Make Sure That You Do Not Inadvertently Void Employment Agreements

Make Sure That You Do Not Inadvertently Void Your Employment Agreements

Thadford A. Felton

ARNSTEIN & LEHR LLP 120 SOUTH RIVERSIDE PLAZA | SUITE 1200 CHICAGO, ILLINOIS 60606 P 312.876.6934 | F 312.876.0288 [email protected]

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any companies seek to maintain and protect their competitive edge through the use of employment agreements. Besides setting forth salary information and terms of employment, employment agreements typically contain various restrictive covenants such as non-competition, non-solicitation and non-disclosure clauses. However, companies must take care not to “materially breach” the employment agreement, as such a breach may render the employment agreement, and the restrictive covenants, unenforceable. A recent case involving an employment dispute between two physicians showed the perils of what can happen when an employer breaches an employment agreement. In that case the physician employer entered into an employment agreement to employ another physician, which provided, among other things, that after 3 years of full employment, the physician employee would be offered on option to purchase 50% of the employer’s corporation. The employment agreement also contained a restrictive covenant that prohibited the physician employee from practicing medicine within a 10 mile radius of the place of business of his employer for 12 months after termination of his employment agreement. After 3 years of employment, the employer failed to offer the physician employee the option to acquire 50% of the employer’s business. Instead, employer offered to allow the employee to purchase 45% of the employer’s company and presented him with an “Amended and Restated Employment Agreement.” The physician’s employee refused to sign either agreement, but continued to work for his employer. Over the next few years, while continuing to work for his employer, the physician employee started his own medical practice within the restricted area. When the employer sought to enforce the non-competition clause of the employment agreement, the Court refused to do so for several reasons: 1. The employment agreement that contained the non-competition clause had expired several years before and had not been renewed. Thus, the physician employee had been working for several years without an employment agreement and without restrictions on competition. 2. Even if the employment agreement had been in effect, the employer had “materially” breached the employment agreement by offering the physician employer the opportunity to purchase only 45 percent, as opposed to 50 percent, of the corporation. 3. During the same period, the corporation was involuntarily and administratively dissolved by the Secretary of State. This decision underscores the need for companies to be cognizant of the risk of breaching agreements with www.arnstein.com 1

employees that contain restrictive covenants. The court in this case defined a “material” breach to be one that worked to defeat the bargained-for objective of the parties or caused disproportionate prejudice to the non-breaching party. The court also said one needs to examine whether custom and usage consider such a breach to be material and whether the allowance of reciprocal non-performance by the non-breaching party will result in his/her accrual of an unreasonable or unfair advantage. Unfortunately, this definition, as most in the law, is broad and depends on the facts of each case. However, be assured that if you seek to enforce an employment agreement, your former employee will surely claim some action or inaction on your part was a “material” breach of the employment agreement. Finally, the court’s view on the effect of the involuntary administrative dissolution of the employer’s corporation is yet another reason to ensure that you have detailed and comprehensive employment agreements. The court seemingly ignored the wording of the Illinois Business Corporation Act, which provides that when an administratively dissolved corporation is reinstated, the corporation will be deemed to have continued without interruption as if it had never been dissolved. Despite this, because the employment agreement did not contain a clause that provided that the employment agreement remains valid, even when the corporation is dissolved, the court found the employment agreement to be unenforceable. Many companies have employment agreements with employees that were signed years ago and have not been updated in many years, if at all. A good practice is to review these employment agreements on a periodic basis to ensure that they remain enforceable and in compliance with the evolving legal environment and the demands of your business.

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