Buyers Beware: Employee Non-Compete Agreements in the Sale of a Business
Illinois courts will generally not enforce non-compete and non-solicitation agreements (restrictive covenants) in an employment context unless there is a legitimate business interest to protect. At the moment, those protectable interests are likely limited to near-permanent customer relationships and trade secrets/confidential information. But this may change. The Illinois Supreme Court is currently considering a case, Reliable Fire Equipment Company v. Arredondo, that might broaden the categories of protectable interests. For a more thorough discussion of the Reliable case, please read "There's Something Happening Here (What It Is Ain't Exactly Clear): Is Illinois Non-Compete Law Changing?"
On the other hand, when a restrictive covenant is ancillary to the sale of business, Illinois law is much different, as a recent United States District Court case pointed out. In Harris v. Central Garden and Pet Co., the Northern District of Illinois noted that a restrictive covenant ancillary to the sale of business can be enforced if it is merely reasonable in scope and duration. Generally, nothing else is required. The protectable interest in such a case is the goodwill being sold with the business.
The Upshot for Employers
What does this mean for employers in Illinois? If a restrictive covenant is ancillary to the sale of a business, it almost always will be upheld. If it is ancillary to an employment contract, however, an employer will likely have a much more difficult time enforcing the agreement.
As clear as that may sound, there is much more to the story. Sometimes it is not so easy to determine whether a non-compete or non-solicitation agreement is ancillary to employment or the sale of business. What if the restrictive covenant, for example, is contained in an employment agreement that is signed as part of the sale? In that situation, the courts have struggled at times with how to examine the covenant. In establishing the applicable context, courts will focus on the facts involved in the case to determine whether the parties intended the restrictive covenant to be an integral part of the sale. For example, courts will look to see if the agreement was a condition to the sale or if it was, perhaps, identified as a necessary closing document. (See Health Professionals Ltd. v. Johnson, a 2003 Illinois case that discusses this issue.)
In Harris v. Central Garden and Pet Co., the court was faced with this very situation, but with a twist. The plaintiff, Geoffrey Harris, was the original owner of a business that he sold to New England Pottery. New England Pottery, which retained Harris as an employee, later sold the assets to Central Garden. Right after that sale, Harris signed a non-compete agreement. When things did not work out a few years later, Harris left, filing suit for a declaration that the non-compete was unenforceable.
The court scrutinized the restrictive covenant under the strict standard used in the employment context. In making its decision, the Northern District of Illinois was persuaded by the argument that the asset purchase agreement did not incorporate the non-compete, did not identify the non-compete as a necessary closing document and did not otherwise condition the sale in any way on Harris signing a non-compete agreement. For those reasons, the court held that the agreement was ancillary to his employment relationship, not the sale of the assets. That made all the difference. Using the tougher standard, the court found that the restrictive covenant was not enforceable.
There is a simple lesson to be learned here. If you buy a business and want certain employees or former principals to continue working for you under valid restrictive covenants, make sure those agreements are ancillary to the sale of the business, rather than the employment relationship. You can help do that by simply adding a provision to the asset purchase agreement that recognizes the covenants as conditions to the sale and necessary for closing.
There is another important lesson to learn from this case: always make sure you "put it in writing." Central Garden argued that it had an oral understanding with Harris that he would sign a non-compete after the deal closed. The court refused to even listen to this testimony, finding that it was inadmissible extrinsic evidence that could not be used to contradict the fully integrated closing documents. That ruling is not surprising. What is surprising, however, is how willing sophisticated businesspeople are to rely on these types of oral understandings. As lawyers are fond of saying, a verbal understanding is often not worth the paper it is written on.