Illinois may not get a resolution any time soon to whether an employer is required to prove that a non-compete covenant must support a recognized, legitimate business interest. By now, lawyers and commentators are fully aware of the Fourth District’s ruling in Sunbelt Rentals, Inc. v. Ehlers and its repudiation of a decades-long test used to determine the validity of non-competes. Though that test had a somewhat bizarre development, courts throughout Illinois recognized it.

Applying the test in practice perversely has made litigation more expensive for employees, as cases frequently devolved into lengthy discovery disputes over the so-called protectable interest and whether it was threatened. Often times the concept of “reasonableness” gets lost in the shuffle. Still, many employers lost cases after failing to prove a legitimate business interest was at stake.

But Ehlers settled his case with Sunbelt Rentals, and so there won’t be a decision from the Illinois Supreme Court any time soon on the inter-district conflict. For now, that means that outside of the Fourth District, courts are still applying the legitimate business interest test. District Judge Gettleman recognized as such this week in Aspen Marketing Services v. Russell, when he denied a motion to dismiss a non-compete suit. Gettleman expressly noted the ruling in Sunbelt Rentals and declined to apply it, noting that the Illinois Supreme Court and other Illinois courts outside the Fourth District haven’t weighed in.

On a separate note, the idea of challenging the validity of a non-compete on a motion to dismiss is rarely a good one. Almost invariably, this results in an early loss for the defendant, since the concept of “reasonableness” cannot be examined under the pleadings alone. Unless there is some obvious defect (such as a nationwide covenant when the contract specifies a very limited area of responsibility), lawyers ought not to count on dismissal of a non-compete claim until at least summary judgment.

The Chicago Tribune’s business reporter, Ameet Sachdev, writes this morning on the hotly contested dispute between Kathleen Lawlor and North American Corp. of Illinois, a case recently tried to judgment in the Circuit Court of Cook County.

The dispute touches on a number of hair-trigger employment law issues, including rights to privacy, unpaid commissions, theft of confidential information and threats to steal customers. It also makes an oblique reference to another issue that always underscores the difficulty of employment litigation: Lawlor’s attorneys’ fees have approached $1 million.

The case involves the marketing services industry, and the dispute arose right after Lawlor, a successful salesperson, left in 2005. She claimed she was owed accrued commissions, and her employer feared she would steal customers. It also had her followed by a somewhat amateur gumshoe, a fact that would later prove to be damaging to North American.

There was no hint in Sachdev’s article that Lawlor was bound by a non-compete contract, so North American was left to pursue common-law remedies. It found potential smoking guns when a North American consutant swore out an affidavit that Lawlor offered to introduce him to a competitor before she quit, and when Lawlor disclosed historical sales and margin data to a competitor on a job interview.

This conduct directly implicated Lawlor’s duty of loyalty to her then-employer. That duty prohibits an employee from disclosing confidential information, facilitating a mass exodus of co-workers, and diverting business opportunities away from the employer. Employees must take this duty seriously - a violation can result in salary forfeiture during a period of disloyalty, an injunction against competitive conduct (even in the absence of a non-compete agreement), and punitive damages.

At trial, the parties appeared to split their claims against one another. Lawlor ended up prevailing on her invasion of privacy claim, after North American’s overzealous investigators improperly obtained Lawlor’s phone records and gave them to the company. North American, on the other hand, was able to obtain some measure of compensation forfeiture, presumably based on Lawlor’s pre-termination activity with existing customers or improper disclosure of North American financial data. Despite relatively low actual damages ($78,781), the trial judge imposed punitive damages of $551,467 - a multiple of seven.

Aside from the enormous fees generated in this case, the litigation serves as a reminder that the absence of a non-compete agreement does not - by any stretch - sanitize an employee’s conduct on the way out the door. Breach of the common law duty of loyalty provides for extensive legal and equitable remedies. Proving such a claim can be difficult for an employer, but if the employer is able to marshall evidence of improper pre-termination activity (often learned through a forensic examination of the ex-employee’s computer), it may be able to put a halt to anti-competitive conduct and obtain significant monetary relief.

One of the most high-profile non-compete disputes in the Chicago area has resulted in a victory for Citadel Investment Group and a set-back for two executives who defected to start their own high-frequency trading firm.

In a 36-page memorandum opinion and order Judge Mary K. Rochford enjoined Mikhail Malyshev and Jace Kohlmeier from violating non-compete restrictions contained in their Citadel employment agreements for the balance of the nine-month term. Effectively, this means that both Malyshev and Kohlmeier may be free to compete as soon as February of 2010, since the court refused to extend the non-compete term on an equitable basis for the period in which the defendants were in breach.

The case involves a shadowy, but highly profitable, business known as high-frequency trading (HFT). In essence, HFT relies on powerful computers to enter trade orders (often without human intervention), with algorithms deciding on specific aspects of the trade such as how much to buy, when, and at what price. HFT is a relatively new phenomenon, but it yields enormous profits. A disproportionate amount of equity trading volume is conducted by HFT firms.

Citadel itself invested heavily in HFT. It paid off - Citadel’s HFT unit reaped earnings of $1.15 billion in 2008. Malyshev and Kohlmeier were instrumental, key employees for Citadel’s HFT group. Neither had HFT experience prior to joining Citadel. For quite some time, each considered leaving to start his own proprietary trading firm. And each had a non-compete agreement, barring employment with a “Competitive Enterprise” for a period to be selected by Citadel upon departure, ranging from 0 to 9 months.

Upon their departure, Citadel elected the maximum 9-month period and paid Malyshev and Kohlmeier to sit on the sidelines. No surprise, there, given their access to proprietary information and involvement in recruiting R&D talent to Citadel. However, both ex-employees formed Teza Technologies and hired 15 employees, essentially daring Citadel to file suit.

It did. Citadel pursued each aggressively and sought preliminary injunctive relief. The court dispatched with a number of the arguments raised by the defense. Given that one of the defendants deleted a fair amount of Citadel information (despite a court order not to do so), the court really did not have to address whether a legitimate business interest supported the non-compete. The adverse inference it could draw about the document deletion was more than enough to demonstrate the defendants had access to and attempted to use Citadel’s confidential information.

The defendants also seemed to challenge the non-compete due to the fact that they really weren’t actively trading, but merely preparing the firm’s trading infrastructure to compete eventually. However, nothing in the non-compete allowed the defendants to wash their hands of liability based on this “preparing to compete” theory, and the theory itself ignored the fact that HFT firms depend heavily on building infrastructure. By getting a headstart in developing a trading platform, the defendants were essentially entering the market much faster than they agreed to under their employment contracts.

The most important feature of the decision, though, concerned the length of the injunction. And it is here where the defendants probably were able to take some solace in defeat. The court refused to extend, or equitably toll, the non-compete period for the time in which the defendants were in breach. The court looked at the Second District Appellate Court’s decision from two years ago to hold that, under Illinois law, a contract must specifically provide for an equitable tolling, or extension, remedy. Otherwise, the court will not imply the term under the contract.

This, of course, does nothing to mitigate the defendants’ damages during the non-compete period. But it does serve as a cautionary tale for counsel in drafting non-compete clauses. Unless an equitable tolling remedy is clearly contained in the contract, the court will not agree to extend it even if the defendants were in breach leading up to the injunction order.

The sights are off on the Second Amendment debate as both sides miss the target strictly for political reasons. The debate takes aim at personal and home defense by the law-abiding and the competing rights of criminals, ignoring the rights of the people to ensure the security of “free” States. Thus, in another politically-charged 5-4 opinion, District of Columbia v. Heller, and its later interpretation, both sides continue to overreach and ignore facts, then decry each other for doing exactly that, as I have noted in my previous blogs on these partisan opinions.

The Right consistently overplays its hand to excite political passions by claiming the Second Amendment secures law-abiding citizens’ ability to have guns to defend themselves and their homes against criminals. If this tack cannot mobilize conservatives, nothing will. The Left likewise overreaches to excite political passions by invoking circular reasoning to abrogate any right to keep and bear arms and thus allow gun bans purportedly to protect innocent bystanders, including “the children.” If this tack cannot mobilize liberals, nothing will.

Despite the urgings of the Heller majority, the Second Amendment is not rooted in personal and home defense but ensures only that “the people” have armed militias ready to protect the security of free States (particularly where police cannot or simply will not). The best modern example of this is New Orleans after Katrina, where police either evacuated or were overwhelmed and thus could not provide security for that portion of the free State of Louisiana. (Only because rampant criminals threatened security there was personal and home defense involved.) The people who remained, without police and effectively having been disarmed, were unable to invoke their militia to provide security and instead had to wait days for the US military to do so. This is exactly why militias always are necessary and exist in at least inchoate form.

Willfully ignoring this example, the Heller dissents quickly dismiss such state militias as “obsolete” and no longer in existence, disposing of any constitutional right of the people to keep and bear arms. Yet constitutional rights are not so fleeting, which is why amendments are so difficult to pass. (Indeed, if imaging technology eventually obviates physical searches, will these dissenters likewise dismiss as “obsolete” the right against unreasonable physical searches?) This hasty disposition of state militias enables the specious claim that the right to keep and bear arms relates only to military action and thus cannot be infringed only as to that purpose. Yet without state militias, the only possible military action is under the federal government, meaning the only guns it cannot take from the people are those used in serving its own military. But the Bill of Rights guarantees rights of the people against the federal government. The dissents even note that the Second Amendment was written out of fear that a federal standing army (which, of course, police never would fight against) could threaten the security of a free State.

The more sound reasoning is that the principally controlling plain language of the Second Amendment guarantees the right of the people to keep and bear arms for having state militias ready to provide security for their free States (or portions thereof) when the people’s security “proxies” can or will not. It is not hard to fathom an Al Qaeda cell storming a municipality and overwhelming local police, leaving a disarmed people helpless until other police and US military can arrive. There, the militia will be the first responders with the best chance of stopping the carnage that likely would ensue before other police or US military could respond. And with the right to keep and bear arms ensuring militias are ready for such security purposes, those arms will be available also to defend ourselves and our homes against criminals and otherwise.

The Fourth District Appellate Court of Illinois has just made it substantially more difficult for employees to break their non-compete agreements.

Justice Steigmann authored an opinion that built upon his special concurrence two years ago in Lifetec, Inc. v. Edwards, a case where he called into question the applicability of the so-called “legitimate business interest” test used by Illinois courts to analyze restrictive covenants. This time around, Steigmann succeeded in convincing his robed colleagues to abandon the test altogether, overturning a number of Fourth District cases in the process. The decision does nothing to alter the test in other districts, and each of those still uses the test which is widely believed to be employee friendly.

By way of brief background, Illinois courts have essentially used a two-part analysis to determine whether a non-compete agreement is valid. First, it must be reasonable in scope. Second, it must protect a legitimate business interest. The second part of the test demanded an employer show that it had an interest in misuse of confidential information or near-permanent customer relationships acquired through the employee’s association with the employer. This is not a marked departure from what other states require, though some would argue Illinois is fairly narrow in not recognizing other types of business interests, such as special training. However, Justice Steigmann could not find Illinois Supreme Court authority for part two of the test.

By reviewing Supreme Court precedent, Steigmann is correct in that the Court never formally adopted the test which has been used for years by all five district appellate courts. He casually neglects to mention that in the past 60 years, the Court has taken on a grand total of six non-compete cases, and several of those looked at covenants outside the employment context. His analysis is not entirely accurate because his discussion also neglects to confront one of the Court’s leading precedents, House of Vision v. Hiyane. That case was authored by Justice Schaefer, probably Illinois’ most famous jurist.

In House of Vision, the Court specifically discussed at length the interest of a business in protecting customer relationships. It even distinguished prior precedents (also cited by Justice Steigmann) where the Court noted that in a sale-of-business non-compete, the legitimate interest to be protected concerned intangible goodwill. Covenants ancillary to a sale of a business are always easier to uphold, and it may well be true that a legitimate business interest is virtually presumed in such circumstances. But it seems illogical that the Court would discuss a legitimate business interest in connection with a sale-of-business covenant, and then deem the test inapplicable to more problematic employment covenants. Steigmann has assured us the Court will have to take an employment non-compete case soon to resolve the tension between the Fourth District and the rest of the state’s appellate courts.

Justice Steigmann’s analysis defaults to the reasonablenes test he cites from what he considers binding precedent: an employer must show that the covenant is no greater than is necessary for its protection. As applied to the facts involving Sunbelt Rentals and Neil Ehlers, the court concluded the 50-mile non-compete was reasonable even though the employment agreement also contained a well-drafted client non-solicitation clause.

It’s hard to see, though, how a court can determine whether a covenant is “no greater than is necessary for its protection” without analyzing what business interest it seeks to protect in the first place. The legitimate business interest test fills that vacuum and allows a court to fashion an appropriate restraint, or strike one entirely if the employer can’t articulate the need for a restriction.

The Illinois Home Repair and Remodeling Act (815 ILCS 513/1 et seq.) (view it on the web here) declared that “the business of home repair and remodeling is a matter affecting public interest” and found that “improved communications and accurate representations between persons engaged in the business of making home repairs or remodeling and their consumers will increase consumer confidence, reduce the likelihood of disputes, and promote fair and honest practices in that business in this State.”  815 ILCS 513/5.

Courts have taken the Act very seriously, strictly enforcing its edicts that a contractor 1) must have a written contract for any remodeling or repair work over $1,000; 2) must provide specific notice of certain provisions if they are present in a contract; and, 3) must provide a consumer with a brochure detailing the consumer’s rights.  As I have previously written in a CC&M Briefing to clients (CC&M Briefing, Fall, 2008, available here), in their effort to enforce the policy set forth in the Act, courts have denied sizable claims by contractors based on their failure to comply with it.

Courts in Illinois’ Third and Fourth Appellate Districts have denied contractors’ claims for roughly $11,000 and $14,000 due to failure to obtain written contracts (Central Illinois Electrical Services, LLC v. Slepian, 358 Ill. App. 3d 545 (3d Dist. 2005; Smith v. Bogard, 377 Ill. App. 3d 842 (4th Dist. 2007)).  Most importantly, those courts determined that the contractors were not only precluded from bringing contract actions, but were also precluded from making claims in quantum meruit (a theory allowing a party to seek the fair value of work and materials actually provided to and accepted by the consumer in order to preserve substantial fairness).  Thus, under these analyses, a contractor would have no recourse to obtain payment for work, no matter how satisfactory, if the contractor did not fully comply with the Act.

The Illinois Court of Appeals for the First District has recently disagreed with its sister courts.  In an interesting case (K. Miller Construction Company, Inc. v. McGinnis, No. 1-08-2514, 1st Dist., August 10, 2009, available here), the Court determined that fundamental fairness did not allow it to restrict a contractor so completely, even in the absence of a written contract for work.

In K. Miller, the contracting company’s sole owner and the homeowners were friends who reached an oral agreement for remodeling work, but never reduced the agreement to writing.  The homeowners initially agreed to pay $187,000 for the work, but later expanded the scope of the project to a price of slightly more than $500,000.  The project was completed in accordance with the expanded plans, and the parties conducted a “walk-through” of the property.  The homeowners allegedly accepted and approved the work after agreeing to a small ($300) credit to address some minor flood damage.  The homeowners made some further payments to the contractor, but refused to pay more than a total of $177,580.33.

The Court quickly dispensed with any question of a contract claim or claim for foreclosure of a mechanic’s lien, acknowledging that the Act strictly precluded such actions in the absence of a written contract.  However, the Court more carefully considered the contractor’s claim in quantum meruit and determined, at least under the facts of this case, the claim should be allowed.

The Court carefully considered the effect of the Home Repair and Remodeling Act and the cases that had previously construed it.  After a lengthy discussion of the history of quantum meruit actions and their main purpose, i.e., providing a fair payment to a party for work that it has done.  The Court determined that allowing the claim to go forward in this case would be most equitable, allowing the homeowners to contest the fair value of the work they received but allowing the contractor to attempt to prove its entitlement to payment for the work it had done.

This case is interesting in its effect, creating a conflict between Illinois Appellate Districts that is ripe to be resolved by the Illinois Supreme Court.  However, additional facts considered by the Appellate Court may limit the applicability of the case in other Appellate Districts that have not yet ruled on the effect of the Act.  The Court took great care to note that there were significant allegations affecting the fundamental fairness questions in this case.  Most notably, the homeowner in this instance was allegedly an attorney who has practiced real estate law for nearly forty years, and the contractor was allegedly relying on a past business relationship and friendship with the homeowner when he entered this relationship without a written contract.  These additional facts seem to have had some impact on the Court’s analysis in balancing the fairness of denying any claim.  The Court specifically stated, “Such a consumer, after receiving the benefit of the contractor’s services, could use the Act, meant as a shield to protect vulnerable consumers, as a sword to deprive a contractor of the reasonable value of his services.”  The Court also stated, “Rejecting Miller’s claim would only penalize a reputable contractor, who, relying on a past business relationship and friendship with the consumer, performed remodeling work to the consumer’s satisfaction, with no involvement of predatory remodeling practices the Act sought to address.”  In other words, the Court was persuaded that a court should not be denied its equitable power to do justice between parties where one of those parties could have intentionally sought to achieve an injustice based on a technicality.

While a resolution of the conflict created by this case will be interesting, contractors and consumers are better off avoiding conflicts created by the Act.  Obtaining the advice necessary to comply with the Act when entering into a relationship will protect both the honest contractor and the honest consumer, assuring that all parties understand and agree to their rights and responsibilities under a contract and avoiding some unpleasant surprises during the project or after work is completed.  However, it will be interesting to follow the evolving case law regarding the Act, evolving law that has the potential to continue providing creative legal arguments for all parties involved in this kind of conflict.

Many commercial leases contain provisions granting landlords a lien on the tenant’s assets. These leases often provide that property abandoned by the tenant upon termination of the lease belongs to the landlord. These lease provisions reduce the security granted to commercial lenders because they can create conflicting priorities of liens.

Article 9 of the Uniform Commercial Code does not always address the priority of non-Article 9 liens. Worse, landlord liens are expressly excluded from the scope of Article 9. See 810 Ill. Comp. Stat. 5/9-109(d). If the debtor defaults, the secured creditor is likely to find itself in a priority fight with the landlord over the collateral.

It can get worse than a simple priority fight. In this economy it is not uncommon for businesses to abruptly close shop and abandon their property on the leased premises. As a result, the landlord is often the first party to discover the debtor’s insolvency. This gives the landlord a huge head start in the race to the courthouse door to obtain a judicial order confirming the landlord’s ownership. In some cases the secured creditor is not aware of the location of the collateral. In such a scenario, the landlord may have disposed the debtor’s property before the secured creditor became aware of the default. In addition, if the landlord does not cooperate the secured creditor may not be able to access the premises to remove the collateral without a court order.

However, the secured creditor may be able to reach an agreement with the landlord regarding the collateral. Many landlords do not have the interest or ability to hold auctions for abandoned property. So long as they obtain some redress for their damages, the landlord may permit the secured creditor to remove the collateral from the premises. Removal of the collateral also makes it easier to relet the premises.

Many of the secured creditor’s nightmares with respect to landlords can be avoided with two simple measures (1) regular inspections of the tenant’s business facilities to ensure that the collateral has not been moved; and (2) obtaining landlord waivers where the landlord recognizes the lien and permits the secured creditor to remove the collateral upon default. Most landlords understand that the health of their tenant’s business depends on their ability to secure adequate financing. As a result landlords generally are willing to waive their lien rights in exchange for a relatively nominal amount (often partial rent while the premises are accessed by the secured creditor).

One final item to note, which is overlooked with surprising frequency.  Secured creditors should not engage in self help when their collateral is under lock and key under premises owned by another party.  Article 9 security interests will not provide a defense to a charge of breaking and entering.