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December 13, 2019 Articles

How a Court’s “Pencil Color” Impacts Restrictive Covenants

The difference between red and blue is significant enough in employment agreements to make or break a restrictive covenant case.

By Christopher Hennessy and Jeremy Glenn

As we approach the 2020 election, the media will invariably reference “red states” and “blue states.” Within the context of restrictive covenants in employment agreements, there are also “red” and “blue” states—as well as “independent” states—with the color a reference to the doctrine courts apply in that state when enforcing those agreements.

The difference between red and blue is significant in the election context, and many predictions as to the outcome of an election are tied directly to the color historically connected to that state. The difference is also significant enough in employment agreements to make or break a restrictive covenant case. As with elections, states that are not so clearly connected to red or blue make the outcome more difficult to predict. At the same time, the ever-developing body of case law showcases the continual challenges that employers face across the country.

Case Example

In Medix Staffing Solutions, Inc. v. Dumrauf, the regional director of a national company entered into a restrictive covenant under which, for a period of 18 months after leaving employment, the employee could not, “directly or indirectly, own, manage, operate, control, be employed by, participate in or be connected in any manner with the ownership, management, operation or control of any business” that competed directly or indirectly within 50 miles of any of the locations of the employer for whom the employee had worked. No. 17-cv-6648, 2018 WL 1859039 (N.D. Ill. Apr. 17, 2018). The employee resigned and took subsequent executive employment on the other side of the country. The employer sought to enforce the restriction. The court, applying Illinois law, found the restriction unreasonable, unsalvageable, and unenforceable.

Medix Staffing Solutions will be employed throughout the article as a point of comparison to help readers understand the manner of review that courts routinely apply to restrictive covenant cases.

Red and Blue States: Clear Lines Are Drawn

Under what is referred to as the red-pencil doctrine, a court will strike an entire restrictive covenant if any part of it is invalid. Under the blue-pencil doctrine, a court will strike only those portions that render the restrictive covenant invalid, leaving the remaining provisions intact.

Red penciling is the least-followed approach among those states that allow for restrictive covenants such as noncompetes, with Nebraska and Virginia being examples of long-standing adherents to what many view as a Draconian rule. See, e.g., Unlimited Opportunity, Inc. v. Waadah, 861 N.W.2d 437 (Neb. 2015) (declining to apply the blue-pencil rule, stating that the courts lack the power to modify private agreements); Better Living Components, Inc. v. Coleman, 67 Va. Cir. 221, 2005 Va. Cir. LEXIS 145 (Apr. 6, 2005) (declining to adopt the blue-pencil rule despite presence of a modification clause in the agreement). For a time, it appeared that South Carolina might be a blue state, but the South Carolina Supreme Court cleared up any potential confusion in Poynter Investments v. Century Builders, thus placing South Carolina squarely in the red-pencil column. 694 S.E.2d 15 (S.C. 2010) (finding that “the restrictions in a non-compete clause cannot be rewritten by a court or limited by the parties’ agreement, but must stand or fall on their own terms”).

Blue penciling has its own long-time adherents, such as New York, North Carolina, and Indiana, among others. See, e.g., Brown & Brown, Inc. v. Johnson, 25 N.Y.3d 364, 371 (N.Y. 2015) (recognizing a court’s power to “sever and grant partial enforcement” of an otherwise overbroad restrictive covenant); Beverage Sys. of the Carolinas, LLC v. Associated Beverage Repair, LLC, 368 N.C. 693, 699–700, 784 S.E.2d 457 (2016) (recognizing the blue penciling of unreasonable terms provided they can be distinguished from reasonable terms, but rejecting reformation even in the presence of a modification clause); Dicen v. New Sesco, Inc., 839 N.E.2d 684, 687 (Ind. 2005) (supporting the enforcement of reasonable restriction and the striking of unreasonable restrictions, “granted they are divisible”).

If a court in a red-pencil state found the clause in Medix Staffing Solutions to be unreasonable, the entire clause—the geographic restriction, the time restriction, and the activity restriction—would be stricken. If the same clause were reviewed in a blue-pencil state, the outcome would depend on whether the court saw a way to excise those provisions that were unreasonable and leave the remaining provisions.

Consider the following example of a contract clause:

[Employee] will not during the term of this employment, and for a period of five whole years thereafter, engage directly or indirectly, for herself or as a representative or employee of others, in the same kind or similar business as that engaged in by the Company, (1) in Kokomo, Ind., and/or (2) in any other city, town, borough, township, village or other place in the United States in which the Company is then rendering its said services, and/or (3) in any city, town, borough, township, village or other place in the United States in which it has been or has signified its intention to be engaged in rendering its said services.

Welcome Wagon v. Haschert, 127 N.E.2d 103, 106 (Ind. Ct. App. 1955). In a red-pencil state, no part of the provision would be enforced if a court determined that some portion of the restriction was unreasonable. See, e.g., CAE Vanguard, Inc. v. Newman, 518 N.W.2d 652, 655–56 (Neb. 1994) (noting the trial court found as unreasonable a five-year restriction with a geographic area “anywhere else on earth”). In a blue-pencil state, the court very well could decide to enforce the restriction in Kokomo but strike the restrictions in the broader geographic area because the geographic restrictions were separated into subnumbered paragraphs. The provision in Medix Staffing Solutions did not separate the geographic restrictions, making blue penciling that much more difficult if the court found that restriction unreasonable.

Independent States: The Lines Are Not as Clear

Many states are neither red nor blue but instead independent (in keeping with the political parlance), in the sense that the courts are empowered—either by statute or through the evolution of case law—to modify or reform restrictive covenants to be consistent with their intent and the applicable law. While this may appear on its face to be the most flexible scenario, it can leave employers with greater uncertainty.

Courts often use the terms blue penciling and reformation interchangeably. See, e.g., Turnell v. CentiMark Corp., 796 F.3d 656, 662–63 (7th Cir. 2015). The distinction can be subtle because both involve modifying the original terms of the agreement. However, blue penciling, in the strictest sense, results in selective enforcement of existing reasonable terms as if the unreasonable terms did not exist or were blue penciled out of the agreement. Reformation involves modifying unreasonable terms to make them reasonable. In Beverage Systems of the Carolinas, the North Carolina Supreme Court rejected rewriting the agreement as outside the power of the court—thus rejecting reformation—and instead evaluated whether the provision could be selectively enforced, where the unreasonable terms would be ignored, thus adhering to North Carolina’s stricter interpretation of blue penciling. 368 N.C. at 699.

Some states have statutes that specifically address restrictive covenants, including authorizing courts to modify agreements. See, e.g., Tex. Bus. & Com. Code § 15.51 (“[T]he court shall reform the covenant to the extent necessary to cause the limitations contained in the covenant as to time, geographical area, and scope of activity to be restrained to be reasonable and to impose a restraint that is not greater than necessary to protect the goodwill or other business interest of the promisee and enforce the covenant as reformed.”); Ga. Code § 13-8-54 (“[I]f a court finds that a contractually specified restraint does not comply with the [Code], then the court may modify the restraint provision and grant only the relief reasonably necessary to protect such interest or interests and to achieve the original intent of the contracting parties to the extent possible.”). Thus, by statute, some states have given courts a rewriting authority that parties commonly attempt with a severability clause.

In our home state of Illinois, courts have been willing to modify or reform agreements to be reasonable where they otherwise were not. See, e.g., Gillespie v. Carbondale, 622 N.E.2d 1267 (Ill. App. Ct. 1993) (affirming judicial modification of geographic limitation); Weitekamp v. Lane, 620 N.E.2d 454, 461 (Ill. App. Ct. 1993) (“A court may modify the restraints in a covenant not to compete.”); Arpac Corp. v. Murray, 589 N.E.2d 640, 652 (Ill. App. Ct. 1992) (affirming trial court’s “reasonable” and “slight” modifications, and noting that the agreement in question contained a modification clause).

Yet in Cambridge Engineering, Inc. v. Mercury Partners 90 BI, Inc., the court expressed serious reservations about that process. 879 N.E.2d 512 (Ill. App. Ct. 2007). In that case, the court noted that reformation of unreasonable restrictive covenants could actually incentivize employers to draft overly broad restrictions with the knowledge that the courts would amend them as necessary. Furthermore, acknowledging that employees “unschooled in the law” would not be expected to know the reasonable from the unreasonable, the court went on to comment that judicial reformation “should be looked upon with suspicion.” Id. at 529.

Whether Illinois remains among those states employing judicial reformation is increasingly unclear, which leaves employers with some uncertainty. Several opinions post–Cambridge Engineering seem to have picked up on the skepticism expressed by that court. See, e.g., Montel Aetnastak, Inc. v. Miessen, 998 F. Supp. 2d 694, 718 (N.D. Ill. 2014) (citing Cambridge Engineering and finding that “Illinois courts have found that extensive judicial reformation of unenforceable post-termination restrictive covenants may be counter to public policy”); Critical Care Sys., Inc. v. Heuer, 2014 IL App (2d) 130745-U, at *34 (citing, among other cases, Cambridge Engineering, and declining to modify contract to make it enforceable “because that would be an impermissible rewriting of the covenant”).

In an unpublished opinion, the Illinois Appellate Court in Deere Employees Credit Union v. Smith again seemed to depart from the reformation approach. 2016 IL App (3d) 150516-U. After deciding that a noncompete provision was unenforceable, the court determined that as an essential term of the contract, it was not severable and the entire contract was void. The court commented on the trial court’s attempts to reform the agreement into something consistent with Illinois law, finding that judicial reformation was “not favored” as it would incentivize employers to overreach with respect to the restrictive covenant due to the comfort in knowing that the court would save them from their overdrafting. Id. ¶ 37. At the same time, the court noted that the contract did not include the severability language that could have been used to “salvage” the agreement if the trial court found certain provisions to be unenforceable. Id. ¶ 36.

Reading the opinion in Deere Employees Credit Union might give the impression that the presence of a severability clause would have brought a different result. Yet, in AssuredPartners, Inc. v. Schmidt, the presence of a severability clause was still not enough to save the restrictions. 2015 IL App (1st) 141863. In AssuredPartners, the parties had expressly agreed that if the duration, scope, and geographical area of the restrictions were found to be unreasonable, the court “shall be allowed to revise the restrictions . . . to cover the maximum duration, scope, and area permitted by law.” Id. ¶ 50. The court reviewed all of the restrictions and found them to be so deficient that they were not only unreasonable but unsalvageable. The court declined to reform the agreement, noting that in light of what it found to be significant deficiencies, modifying the agreement’s terms “would be tantamount to fashioning a new agreement.” Id. ¶ 52 (internal citations omitted).

No Illinois court has expressly rejected reformation, but language in these recent decisions sounds eerily similar to language used in red-pencil states such as Nebraska and Virginia. For example, compare the following:

  • “It is the function and duty of the reviewing court to construe the contract and not to make a new contract under the guise of construction.”
  • “It is not the function of the courts to reform unreasonable covenants not to compete solely for the purpose of making them legally enforceable.” 

At first blush, it is hard to tell which quote is from a reformation state (the first one) and which is from a red-pencil state (the second one). Compare Critical Care Sys., 2014 IL App (2d) 130745-U, at *34 (quoting Terry v. State Farm Mut. Auto. Ins. Co., 677 N.E.2d 1019 (Ill. App. Ct. 1997)), with Vlasin v. Len Johnson & Co., Inc., 455 N.W.2d 772, 776 (Neb. 1990). There is certainly a long history of Illinois cases supporting reformation. Illinois courts do not appear ready to reject that history but increasingly seem to raise the bar regarding when reformation or modification might apply. The presence of a severability clause is not a guarantee of reformation, but the absence of one certainly appears like a guarantee of no reformation.

This leads us back to Medix Staffing Solutions. There, the court applied Illinois law. There is no indication that the court found the duration provision (18 months) or the geographic provision (50 miles) to be unreasonable. However, the court unquestionably found the scope of employment provision to be overly broad and unreasonable—the former employee could not even accept employment as a janitor with a competitor. In the court’s opinion, “the limitless scope of the activity restriction alone dooms the [agreement].” 2018 WL 1859039. The court declined reformation of the activity restriction as it was a “broad ban on competition,” noting that the employer had its opportunity to draft an appropriate restriction and had to live with what it drafted. Id. Instead of a temporally and geographically reasonable limitation, the employee was not restricted at all.

Mitigating the Confusion

Where does this leave employers?

First and foremost, it is critical that restrictive covenants are written in a way that makes them most enforceable under the relevant law. In a red-pencil state, an unreasonable provision simply will make the covenant unenforceable in its entirety. Where appropriate—and subject to a court looking askance at any attempt to cherry-pick a jurisdiction with no connection to the employment—employers can use forum-selection clauses and choice-of-law clauses to establish applicable law in a jurisdiction that will blue pencil or reform the contract. Drafting restrictions in a manner that allows for their separation could also be useful in a state where courts are willing to blue pencil the agreement.

Furthermore, including within the agreement a clause expressing the parties’ intent to have a court modify the agreement as necessary to comply with state law can likely be beneficial in states that allow for reformation. However, a severability clause is only one component of what the court is likely to consider and should not be relied upon as a way to salvage the restrictions from being unreasonable.

In the end, much like red and blue states in the political context, where each state stands on restrictive covenants is an ever-evolving landscape.

Christopher Hennessy and Jeremy Glenn are members of Cozen O'Connor in Chicago, Illinois. A version of this article first appeared on Law360.

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