Review Your EMPLOYMENT AGREEMENT Forms: Starting January 1, 2022, New Law Restricts Non-Competition and Non-Solicitation Clauses
Illinois courts have recently shown reluctance to enforce “restrictive covenants,” including both non-competition and non-solicitation provisions, in employment agreements. Courts have seemed not to favor restricting an individual’s right to work, unless a very compelling reason exists. The Illinois General Assembly has now incorporated this judicial trend in an amendment to the Illinois Freedom to Work law, effective January 1, 2022. The amendment will impose many new elements that must be present for an employer to enforce non-competition and non-solicitation provisions in future agreements.
The new provision will apply to employment agreements entered into on or after January 1, 2022; it is not retroactive. It arguably would not apply to an automatically renewing contract, because such a contract was not entered into on or after January 1, 2022. However, physician employers will want to review and revise their employment agreement templates for contracts going forward, as well as existing contracts that may self-terminate (rather than self-renew) and need to be newly executed after January 1. Old restrictive covenant language may be unenforceable as it is probably inadequate to fully comply with the new law.
A Quick Review – What Are Non-Competition and Non-Solicit Agreements?
Non-competition agreements prohibit a former employee from working within a certain distance from the former employer for a defined amount of time following separation. Non-solicitation clauses, often used in conjunction with non-compete provisions, prevent a former employee from: 1) soliciting the former employer’s staff to work for the separated employee; and 2) soliciting business from the former employer’s clients or patients. Employers have an understandable interest in mitigating the risk of an employee taking the benefit of the employer’s training and business information to set up a competing business in a location near the employer; however, an individual’s right to work is an important benefit of citizenship. (Note that these agreements are distinct from confidentiality agreements. The Right to Work Act does not void an employee’s obligation to honor an agreement not to improperly take an employer’s trade secrets or inventions.)
Highlights of the New Law
- Starting in 2022, employers may only enter into non-compete agreements with employees earning $75,000 or more annually, including the value of employee retirement contributions, health care-related accounts, and other deductions and benefits. Generally, this would be the amount reflected on the W-2 form as wages, tips, and other compensation. It does not include employer contributions to retirements plans, tax payments, and other employer payments. This $75,000 amount is “annualized,” meaning it would be prorated for employees who work for less than a full year. Note that for physicians who are paid based on collections, the earnings amount is not calculable until the end of the year. If the amount at year-end totals less than $75,000, any non-compete agreement for that period would be void. The $75,000 threshold increases by $5,000 every 5 years starting on January 1, 2027, and increasing ultimately to $90,000 per year beginning on January 1, 2037. A covenant in violation of this section is void.
- Starting in 2022, employers may only enter into non-solicitation agreements with employees earing $45,000 or more annually (including the value of retirement contributions, health care-related accounts, and other deductions and benefits). This amount increases by $2,500 every 5 years starting on January 1, 2027, and increasing ultimately to $52,500 per year beginning on January 1, 2037. A covenant in violation this section is void.
- Employers may not enter into or enforce non-compete or non-solicit agreements with employees who are laid off due to business circumstances or governmental orders related to the COVID-19 pandemic, unless the employer pays the employee the regular salary amount during the period of enforcement.
- A covenant not to compete is illegal with respect to persons covered under a collective bargaining agreement, the Illinois Educational Labor Relations Act (educators), and individuals employed in construction (with certain construction managerial exceptions).
Requirements for Non-Competition and Non-Solicitation Agreements with Employees who are Above the Earnings Threshold
Even for employees who are above the earnings threshold or are in one of the other prohibited categories above, a non-compete or non-solicitation covenant is not automatically enforceable. In fact, this section of the law is written in the converse: a covenant is illegal and void unless:
- The employee receives “adequate consideration” or value. Courts have said this means either the employee worked for the employer for at least 2 years after the employee signed an agreement, or the employer provided some other form of value such as additional compensation.
- There is a valid employment relationship between the parties (restrictive covenants are not applicable to contractors).
- The restriction is no more stringent than required to protect of a “legitimate business interest of the employer.” Elements in a physician situation could include the employee’s exposure to patient relationships or other employees, whether patient relationships with the employer are well-established, the employee’s use of confidential information through the employee’s employment, the time restrictions, the place restrictions, and the scope of the activity restrictions. For example, a court refused to enforce a non-competition agreement in a case where a physician employee brought his own long-standing patients to a practice, the physician treated his own patients and very few from the practice, and patients were referred specifically to the physician rather than the practice. No factor carries any more weight than any other but is viewed in context of the facts and circumstances of the individual case.
- The covenant does not impose undue hardship on the employee. The law doesn’t provide a definition of “undue hardship,” but one example may be found in a 2016 case against Jimmy John’s which required all employees to sign a non-competition agreement as part of its routine hiring practice. This meant that even low-wage staff could not work after separation in another sandwich shop anywhere in proximity to the employer. Physician cases may be more nuanced, but courts will probably look at the employee’s ability to reasonably and fairly earn a living after separation.
- The covenant is not injurious to the public. The new law does not provide a definition of a covenant that is “injurious to the public.” However, a hypothetical example could be where a physician is prohibited from working within 100 miles in a rural area that has a doctor shortage. Such a restriction could be harmful to the public for obvious reasons.
Therefore, if an employee challenges a restrictive covenant, the burden is shifted to the employer to prove all of the requirements are met. Presumably, courts will assess all of the enforceability factors in individual cases based on their unique facts.
Important Notice Requirements
One of the most important elements of the new law is that employers must give the employee written notice to consult with an attorney before signing a restrictive covenant. Employers are also required to provide the employee with a copy of the agreement at least 14 days prior to the commencement of employment. The ICS has prepared a form for member physicians to use that will document both of these requirements. ICS members may access a template for this notice here. The ICS recommends that employers obtain the employee signature on the form and retain the original notice in the employee’s file.
Attorney’s Fees and Court Costs Are Recoverable by a Prevailing Employee
If an employer loses in a court or arbitration hearing to hold an employee to a covenant not to compete or covenant not to solicit (entered into on or after January 2022), the employer must pay the employee for all costs and reasonable attorney’s fees expended in defending the employer’s claim. This provision should give employers good reason to pause and carefully analyze the strengths and weaknesses of any non-compete or non-solicitation agreement they intend to enforce in court or arbitration.
A Note about Independent Contractors
Although the law does not apply to true independent contractors, physician offices should be careful about classification of an individual as an independent contractor. For example, an office has an agreement to lease a room to a physician; the agreement mandates the physician’s work hours, days off, and other working conditions, and also contains a non-competition provision. If the “contractor” leaves the office and sets up practice in violation of the non-compete (e.g., in close proximity) and the physician office tries to enforce the non-compete, the “contractor” is likely to challenge his/her classification as a contractor because the office’s level of control renders the position as one of an employee. If the “contractor” is reclassified as an employee, it could result in substantial financial liability to the office for back taxes, penalties, and employee benefits. For information about the distinction between employees and independent contractors, see Independent Contractor or Employee?
Anticipated Impact of the New Law
Because it will be more difficult for employers to rely on restrictive covenants to manage the risk of investing in new employees, employers may need to think about creative new ways to provide benefits for employees who are under the $75,000/$45,000 cutoff. One idea could be to frame certain benefits in a quasi- “prenuptial agreement” manner. For example, the employer may agree to pay for employee continuing education as a loan that is to be repaid if the employee leaves employment within a short time but will be forgiven if the employee remains employed for a longer period of time.
Even for employees whose compensation is above the salary triggers, employers will need to make certain that their restrictive covenant language complies with the five requirements for enforceability (discussed above) under the new law. Combined with the pandemic-related employee shortage, employers may need to make greater concessions on restrictive covenants and view them in the perspective of supply and demand, because employees will have greater bargaining power in negotiating these provisions (or possibly the elimination of them) in their employment agreements. Employers should be aware that the new law signals a policy shift under which they will have less ability to restrict their former employees’ prerogative to practice their occupations in the locations and time of their choosing.