Strategies for Calculating Adequate Consideration under the Illinois Freedom to Work Act

Strategies for Calculating Adequate Consideration under the Illinois Freedom to Work Act

The Illinois Freedom to Work Act (“IFWA”) (820 ILCS 90/1-90/10) makes it clear that invalid non-compete agreements are prohibited and subject to penalties for each violation. Given the statutes limitations, prohibitions and penalties for violation, employers should reconsider when and how they use non-compete agreements. Having a one-size fits all non-compete agreement for all employees will likely incur financial penalties. The IFWA also enshrines in statute a requirement that an employer must provide adequate consideration in exchange for the promise not to compete. Employers must now balance the risk of penalty and the cost of the consideration when executing non-compete agreements with their employees.

The IFWA states that any non-compete agreement entered into on or after January 1,2022 is void unless it was made with adequate consideration. The new law also codifies what adequate consideration means. According to the statute, adequate considerations is either:

  1. The employee worked for the employer for at least 2 years after the employee signed an agreement containing a non-compete agreement.
  2. The employer otherwise provided consideration adequate to support an agreement not to compete. This consideration can consist of a period of employment plus additional professional or financial benefits or merely professional or financial benefits adequate by themselves.

Before the enactment of the IFWA, the courts had established that two years of employment is necessary because any promise of employment as consideration for a non-compete was illusory for employment at will. The result was that Illinois courts found that absent other consideration, two years of employment is required for a non-compete agreement to be deemed adequate. Fifield v. Premier Dealer Services, Inc. 2013 IL App (1st) 120327, ¶19 (2013).

While traditionally, “any act or promise that benefits one party or disadvantages the other is sufficient consideration to support the formation of a contract.”  Bires v. WalTom, LLC, 662 F. Supp. 2d 1019, 1028 (N.D. Ill. 2009), citing Cincinnati Ins. Co. v. American Hardware Mfrs. Ass’n, 387 Ill. App. 3d 85, (1st Dist. 2008). “In the context of postemployment restrictive covenants, Illinois courts depart from the traditional rule that the law does not inquire into the adequacy of consideration, only its existence.” Brown & Brown, Inc. v. Mudron, 379 Ill. App. 3d 724 (Ill. App. Ct. 2008); Bires v. WalTom, LLC, 662 F. Supp. 2d 1019, 1030 (N.D. Ill. 2009).

 

Courts have suggested what might be adequate consideration when coupled with some number of years of employment less than two. “If there is evidence that there was additional consideration, such as added bonus in exchange for this restrictive covenant, more sick days, some incentives, some kind of newfangled compensation that would be considered in the eyes of the law additional consideration that would then support the restrictive covenant as being less than two years.” McInnis v. OAG Motorcycle Ventures, Inc., 2015 IL App (1st) 142644, ¶ 18, (2015)

Consideration is sufficient for a contract which includes a non-compete clause when it is a substantially related to the actual value of the transaction. In Russell v. Jim Russell Supply, Inc., the consideration was held to be both existent and adequate to support the contract which included the covenant not to compete. Jim Russell received $ 550,000 cash, a $ 10,000 truck and the release of all partnership liabilities in exchange for the transfer of Jim’s 50% interest in the partnership assets and the covenant not to compete. Russell v. Jim Russell Supply, Inc., 200 Ill. App. 3d 855, 860-61, (5th Dist. 1990).  In Russell, the consideration for the 50% business interest and the promise not to compete was a substantial cash payout, a valuable truck and release of partnership liabilities.

While no Illinois case has yet established an exact standard for determining the adequacy of cash consideration for a non-compete, what the case law does suggest is that consideration for a non-compete cannot be nominal, must be of actual financial value to the employee and must be a value equal to the benefit of having guaranteed employment for two years.

To answer the question everyone wants to know – how much cash should I pay as consideration for a non-compete agreement with an employee to ensure that the non-compete agreement is enforceable? While no court has yet answered this question with a formulaic answer, the current case law suggests that the value of the consideration is inverse to the value of the length of employment up to the statutory two-year period.

What then is the financial value to the employee of guaranteed two years of employment? That value is the difference between what the employee receives with their current employer and what the employee could receive if they left the job to compete against their employer. That value is the amount of profit that the employee could take away from their current employer if they left.

Therefore, to be immediately enforceable, the amount of consideration should be equal to the amount of damage that the employee’s competition could cause, multiplied by the probability that the employee’s competitive activity would cause that harm to the business. Anything less than this amount would require a proportional amount of time employed by the company before the non-compete would become enforceable.

Keep in mind that cash consideration paid at the time of execution is not the only financial consideration that the courts will use to evaluate whether the consideration was adequate. The court will consider both the cash payment at the time execution along with applicable future increased earnings or benefits the employee receives when determining the adequacy of the consideration.

Employers must carefully weight the value of the future financial benefits to the employee along with any upfront cash payments against the two-year statutory period to ensure that consideration is adequate within a short enough timespan so the non-compete agreement’s enforceability date meets the employer’s business objectives. A business should conduct a cost/benefit analysis to determine if implementing a non-compete is financially worth the cost given that the consideration must be more than a mere promise or nominal cash payments and must be whatever the value is of having a position guaranteed for two years.

A simple analysis which balances the cash costs of the non-compete agreement against the risk of damage will help guide a business when deciding whether a non-compete agreement is worth the financial costs of the consideration.

If  then the risk of loss from the employee’s competition outweighs the financial cost of the non-compete agreement where,

  1. is the dollar amount of the consideration paid in cash to the employee at the time of execution.
  2. is the time value of the cash paid to the employee.
  3. is the cost to enforce the agreement.
  4. is the probability of having to enforce the agreement.
  5. is the amount of damage that the employee’s competition could inflict on the business.

Businesses have long struggled to adequately enforce non-compete agreements in part because of the adequately of the consideration. The IFWA only further escalates that risk.  By strategically implement a non-compete consideration strategy which outlines the calculation methodology, businesses are in a significantly stronger position when it comes to enforcing a non-compete.

For assistance with a question relating to this topic or other Illinois employment law issues, please contact the Law of Office Andrew Szocka, P.C. to speak with an attorney today.