Noncompete Agreements: Finding the Balance Between Reasonable Restraints and Free Range Talent

September 26, 2021

IP Watchdog

“There’s no doubt that restricting an employee’s ability to leave and compete can impose serious costs on the individual…. But that doesn’t necessarily mean that the competition would be fair.”

“It is impossible to unsign a contract, so do all your thinking before you sign.”

Warren Buffet

You may remember 2014 as the year when we all discovered a plague of noncompete agreements threatening our economy. No? Let me help you.

In June that year, the New York Times published an expose of sorts relating the story of a 19-year-old summer camp counselor who couldn’t get hired by a certain camp because the year before she signed a contract with another camp that blocked her from working for any nearby competitor. Noncompete contracts, the article suggested, had previously been reserved for high level corporate executives, and suddenly (and “increasingly”) they were being foisted on rank and file employees engaged in event planning, investment management, and even yoga instruction. A follow-on piece in the Times confirmed the emerging crisis by revealing that the Jimmy John’s fast food chain had forced noncompete clauses on all its sandwich makers (acknowledging, however, that there was no evidence that the company had ever tried to enforce the contracts).

The inspiration for this concern may have come from a then-recent book published by Orly Lobel, a California law professor, called Talent Wants to be Free. She argued not only the unsurprising point suggested by the title, but also that it was actually in the interest of businesses to release departing employees from all restrictions, because in some organic way that would redound to the companies’ benefit. Unfortunately, as I reported in a review at the time, this hypothesis was unsupported by any serious evidence.

A Surging Concern About Unfair Contracts

Nevertheless, the anecdotes about preventing low-level employees from competing caught the attention of other journalists and academics, as well as politicians. Some of those stories were compelling, especially when the employee had no idea that a noncompete would be required until they showed up the first day on the job. A movement to reform the law began to grow. Massachusetts, which for years had resisted tamping down on noncompete agreements, radically amended its law to prohibit them for lower salaried employees, and to require notice to the employee at least 14 days in advance of starting work. Other states have joined in. According to the leading blog on employee contracts, just through the first six months of this year there were 66 bills filed in 25 states.

The federal government has also entered the ring. On July 9, President Biden issued an executive order designed to increase competition in the national economy. Among many other directives to government agencies, he commanded the Federal Trade Commission to examine what action it might take to rein in the negative effects of employee noncompete agreements (a responsive letter crafted by Russell Beck and signed by dozens of practitioners, including myself, has urged caution on the issue).

Why doesn’t everyone see this as a form of social crisis? After all, it looks like a new example of corporate overreach in an economy that has already discounted almost to irrelevance the dignity of work. But in fact, businesses have been using noncompete agreements for more than a century, subject to strict limitations imposed by state law. California, North Dakota and Oklahoma have long refused to enforce them at all. And in the rest of the country, they are enforced only when a judge agrees that they are reasonable in time, subject matter and geography.

Balancing Legitimate Interests

There’s no doubt that restricting an employee’s ability to leave and compete can impose serious costs on the individual. And although studies show that it’s impossible to measure any loss of innovative capacity or output, it’s probably safe to assume that some situations prevent competition that might benefit the community. But that doesn’t necessarily mean that the competition would be fair.

In the digital economy, more and more employees have to be trusted with sensitive information in order for the enterprise to succeed in an increasingly competitive environment. To maintain that success a company has to be able to protect its information assets from flowing out the door to the competition. In the U.S. we enjoy robust laws, at both the state and federal level, that are designed to reduce that risk by providing remedies for trade secret misappropriation.

But companies often don’t – and can’t – know when a former employee is using what they know to benefit their new employer. Surveys show that a large percentage of employees, perhaps a majority, are so unsure of their secrecy obligations that they are willing to use sensitive information at the next job. And even if the left-behind company suspects foul play, trade secret litigation can be messy, unpredictable and expensive. It’s certainly not the most efficient way to resolve misunderstandings. So, from the company’s point of view, simply preventing the risk for a limited time with a noncompete clause can seem very attractive. This is especially true for smaller companies whose trade secrets consist of information about customers, in other words the sort of goodwill built up over time that sustains the business.

For the employee, of course the constraints of a noncompete will feel like a blunt weapon, prohibiting not only trade secret theft but also preventing fair competition. And it’s entirely legitimate for a community – say, a state like California – to decide that the obvious individual costs and the possible detriment to the collective economy are not worth preserving the private interests of individual employers. Indeed, some have pointed to the astonishing success of Silicon Valley as proof that the broad social benefits of “knowledge spillovers” from free movement of labor vastly outweigh the private losses from those spillovers.

Unfortunately, the empirical evidence so far doesn’t permit a firm conclusion on that larger point. But it’s clear enough that noncompete agreements have been abused to some extent. States – and perhaps the federal government – will likely continue to press for reforms, especially for categories of employees who are not practically in a position to cause a company damage when they leave.

Using Noncompete Agreements Sensibly

In the meantime, what’s a business to do? First, you should consider whether noncompete agreements are right for the culture of your company. Do you really need them to protect yourself? What might be the cost in decreased trust and increased resentment among a workforce that expects to enjoy career flexibility? Consider imposing these restrictions only on those senior employees who have access to your most sensitive information. Be prepared to consider relaxing or eliminating constraints in special situations where taking a bit of calculated risk might help establish or improve an important relationship.

Second, whatever you decide to do about noncompete agreements, don’t depend on them as the primary way to protect your trade secrets. Be sure that you have established a comprehensive information security program, including continuous training and robust enforcement. The most reliable way to reduce the risk that you might lose control of your secrets is through active management, not passive dependence on post-employment restrictions.

Third, if you do use noncompete agreements, watch out for changes in state laws that might affect you. If any meaningful reforms emerge from the federal government, you will certainly hear about them. In any event, pay attention and be ready to adjust so that you comply with any new standards.

Outrage over imposition of restrictive contracts on teenage camp counselors or sandwich makers is understandable, but it can lead to careless thinking. Not all employee restraints are unreasonable. We expect that the workplace should provide not only a job but also the opportunity for learning and advancement. In the information economy, that often leads to greater exposure to secrets. And preserving those secrets sustains competitive advantage and creates more jobs.

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