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.