a new hire packet on the employee’s start date), because the employee can argue they were coerced or pressured into signing. The amended act converts this idea into law.

Under the new law, an employer must advise the employee in writing to consult with an attorney prior to entering into the non-competition or non-solicitation covenant and also must provide the employee with at least 14 calendar days to review the covenant before signing. If an employer fails to comply with either requirement, the covenant will be void and unenforceable.

What will constitute sufficient consideration for a restrictive covenant under the new law?

The concept of “consideration” for a restrictive covenant in Illinois often surprises employers. In 2013, in a pivotal case called Fifield v. Premier Dealer Services, an Illinois court 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 the employer for at least two years after signing the agreement.

Beginning January 1, 2022, this heavily debated standard will now be law. The amended act expressly defines “adequate consideration” as either (1) the employee working for the employer for at least two years after signing the non-compete or non-solicitation covenant or (2) other sufficient consideration, such as “a period of employment plus additional professional or financial benefits or merely professional or financial benefits adequate by themselves.”

Unfortunately for employers, the new law does not define what “additional professional or financial benefits” means, or which “merely professional or financial benefits” are by themselves adequate, but presumably this is our legislature’s way of subtly suggesting that signing bonuses, equity grants, and other types of consideration that have historically been sufficient under current case law will remain sufficient under the amended act. Employers will, as always, need to wait for courts to interpret the statute to get clarity on these issues.

What will constitute a “legitimate business interest”? Is that changing?

No. The definition of “legitimate business interest” will be familiar to anyone who has dealt with restrictive covenants in Illinois in the past decade or so. Reflecting established case law, the new statute sets forth several factors that can be considered in the analysis of whether a legitimate business interest exists, including the employee’s exposure to customer and other relationships; the near-permanence of the customer relationships; the employee’s acquisition, use, or knowledge of the employer’s confidential information; and the geographic, temporal, and activity restrictions of the covenants. No one factor will be determinative, and the totality of facts and circumstances will be considered.

So what’s the deal with the earnings thresholds?

The current act prohibits non-competition covenants for any employee earning $13 per hour or less or the applicable minimum wage, whichever is greater. The amended act will greatly expand that concept, prohibiting employers from entering into non-compete and non-solicitation covenants with employees earning less than specified thresholds.

Specifically, the amended Act will prohibit employers from entering into non-compete agreements with employees whose actual or expected earnings are $75,000 or less annually. For non-solicitation agreements, that annual threshold is $45,000. The thresholds that actual or expected earnings must exceed will increase every five years, with the initial increases set forth in the chart below:

For purposes of these thresholds, “earnings” includes any compensation that would show up on a Form W-2, including salary, earned bonuses and commissions, and tips, as well as any elected deferrals not reflected as wages, tips, and other compensation on a Form W-2, such as employee contributions to a 401(k) plan, an FSA or HSA, and commuter-benefit deductions.

Will there be any other restrictions on how employers can use or enforce non-compete and non-solicitation agreements?

Yes, in some circumstances, other restrictions will apply. Clearly inspired by the many furloughs and layoffs at the outset of the COVID-19 pandemic, the amended act will prohibit employers from enforcing any non-compete or non-solicitation covenant with respect to an employee who is furloughed, terminated, or laid off as “the result of business circumstances or governmental orders related to the COVID-19 pandemic or under circumstances that are similar to the COVID-19 pandemic[.]” (We hope we never find out what circumstances are considered “similar.”)

The only exception to this is for terminated, furloughed, or laid off employees on paid garden leave – for these employees, employers can still enforce non-competition or non-solicitation covenants if the operative agreement entitles the employee to compensation equal to the employee’s then-current base salary for the entirety of the non-compete or non-solicitation period. In other words, if the employer wants to enforce such an employee’s 12-month non-compete, the employer needs to pay the employee their base pay for those 12 months.

Will the new law address collective bargaining agreements or particular industries?

It will. Covenants not to compete 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, or who are shareholders, partners, or owners of the business.

Will the new law allow for reformation of restrictive covenants?

Yes. While the amended Act warns that “extensive” reformation of covenants by a court may be against public policy, the legislators acknowledged that “in some circumstances” courts may choose to reform or sever provisions from a covenant rather than hold the entire covenant unenforceable. Courts will determine whether to modify an otherwise unenforceable covenant by reviewing how reasonable the original covenant is (that is, the more an employer overreaches, the more inclined a court should be to throw out the entire provision) and whether the agreement expressly allows for reformation. In other words, narrow and careful drafting is critical.

What are the penalties for non-compliance?

In addition to any other remedies available, if an employee prevails on an employer’s claim to enforce a non-competition or non-solicitation covenant, the amended Act provides that the employee “shall recover” their costs and reasonable attorney’s fees from the employer. As a result, employers should think carefully before attempting to enforce non-compete and non-solicitation covenants going forward.

In addition, the amended Act will authorize the Illinois Attorney General to investigate and file civil lawsuits against employers who engage in a “pattern and practice” prohibited by the new law.

Are these changes unusual, or is this how things are trending?

This is a trend. Illinois is just the latest state to impose restrictions on use and enforcement of non-competition and non-solicitation covenants. For example, in 2020, stringent requirements for non-competition covenants took effect in Washington state, including higher earnings thresholds for non-compete agreements than in Illinois’ amended Act, as well as stricter limitations on how long non-competes can last post-employment. Several states, such as Maryland, New Hampshire, and Virginia, prohibit non-competition covenants for low wage employees. Massachusetts enacted a statute in 2018 that, among other things, prohibits employers from using non-compete covenants for non-exempt employees and requires paid garden leave for the duration of the non-compete period.

At the federal level, President Joe Biden recently issued an executive order asking the Federal Trade Commission to examine the use of non-compete agreements and exercise its authority to issue new rules to restrict the use of covenants limiting worker mobility, although whether that request actually leads anywhere remains to be seen.

As a whole, these developments show a growing trend against the use of non-compete agreements and toward increasing worker mobility. For employers, this can be a mixed outcome, for while it may be more challenging to implement protections they deem necessary, it may be easier to hire candidates who they otherwise would have passed over because of their existing restrictive covenant agreements with prior employers.

So, what should employers do now?

The new law takes effect January 1, 2022, so while there is time to plan, the changes will be here sooner than many employers would like. Employers should examine their existing “form” restrictive covenant agreements and consider whether changes ought to be made with respect to how such agreements are being used – and which job candidates and employees are asked to sign them – in the new year. And although the amended Act will not apply retroactively, entering into an agreement before the clock strikes midnight on December 31, 2021, may not act as a magical incantation that wards off the effects of the new law – with new statutory thresholds for notice and earnings in place, courts may look to the new law as persuasive authority when examining older agreements. And even if courts do not make that connection, parties arguing against the enforceability of agreements most likely will.

It may take months or years for the real-world implications of the amended Act to become apparent, but the wide use of one-size-fits-all non-compete and non-solicitation covenants in Illinois may be coming to an end, and employers should consult with their employment counsel to be prepared for the changes to come. As always, Much's Labor & Employment attorneys are available to help.