Prior Breach and Unclean Hands Defenses to Non-Compete and Non-Solicitation Agreements

An employer that has materially breached an employment agreement before an employee has violated a covenant not to compete may not enforce the covenant. Callman on Unfair Competition defines a material breach of the employment agreement as follows and warns that if an employee wants to get out of a restrictive covenant, he or should not ratify the employer’s misconduct by continuing to work for the employer for an extended period after learning of the misconduct:

Whether a breach is material involves a determination of whether the breach worked to defeat the bargained-for objective of the parties or caused disproportionate prejudice to the non-breaching party, whether custom and usage consider such a breach to be material, and whether the allowance of reciprocal non-performance by the nonbreaching party will result in his accrual of an unreasonable or unfair advantage. In addition, the employer’s breach of a separate obligation does not affect the employee’s obligations under the employment contract. But the employee must be careful not to ratify the employer’s breach by continuing in the employment for an unreasonable time without protesting. It has also been held that a covenantor may not take advantage of the covenantee’s breach if the covenantor himself is in breach of their agreement.

An employee does not have to continue to work for an employer engaged in unethical, dishonest or even criminal conduct. By engaging in such conduct, an employer may be in breach of the underlying employment agreement, even if there is no written employment contract and the employee is working in an at-will or month to month relationship for the employer.

The employer’s breach of the parties’ employment relationship or unclean hands can serve as a defense to defeat a covenant not to compete or non-solicitation clause signed by the employee, even if that agreement is otherwise properly narrowly drafted and enforceable. For instance, when a sales employee is sued on a covenant not to compete and the employee demonstrates that the plaintiff-employer wrongfully deprived the employee of commissions payable after termination of the employment, the “unclean hands” rule could be used to bar the employer from enforcing a non-compete or non-solicitation agreement.

In Rao v. Rao, 718 F.2d 219 (7th Cir.1983), the Appeals Court deciding the matter under Illinois law held that all contracts have an implied covenant of good faith which precludes an employer from firing an employee in bad faith and then trying to preclude the employee from obtaining employment elsewhere due to the covenant not compete in the employment agreement. Rao, 718 F.2d at 223-24. The court found that allowing for enforcement of the restrictive covenant in this situation would be unreasonably oppressive and was not tied to the employer’s legitimate business interests of the employer nor necessary to preclude unfair or improper competition. Id. This rule stated in Rao arises out of the general principle that prior material of a party excuses the later non-performance by the non-breaching party. See Arrow Master, Inc. v. Unique Forming Ltd., 12 F.3d 709, 714 (7th Cir.1993); Borys v. Rudd, 207 Ill.App.3d 610 (1990), appeal denied, 139 Ill.2d 593. Rao concluded that terminating an employee in bad faith constitutes a material breach of the employment contract (i.e. a breach of the the implied covenant of good faith and fair dealing) which thus excuses compliance with the covenant not to compete contained in the same contract or agreement. See Dunning v. Chemical Waste Management, Inc., 1997 WL 222891, at *10-11 (N.D.Ill. Apr.22, 1997) (an employer cannot “expect to uphold the restrictive covenant” if it is already in material breach of the employment contact).

6 Bishop v. Lakeland Animal Hospital, P.C., 268 Ill.App.3d 114 (1994), takes Rao further. The Court in Bishop held that an employer cannot enforce a restrictive covenant as to an employee it has fired without case, even when the employment contract noncompetition agreement against an employee who has been dismissed without cause, even if the employment contract expressly allows for termination without cause because the termination would still be a breach of the covenant of good faith and fair dealing which is implied in all contracts. Id. at 36. A number of other courts in Illinois agree with the appellate courts in Rao and Bishop. Galesburg Clinic Association v. West, 302 Ill.App.3d 1016 (1999) excused complying with a non-compete clause when one of the partners breached the partnership agreement. C.G. Caster Co. v. Regan, 88 Ill.App.3d 280 (1980) found that the employer by failing to pay contractually mandated post-employment benefits breached the employment agreement which excused compliance with the non-compete clause in the employment contract.

Thus, if an employer materially breaches its employment contract with an employee, e.g., by acting in bad faith, engaging in illegal behavior that undermines the employment relationship, or firing the employee without cause, it cannot then enforce a restrictive covenant against that former employee.

The attorneys at Lubin Austermuehle have over thirty years of experience defending and prosecuting non-compete, trade secret and restrictive covenant lawsuits. We are committed to fighting for our clients’ rights in the courtroom and at the negotiating table. Conveniently located in Chicago and Elmhurst, Illinois, we have successfully litigated non-compete and trade secret and covenant not to compete cases for clients all over the Chicago area. To schedule a consultation with one of our skilled attorneys, you can contact us online or give us a call at 630-333-0333.