Consideration Necessary for All Post-Employment Restrictive Covenants
Post-employment restrictive covenants, also called non-compete agreements or covenants not to compete, are a frequent topic of litigation in all jurisdictions. A recent case from the Third District, Prairie Rheumatology Associates, S.C. v. Francis, 2014 IL App (3d) 140338, applied Illinois law regarding restrictive covenants to invalidate such an agreement between a medical clinic and a doctor, finding that the agreement was not properly supported by consideration. The case serves as a good reminder of the requirements for a valid restrictive covenant with employees.
General Rules Regarding Restrictive Covenants
Under Illinois law, a post-employment restrictive covenant is enforceable only if it is reasonable in geographic and temporal scope and is necessary to protect an employer's legitimate business interest. Abel v. Fox, 274 Ill.App.3d 811, 813 (4th Dist. 1995).
Prior to examining the reasonableness of a restrictive covenant, the court must first make two determinations: (1) that the covenant is ancillary to either a valid transaction or a valid relationship; and (2) that there is adequate consideration to support the covenant. Creative Entertainment, Inc. v. Lorenz, 265 Ill.App.3d 343 (1st Dist. 1994).
Assuming both determinations are made, a court then is to determine if the terms of the covenant are reasonable. The reasonableness of the terms of a restrictive covenant is evaluated through a three-part test found in the Restatement of Contracts and Reliable Fire Equipment Co. v. Arredondo, 2011 IL 111871, ¶ 17. Under that 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; (2) does not impose undue hardship on the employee; and (3) is not injurious to the public. Id.
Facts of Prairie Rheumatology Associates Case
In Prairie Rheumatology Associates, the plaintiff was a medical clinic ("PRA") in Joliet specializing in rheumatology. The majority of PRA's patients came to the clinic on referrals from physicians, including the physicians on staff at the two area hospitals, Saint Joseph and Silver Cross. 2014 IL App (3d) 140338, ¶ 2.
The defendant, Dr. Francis, a licensed physician specializing in rheumatology, took a job with PRA in 2012 and entered a "Physician Agreement" with an effective date of April 9, 2012. The agreement provided Francis with an annual salary and required PRA to assist her in gaining staff privileges at St. Joseph and Silver Cross, paying her hospital dues, and introducing her to PRA patients and referral sources, particularly the physicians on staff at St. Joseph and Silver Cross. The employment agreement included a 2-year, 14-mile non-competition agreement in favor of PRA. Id. at ¶ 3.
Dr. Francis began working at PRA on April 16, 2012, moving to PRA from an office in Kankakee. She began developing clients in the Joliet area. The statistics presented showed that during her time with PRA, Francis treated 1,118 patients, with about 136 being patients who followed her from her Kankakee practice and 948 being new patients. According to PRA, less than 8% of the new patients Francis treated while working there had a prior relationship with PRA, and most of those new patients were referred by physicians. Id. at ¶ 4.
Dr. Francis gave notice in July 2013 that she was voluntarily terminating her employment with PRA effective November 22, 2013. Francis indicated that she would honor the non-competition agreement in her employment contract and informed PRA that she would be working at Hinsdale Orthopedics, which had offices in Hinsdale and New Lenox. Francis began working there in January 2014. Hinsdale Orthopedics' New Lenox office was adjacent to Silver Cross, one of the hospitals from which Francis received referrals when at PRA, and was nine miles from PRA's principal office. Id. at ¶¶ 5-6.
As a result, PRA filed a complaint for injunctive relief to enforce the restrictive covenant prohibiting Dr. Francis from practicing within a 14-mile radius of the office and the two nearby hospitals for two years after termination of her employment. The trial court entered a preliminary injunction, enjoining Dr. Francis from treating PRA's current patients but allowing her to treat patients she had prior to joining PRA as well as potential future patients. The trial court determined that the restrictive covenant was ancillary to the main employment contract and was supported by adequate consideration. The trial court also found the restrictive covenant reasonable as to PRA's current patients but unreasonable as to PRA's future patients and the public. The court concluded that PRA had a right in need of protection, would suffer irreparable harm, had no adequate legal remedy and had established a likelihood of success on the merits only as to its current patients. Both parties appealed to the Third District. Id. at ¶¶ 7, 9.
Third District's Decision
On appeal, the Third District Appellate Court determined that the restrictive covenant between PRA and Francis was invalid because it was not adequately supported by consideration. Id. at ¶ 19.
The Third District explained that Illinois courts have generally held that, with certain restrictions, continued employment can be sufficient consideration in support of restrictive covenants. The court explained that post-employment restrictive covenants have been an exception to the traditional rule that courts do not inquire into the adequacy of consideration, only its existence. Such agreements have been the exception due to the fact that a promise of continued employment may be an illusory benefit where the employment is at will. Id. at ¶ 14.
The Third District went on to explain that Illinois courts had generally required two years or more of continued employment to find that continued employment constituted adequate consideration for a restrictive covenant, even in situations in which the employee resigns on his or her own instead of being terminated. In this case, Dr. Francis announced she was leaving 15 months after the start of her employment and left her employment after 19 months, five months less than the general two-year rule of thumb that supports adequate consideration. Id. at ¶¶ 15-16.
In response to the argument regarding the two-year rule of thumb, PRA had argued that Dr. Francis received additional consideration that supported enforcement of the restrictive covenant, such as assistance in obtaining hospital membership and staff privileges, access to previously unknown referral sources, and opportunities for accelerated advancement. Id. at ¶ 17.
The Third District rejected this argument as well, finding that Dr. Francis received little or no additional benefit from PRA in exchange for her agreement not to compete. The court explained that the evidence at the preliminary injunction hearing indicated that PRA failed to assist Dr. Francis in obtaining her hospital credentials and neglected to introduce Dr. Francis to referral sources. While PRA had provided Francis with credentialing applications, it did not pay the entirety of her credential fee, despite its contractual promise to do so. In addition, PRA had not implemented any procedure to introduce Dr. Francis to the doctors on staff at the two nearby hospitals, St. Joseph and Silver Cross. For example, during the hearing, the president of PRA, a rheumatologist herself, could not identify any doctor she introduced Dr. Francis to while Francis was at PRA. Instead, the evidence established that Dr. Francis marketed and developed community programs to increase her visibility on her own. The court also found that the claimed expedited advancement and partnership opportunities were illusory benefits at best. Although the employment agreement provided that Dr. Francis would be considered for partnership after 18 months, there was no guarantee she would become a partner and major shareholder. Id. at ¶ 18.
On these bases, the restrictive covenant was found to be unsupported by consideration and therefore unenforceable. Because there was no consideration for the restrictive covenant, the Third District did not consider the reasonableness of the agreement. Id. at ¶ 19.
In order to be enforceable, a post-employment restrictive covenant, also known as a non-compete agreement or a covenant not to compete, must satisfy several requirements. First, the agreement must be ancillary to a valid transaction or relationship, such as part of an employment contract. Second, the agreement must be supported by adequate consideration. Third, the terms of the agreement must be reasonable under the Reliable three-factor test.
When challenged, which is increasingly frequent, post-employment restrictive covenants are strictly construed by the court to ensure the reasonableness of the agreement. Because of this, for such agreements that are of the utmost importance to a business, it is crucial for the business to have such the restrictive covenant drafted by and approved by counsel. For those who may want to challenge such agreements on their own behalf or on the behalf of a new employee, a review of such agreement by counsel will help in determining if the agreement is one that a court may find invalid.