Debating Non-Competes

A new Treasury Department report examines non-compete agreements and lays out several recommendations. Is it fair to employers or is there a hidden agenda?

Tuesday, May 3, 2016
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Non-compete agreements have long been a source of controversy, with critics decrying them as unfair, unnecessary covenants that disadvantage workers and harm the economy, while proponents defend them as an essential practice that encourages employers to develop new technologies and invest in worker training because they don't have to fear losing their employees, trade secrets or long-standing customer relationships to a competitor.

A new report from the Office of Economic Policy at the U.S. Department of the Treasury has added fuel to the fire. Issued in March, Non-Compete Contracts: Economic Effects and Policy Implications raises concerns about the prevalence of non-competes, which it says negatively impact worker welfare, job mobility, business dynamics and economic growth.

According to the report, 18 percent of all U.S. workers -- roughly 30 million people -- are covered by non-competes. It's not just executives or other highly-paid professionals either. Fourteen percent of employees earning less than $40,000 per year are bound by non-competes, while 15 percent of workers without a four-year college degree say they've been required to sign such agreements.

The report asserts that many employers take advantage of employees' lack of knowledge about non-competes to reduce their negotiating power, wages and mobility. This is evident in the fact that some employers require workers to sign non-competes, even in states such as California and North Dakota, where they generally are not enforceable, according to the report's authors.

Furthermore, the report claims that new employees are frequently not told they will be required to sign such an agreement until they report to work. By that point, they have resigned from their previous positions and may have even relocated their families. Their spouse may have given up their job and their kids have been uprooted from school and friends. In other words, it's too late to go back, so they typically feel little choice but to sign the non-compete, whether they want to or not. report isn't entirely negative, as it highlights a number of positives associated with such covenants. When used appropriately, for example, non-compete agreements result in definite economic benefits, according to Karen Dynan, assistant secretary for economic policy at the U.S. Department of Treasury in Washington.

"They can make firms more comfortable sharing their trade secrets with employees that, in turn, can boost employees' productivity and wages," she says. "In addition, because non-compete agreements make workers more reluctant to leave a firm, employers may be willing to invest in training for their workers."

Among the employment law community, the report is largely considered to be flawed for a number of reasons. It fails to adequately define a non-compete agreement and doesn't even mention the many types of restrictive covenants typically employed, according to Erik Winton, principal in the Boston office of Jackson Lewis and co-leader in the firm's non-competes and protection against unfair competition practice group. That includes non-solicitation agreements, non-disclosure agreements and other employment contracts.

The authors also relied heavily on academic papers, along with employee input culled from an online survey, rather than talking to actual employers about their practices, according to Jackie Johnson, shareholder and co-chair of the unfair competition and trade secrets practice group at Littler in Dallas. She is concerned that the report gives "some aspects of employers' interest short-shrift" and is, therefore, unnecessarily critical of how non-competes are currently being used.

In the end, the report concludes that reform is needed to ensure that non-compete agreements "are being used in ways that best benefit firms, workers and society as a whole." The authors lay out three "directions for reform" – increase transparency in the offering of non-competes, encourage employers to use enforceable non-compete contracts and require that firms provide consideration to workers bound by non-competes in exchange for both signing and abiding by the agreements.

While the report tends to be overly critical of non-competes, the recommendations are generally a matter of common sense and good business practice -- with one exception, according to Robert B. Milligan, co-chair of the trade secrets, computer fraud and non-competes practice group at Seyfarth Shaw in Chicago.

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"Employers should be mindful that they are transparent in their use of non-competes," says Milligan. "They should disclose the requirements of the non-compete in the pre-hire process and ensure that the restrictive covenants are tailored to protect legitimate business interests, including trade secrets. While it is appropriate in certain instances, and employers should provide consideration for the covenants if required under applicable law, requiring severance across the board for a non-compete is not a good idea."

While he agrees it would be difficult to argue with some of the recommendations set forth in the report, Michael Greco, a partner in the Denver and Philadelphia offices of Fisher & Phillips, calls the report "biased" and says there's clearly "an agenda behind the scenes." For starters, he questions why the report came out of the Treasury department, rather than the Department of Labor or the National Labor Relations Board. Greco has a theory as to why Treasury would insert itself into the debate.

 "A possible motive is that this is the starting point of the federal government trying to justify inserting itself into non-compete law," says Greco. "I'm concerned they may be intending to do this not through legislation, but through the executive branch, through some regulation or NLRB action."

Johnson agrees there is little chance of any federal legislation aimed at governing the use of non-competes. She believes the agreements will continue to fall under the jurisdiction of state law. The report does have the potential to spur changes at the state level, she concedes. In the meantime, HR should seek to define what interests their company is aiming to protect, ensure their existing non-compete agreements are aligned with that goal and revisit those agreements frequently.

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