Reliable Fire – Legitimate business interest and the totality of the circumstances.

Reliable Fire v. Arredondo.  Dec. 2011.  The Four Elements of the Three-Dimensional Rule.  The dangling ancillarity.

RELIABLE FIRE EQUIPMENT COMPANY, v. ARNOLD ARREDONDO.  Docket No. 111871. SUPREME COURT OF ILLINOIS. 965 N.E.2d 393; 2011 Ill. LEXIS 1836; 2011 IL 111871; 358 Ill. Dec. 322; 33 I.E.R. Cas. (BNA) 278

CASE SYLLABUS.  The enforceability of an employees’ covenant not to compete should be judged by the three-prong test of reasonableness, of which the employer’s legitimate business interest continues to be a part, and which looks to the totality of all of the circumstances, rather than focusing on named specific factors.

For decades, Illinois Appellate Courts pieced together various tests to determine if a restrictive covenant was enforceable.  They examined different factors or prongs in an effort to identify whether the covenant protected some legitimate business interest.  In this decision, the Illinois Supreme Court addressed these competing tests and declared the law of the land.  The court specifically stated that the decision constituted an opportunity to clarify that Illinois recognizes the legitimate business interest of the promisee (the employer) as a requirement of an enforceable restrictive covenant.  This decision is essential reading for anyone tasked with determining whether their employee restrictive covenant protects a legitimate business interest.  Employers need to remember that the legal standard set forth in this decision clearly means that one size does not fit all.  The court specifically stated that identical agreements can be both legitimate and not legitimate depending on the factual circumstances surrounding the parties.  Careful analysis and deliberate thought are required.

Case Facts.  Reliable Fire was in the fire suppression business.  The firm was established in 1955.  When defendants worked for Reliable Fire, it had approximately 100 employees.  Garcia was hired in 1992 and Arredondo was hired in 1998.  Starting late in 1997, Reliable began requiring employees to sign non-compete agreements.  The agreement prohibited employees from competing against Reliable Fire in the states of Illinois, Indiana and Wisconsin for a period of one year following the termination of their employment.  On September 15, 2004, Arredondo resigned.  On October 1, 2004, Reliable fired Garcia suspecting that he was working with Arredondo to compete against Reliable Fire.  In December, 2004, Reliable Fire filed its complaint alleging that both Arredondo and Garcia were competing against Reliable Fire in violation of their non-compete agreement.  The defendant filed a counterclaim asserting that the non-compete was not enforceable because it did not protect a legitimate business interest held by Reliable Fire.  The issue was heard upon a bench trial in November, 2007.  The trial court found that Reliable Fire did not possess a legitimate business interest to justify the enforcement of the restrictive covenants.  A sharply divided appellate court affirmed.  The question presented to the supreme court was whether the trial court applied the correct legitimate business interest test.  The supreme court reviewed the matter de novo as a question of law.

Restrictive Covenants in Restraint of Trade.  By way of background, Illinois courts have long held that a contract in total and general restraint of trade was “undoubtedly” void because it “necessarily” injures the public at large and the individual promisor. Such a contract deprives the public of the industry of the promisor, and deprives the promisor of the opportunity to pursue an occupation and thereby support his or her family.  However, it is equally established that a restrictive covenant will be upheld if it contains a reasonable restraint and the agreement is supported by consideration.  The supreme court acknowledged that the modern trend in law is the application of a three-prong test to determine whether a legitimate business interest exists.  The court specified that a restrictive covenant, assuming it is ancillary to a valid employment relationship, is reasonable only if the covenant: (1) is no greater than is required for the protection 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. Further, the extent of the employer’s legitimate business interest may be limited by type of activity, geographical area, and time. This court long ago established the three-dimensional rule of reason in Illinois and has repeatedly acknowledged the requirement of the promisee’s legitimate business interest down to the present day.  Since ancillarity is required, one may describe the test of reasonableness as having four elements, expressly listing ancillarity, instead of three elements, which assumes ancillarity.

Good-Bye Kolar Test.  In short, the Kolar test is as follows:  An employer’s business interest in customers is not always subject to protection through enforcement of an employee’s covenant not to compete. Such interest is deemed proprietary and protectable only if certain factors are shown. A covenant not to compete will be enforced if [1] the employee acquired confidential information through his employment and subsequently attempted to use it for his own benefit. An employer’s interest in its customers also is deemed proprietary if, [2] by the nature of the business, the customer relationship is near-permanent and but for his association with plaintiff, defendant would never have had contact with the clients in question. Conversely, a protectable interest in customers is not recognized where the customer list is not secret, or where the customer relationship is short-term and no specialized knowledge or trade secrets are involved.

Further confusion was caused by the templates utilized by appellate courts over the years.  The special concurrence opinion in the appellate decision used the “totality of the circumstances” test, not the three-prong business interest test and urged that this approach was the better reasoned test. 

Good-Bye Sunbelt.  Earlier appellate court decisions, from as far back as Linn and Hursen, through cases such as Bauer and House of Vision, and down to the present day in Mohanty, have repeatedly recognized the three-dimensional rule of reason, specifically including the element of the legitimate business interest of the promisee. However, in Sunbelt Rentals, Inc. v. Ehlers, 394 Ill. App. 3d 421, 915 N.E.2d 862, 333 Ill. Dec. 791 (2009), a panel of our appellate court concluded that the test of reasonableness of a restrictive covenant is something other than the prevalent three-prong inquiry long established by this court.  Accordingly, because (1) the Supreme Court of Illinois has never embraced the ‘legitimate-business-interest’ test and (2) its application is inconsistent with the supreme court’s long history of analysis in restrictive covenant cases, we reject the ‘legitimate-business-interest’ test. The Sunbelt court prescribed that a court, when presented with the issue of whether a restrictive covenant should be enforced, should evaluate its reasonableness based only on its time and territory restrictions. Thus, this court need not engage in an additional discussion regarding the application of the ‘legitimate-business-interest’ test because that test constitutes nothing more than a judicial gloss incorrectly applied to this area of law by the appellate court.  As the supreme court stated in this decision, the legitimate business interest test was not judicial gloss. 

The Courts Thinking.  Parties have long turned to the common law to argue for or against the enforceability of noncompetition agreements. There is, therefore, an especially well-developed and significant body of judicial decisions applying the general rule of reason to such promises. The common law, based on reason and experience, has recognized several factors and subfactors within the component of the promisee’s legitimate business interest.  However, we hold that such factors are only nonconclusive aids in determining the promisee’s legitimate business interest, which in turn is but one component in the three-prong rule of reason, grounded in the totality of the circumstances. Each case must be determined on its own particular facts.  Reasonableness is gauged not just by some but by all of the circumstances. The same identical contract and restraint maybe reasonable and valid under one set of circumstances, and unreasonable and invalid under another set of circumstances. We expressly observe that appellate court precedent for the past three decades remains intact, but only as nonconclusive examples of applying the promisee’s legitimate business interest, as a component of the three-prong rule of reason, and not as establishing inflexible rules beyond the general and established three-prong rule of reason.

In sum, the legitimate business interest test is still a viable test to be employed as part of the three-prong rule of reason to determine the enforceability of a restrictive covenant not to compete. However, the two-factor test created in Kolar, in which a near-permanent customer relationship and the employee’s acquisition of confidential information through his employment are determinative, is no longer valid. Rather, we adopt the position of Justice Hudson’s special concurrence, which is: whether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case. Factors to be considered in this analysis 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. No factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.

The supreme court noted that the lead opinion in the appellate court applied these legitimate business interest “tests” (in upholding the circuit court’s ruling that the noncompetition restrictive covenant was unenforceable. The specially concurring justice agreed with the circuit court’s result, but based on the totality of the circumstances presented in the record. He stated: “Analyzing such covenants with reference to the totality of the circumstances to determine if an employer has a protectable interest, as opposed to utilizing the typical rigid version of the legitimate-business-interest test, will lead to results more grounded in the true considerations of a given case.” (Hudson, J., specially concurring).3 The supreme court was more impressed with the specially concurring opinion in the appellate court.  We agree.

HOLDING.  The supreme court recognized the three-prong rule of reason, grounded in the totality of the circumstances as the appropriate test to use in Illinois.  The two-prong test utilized in Kolar is no longer valid.  In sum, the legitimate business interest test is still a viable test to be employed as part of the three-prong rule of reason to determine the enforceability of a restrictive covenant not to compete. However, the two-factor test created in Kolar, in which a near-permanent customer relationship and the employee’s acquisition of confidential information through his employment are determinative, is no longer valid. Rather, we adopt the position of Justice Hudson’s special concurrence, which is: whether a legitimate business interest exists is based on the totality of the facts and circumstances of the individual case. Factors to be considered in this analysis 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. No factor carries any more weight than any other, but rather its importance will depend on the specific facts and circumstances of the individual case.

Justice Freeman delivered this opinion with six judges concurring.  The decision clarifies that determining whether a restrictive covenant protects a legitimate business interest will depend upon an analysis of the totality of the circumstances.  The two-prong test previously set forth in the Kolar decision is dead.  Employers are admonished to examine their non-compete agreements in light of their customer relationships, employees access to confidential information, and the nature of the restrictions being imposed. Bryan Bagdady is a business trial attorney with decades of litigation experience – including trial and appellate work. He prepares business contracts and prosecutes and defends complex business disputes. Bryan can be contacted by calling (312) 300-6843 or by email at Bryan@celsinfo.com.

Footnote:  Be mindful of the general principle that contracts in total and general restraint of trade are void as against public policy. Contracts which are only in partial restraint of trade are valid if they are reasonable and are supported by consideration.  A restraint is reasonable when it is such only as to afford a fair protection to the interests of the party, in whose favor it is imposed. If the restraint goes beyond such fair protection, it is oppressive to the other party and injurious to the interests of the public, and, consequently, void upon the ground of public policy.

Elements to be an Enforceable Employment Restraint. 

  • Ancillary
  • Consideration
  • Reasonable – Three- Prong Test.  A restrictive covenant is reasonable only if the covenant: (1) is no greater than is required for the protection 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.

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