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Is Your Noncompete Enforceable?

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My thanks to Chicago attorney Daniel N. Janich for contributing this post with his thoughts and suggestions on what you should do if you find yourself dealing with a noncompete agreement from an employer.  While a career management post might seem out of character for this blog, in reality for most of us our earning potential is a key driver in our ability to accumulate assets for financial goals like retirement.

So you decided that a job change is in order and you embark on the adventure of finding your new position. Suddenly you remember that when you were first hired or sometime during your employment you signed an agreement with your current employer that included a noncompete provision prohibiting you from taking employment elsewhere for a specific period of time and within a certain geographic area following your employment termination. Perhaps you realized this when you interviewed at your prospective employer, who mentioned that you would need to sign a declaration that you are not subject to a noncompete should you be offered and accept employment with the company.

Most likely you did not pay close attention—or perhaps none at all—to this provision when you first accepted employment at your current employer or when a separate document entitled “Noncompete” was circulated sometime after you were already hired and working at your current employer. No matter the circumstances of your signing this agreement, you are now worried about its impact on your new job search, your ability to obtain other suitable employment within a reasonable time after you resign or may be let go from your current job, and your own risk tolerance if you’re tempted to simply ignore the language in your noncompete where your current employer threatens you and your new employer with a lawsuit for its violation.

What should you do if you find yourself in this position? How will you know if you have a good reason to worry whether your current employer can enforce the noncompete against you? When is it best for you to consider whether to hire experienced legal counsel to help you ferret out your options, i.e., ignore the restrictions in the provision, beat your current employer to the courthouse and seek a court declaration of unenforceability, contact your current employer to seek a partial or complete waiver of the restriction, or strictly adhere to its terms during the stated relevant period that it is enforceable?

The following discussion is intended to provide you as the employee subject to a noncompete, with a general outline of how to assess whether your noncompete is enforceable and when it might be advisable for you to seek experienced legal counsel to help you minimize your risk before making your move.

Three Factors Courts Generally Consider 

At the outset it is important to emphasize that the laws governing the enforceability of noncompete provisions—whether embodied in a statute or developed by case law or perhaps from both–are not uniform. One court’s decision about enforceability may be entirely at odds with that of another court—even among courts located within the same state—and even involving identical noncompete provisions. Some states are known to strictly uphold these provisions while others—notably California—and Massachusetts may soon join California— by statute prohibit their enforcement all together. Confusing? Perhaps. Notwithstanding this apparent confusion, there is a common set of factors that courts typically will look for and apply in their analysis of the specific facts involved.  These factors are outlined below:

In general, courts address the enforceability of a noncompete provision using a 3-prong test that examines whether:

  • the employer involved has a legitimate business interest that needs to be protected;
  • enforcement of the noncompete as written will create an undue hardship on the employee; and
  • the geographic and time period restrictions are reasonable.

Each of these factors is examined in the specific factual context of the employee and employer involved in the matter. Thus, there is no “magic language” that all employers may use which would establish the enforceability of the noncompete in all factual circumstances. However, in general, courts have suggested that the absence of one or more of these factors may be enough to render the noncompete unenforceable.

#1.  Does the Employer Have Protectable Business Interest?  Whether the employer has a protectable business interest is determined by assessing whether the employee (you) gained “confidential” information through your employment such as trade secrets, customer lists, financial information that would otherwise not be available to the public and if disclosed to a competitor would endanger the employer’s business position. In cases involving customer lists, Illinois courts have also examined whether the employer’s relationships with its customers are nearly permanent.  An employer who cannot affirmatively establish these criteria quite likely would have a difficult time proving that it has a legitimate business interest that needs to be protected by a noncompete.

#2.  Will the Noncompete Pose an Undue Hardship for the Employee?  Even assuming a legitimate business interest, if the noncompete will virtually preclude the employee from earning a living through using his or her primary skills and experience in the workplace with other potential employers (all competitors), it is likely that most courts would find that the noncompete creates an undue hardship on the employee. In such a case, the noncompete would be considered unenforceable. 

#3.  Is the Scope of the Noncompete Reasonable?  This relates to the geographic reach and duration of the noncompete. What is acceptable in one industry may not be acceptable in another. Illinois courts, for example, have found 12 months to be a reasonable duration in many industries. However, in the tech industry 12 months may be a “lifetime” due to its fast paced nature of development, and thus such duration may be unenforceable. The geographic limits must also bear some semblance to where your current employer operates or is expected to operate in the foreseeable future.  If your noncompete covers all of Illinois, for example, you should ask: Does the company do business throughout Illinois? Is it expected to establish business operations in other parts of the state sometime in the next few years? If not, the geographic limit used may be inappropriate and therefore overly inclusive thus rendering the noncompete unenforceable. 

Employees May Be Able to Take Advantage of a Poorly Drafted Provision 

An unclear or vague noncompete provision may also be unenforceable. A noncompete is unclear or vague when the employer is unable to specifically identify: 1) which particular interest is being protected; and/or 2) who the competitors are from an industry wide viewpoint. In such cases courts are inclined to find that the employee should not be bound by the noncompete because the employer who drafted it in the first place did not give the employee sufficient information as to what his/her obligations were under the contract. 

Employers Must Provide Adequate Consideration for an “At Will” Employee to Sign a Noncompete

Courts are increasingly scrutinizing the enforceability of noncompete provisions in new hire situations where the employee is “at will.,” i.e., can be fired at any time. Specifically, courts are questioning whether it is fair to jeopardize an employee’s future employment opportunities as soon as s/he is hired by virtue of the noncompete if the employer reserves the right to terminate that employee at any time, including the right to terminate the worker’s employment immediately after signing the noncompete.

Non-competes Appear in Other Employment Related Agreements 

Often noncompete provisions will find their way into other employment related documents where additional benefits are being provided, such as a grant of employer stock or stock options. In such cases, courts have generally upheld these agreements as enforceable without engaging in the same scrutiny as when an employee’s continued livelihood is at stake because the violation of a noncompete in such cases simply results in a forfeiture of the employee’s vested interest in the stock or stock options. Generally, as an employee you must be mindful of all agreements that you are subject to that contain a noncompete provision and be aware of the consequences of violating it.  In cases where you have to forfeit benefits because you accept employment with a competitor, you want to negotiate a harder bargain with your new employer to make up for the anticipated loss involved in forfeiting appreciated stock grants.

In sum always be aware and wary of anything an employer may want you to sign as there are always consequences in doing so.

Daniel N. Janich is a Partner in the Employee Benefits and Executive Compensation Practice Group at Greensfelder, Hemker & Gale, P.C. in Chicago.  He has extensive experience representing clients in a broad range of benefits and compensation matters, including the drafting, negotiation and litigation of employment agreements and separation packages.  He can be reached at dnj@greensfelder.com or 312-558-1070.  Check out Dan’s profile on LinkedIn as well. Dan is an excellent resource should you find yourself in this position.  Also check out Dan’s prior contribution to this blog YOU RECEIVED A PINK SLIP AND SEPARATION AGREEMENT – NOW WHAT?

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Is My Pension Safe?

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Logo of the United States Pension Benefit Guar...

The city of Detroit recently filed the largest municipal bankruptcy in history.  One of the potential casualties of this situation will likely be retired city workers receiving pensions.  While pension payments are promises made by the employer, should the bankruptcy go through the city will be free to cut pension benefits as part of the restructuring of the city’s finances.  In light of this situation, how safe is your pension?

What is behind your pension? 

Your employer starts an investment fund that is designed to grow via investment returns and contributions from the employer to a level that will support the pension benefits you’ve earned based upon the plan’s benefits formula.  Pension benefits are typically earned by workers based on a formula that usually takes into account factors such as career earnings, years of service and perhaps other factors.  Each year an actuary calculates the amount that the employer must contribute to the pension plan in order to maintain an acceptable level of funding.

Sadly in far too many cases, especially in the public sector, we’ve seen employers under contribute to their pension plan causing severe underfunding.  In my home state of Illinois this is rampant and is a major part of our state’s ongoing pension crisis.  Certainly this was also a factor in Detroit’s case as well.

Let’s take a look at some of the issues with private employer pensions and those in the public sector.

Private employer pensions 

Pension plans offered by private employers (which I define as those employers who are not municipalities, state or federal government entities, etc.) are a liability of the company in much the same fashion are their accounts payable or a bank loan.  Failure to make good on these obligations can result in the bankruptcy of the firm.

Should a private employer be unable to make good on its pension obligation, in most cases the Pension Benefit Guarantee Corporation (PBGC), an independent governmental agency, will step and cover the pension obligations of the company up to its limits.  The maximum benefit they will guarantee depends upon the year in which the plan was terminated and your age among other factors.

For many workers the PBGC maximums will cover the pension payments promised via their employer’s plan.  Some highly paid retirees receiving large monthly pension payments might see their payments reduced once PBGC coverage kicks in.  A case in point occurred here in Chicago in 2005 when locally based United Airlines defaulted on its pension obligations and many retired pilots and other highly paid retirees saw their monthly benefits reduced by the PBGC.

Municipal and governmental pensions 

The issue for the retired Detroit workers is that municipal and governmental pensions have no backstop such as the PBGC.  Detroit will be the biggest test of the Chapter 9 municipal bankruptcy process but there is much speculation that current and future retirees will see cut on the order of 30%-40% or more in their monthly payments.

At the state level it is less clear to what extent that states such as Illinois would be able to reduce pension payments due the rules in place.

Steps to consider

If you are retired and drawing a pension there probably isn’t much that you can do.  One step to consider is taking your Social Security now if you are eligible and have been waiting to draw upon it until a later age to maximize your benefit.   You might also look at getting a part-time job or hanging out your shingle as a self-employed consultant if you have skills that are applicable to this route.

If you are approaching retirement and your pension plan offers the option to take a lump-sum benefit as an alternative to annuitizing this option might be even more attractive now.  As always you should look at all of the factors involved such as the financial stability of your employer, your other resources available in retirement, etc.  This might be a good time to engage the services of a fee-only financial planner who can help you evaluate your options.  While a lump-sum still needs to be managed in terms of the investments chosen and the timing of withdrawals, you do eliminate any issues surrounding future benefit reductions due to your employer encountering financial difficulties.  If you are offered an early retirement package you should give it serious consideration as well.

Younger workers should take this as a wake-up call and make sure they are saving for retirement especially if they are counting on a pension plan from their employer.  Many companies freeze their pension benefit which means that you will receive the benefit that you’ve earned but you won’t be accruing a larger benefit via increased earnings and years of service.  Take full advantage of defined contribution retirement plans such as a 401(k) or a 403(b).  Fund an IRA account.  Save and invest in taxable accounts.  Strive for financial independence as soon as possible.

Employees with a pension plan generally have a leg up in retirement.  The Detroit situation simply highlights the fact that nothing is set in stone.  At the end of the day we are all responsible for our own retirement, plan accordingly to the extent that you can.

For more background on this situation check out these two excellent pieces on the Market Watch site:

Detroit not alone; public pensions vulnerable

Will your pension disappear, post-Detroit?

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

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