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New tool when employees defect to competition: bonus forfeiture

by on
in Employment Law,Human Resources

Employers looking to discourage their employees from going to work for a competitor, take note! As a general matter, courts aren’t in favor of noncompete agreements. Nevertheless, Illinois employers may now have a new weapon to keep employees from taking your secrets when they leave.

According to Viad Corp. v. Houghton (No. 08-CV-6706, ND IL, 2010), employers may be able to accomplish the same objective as a noncompete by creating a forfeiture-for-competition provision.

In Viad, the court enforced an agreement under which an employee was required to repay a hefty bonus she received from her company before leaving to work for a competitor.

If you leave, you must pay

Anne Houghton was a senior vice president at Viad Corp. She voluntarily resigned and went to work for The Freeman Companies, a Viad competitor. Houghton had participated in an incentive plan that required repayment of bonuses received during the last two years of employment if the employee left to work for a competitor.

The work performed by the employee at the competitor had to be “directly concerned” with services the employee performed at Viad or about which the employee had confidential information.

Under the plan, Houghton received a $102,000 bonus in addition to her annual salary of $175,000. Upon Houghton’s departure to Freeman, Viad sued Houghton for the return of the bonus.

Noncompete v. forfeiture

The district court held that Houghton performed services at Freeman that were “directly concerned” with the services she performed at Viad. Therefore, it said, she violated the plan.

The court observed that the Illinois Supreme Court has not decided whether a forfeiture provision related to a bonus payment is enforceable. Notably, the 7th Circuit and other federal courts differentiate between noncompete provisions and provisions requiring an employee to forfeit certain benefits if he or she leaves to work for a competitor.

Two cases illustrate the differences:

  • Tatom v. Ameritech Corp. (305 F.3d 737, 745, 7th Cir., 2002): Noted that “[a] provision that calls for the forfeiture of a bonus in the form of stock options does not strike us as an unreasonable restraint on competition.”
  • Clark v. Lauren Young Tire Ctr. Profit Sharing Trust (816 F.2d 480, 482 n.1, 9th Cir., 1987): Decided that “a noncompetition forfeiture clause in a pension plan is not like a noncompetition agreement in the employment contract, which may unreasonably restrain trade or endanger the employee’s livelihood.”

This difference appears to be because a noncompete may affect an individual’s ability to earn a living. But a forfeiture provision merely requires a financial cost for the right to compete.

Is it reasonable?

In determining whether to enforce Viad’s forfeiture provision, the court looked at factors such as whether the plan was voluntary, the bonus payment was tied to the employee’s performance, the plan sought to return the employee’s wages and the employee’s salary was sufficient.

The court held Viad’s provision to be reasonable because:

  1. Houghton voluntarily participated.
  2. The plan specified that bonuses were not related to an employee’s performance but were tied to company performance.
  3. The forfeiture provision did not seek reimbursement of wages.
  4. Houghton received a comfortable salary from Viad.

However, the court recognized limits to enforcing forfeiture provisions. For example, a forfeiture provision would probably not be enforced if the employee would become dependent on welfare or the employee had been fired without cause.

Since neither of those situations applied to Houghton, the court enforced the bonus forfeiture provision and required Houghton to return her $102,000 bonus. 

What it means for employers

This decision is certainly favorable to employers. However, employers should be cautious to interpret this ruling as giving free license to condition repayment of bonuses on compliance with their forfeiture provisions. Remember, certain reasonableness factors must be present.

Consult with your attorneys to determine how best to draft an enforceable forfeiture provision.

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