Tuesday, October 26, 2010

On Non-Compete Agreements

Alabama, California, Colorado, Delaware, Massachusetts, and North Dakota Have all held that non-compete agreements are completely and always invalid. California, in particular, has a strong policy in favor of "competition and employee freedom."
Gokli, Rayna. Illinois Business Law Journal. http://www.law.uiuc.edu/bljournal/post/2008/11/05/Non-Compete-Agreements-Friend-or-Foe.aspx
While noncompete agreements can indeed protect your business, enforcing them can be tricky - especially in Wisconsin, where the law is peculiar. ... Courts are concerned about protecting the employee's ability to make a living, and in Wisconsin, noncompete agreements are particularly disfavored.
Frantz, Ellen M. River Valley Business Report. Legally Speaking: NonCompete Agreements Tricky Propositions.

Courts in general, and Wisconsin courts in particular, as a rule, are not in favor of employers telling employees what they can and cannot do; particularly after the employee leaves the employer. Of course, it happens all the time. Confidentiality agreements, shareholder agreements, stock redemption agreements, and, yes, non-competes all restrain former employees in some way. But none are so controversial as non-competes.

Why?

Well, think about it for a minute. I hire you and in exchange, demand that you not work in some competitive manner for some period of time afterwards. Sounds reasonable, right? I'm letting you work for me and in exchange just ask that you not work for a competitor afterwards.

However, I am an attorney. I ask that you not work for any law firm in the Midwest for a period of 5 years after you work for me. How reasonable does that sound? You can't do the one thing that you are trained to do (practice law) in the place where your family is (the Midwest) for a period of time that your job skills will deteriorate if not used. If you want to work after you work for me - you have a choice: pick up your family and leave "the Midwest" or change fields. If you don't agree to this, you can't work for me. How many people do you think will agree to this? Will the best attorneys agree to this?

The touchstone for the enforcability of Non-Compete Agreements ("NCA") is reasonableness. Are the terms of the NCA reasonable. What does "reasonable" mean? Well, the court determines that. And, what if the court finds that the NCA is unreasonable, or a part of it is unreasonable? The court uses a "blue pencil" to, basically, re-write the agreement as it deems reasonable.
In examining restrictive covenants, the [Wisconsin Appellate] court applied the following canons of construction to noncompete provisions: “(1) they are prima facie suspect; (2) they must withstand close scrutiny to pass legal muster as being reasonable; (3) they will not be construed to extend beyond their proper import or further than the language of the contract absolutely requires; and (4) they are to be construed in favor of the employee.”
Stevens, Michael L. Wisconsin Court Invalidates Noncompete Agreement Due to Indefinite Extension Provision. February 2, 2008.

So, going back to my example. A court could say that it is unreasonable to prevent an attorney from practicing any kind of law in the whole of the Midwest for a period of five years after s/he's done working for me. So, maybe the judge just re-writes the NCA. Maybe the judge decides its reasonable to limit the scope to just "intellectual property" law, and the geography to just Madison, and the time to just 2 years. So, now, my NCA has gone from "law in the Midwest for 5 years" to "intellectual property in Madison for 2 years." And, if I don't like it, maybe the court just scratches the whole thing. Pretty big risk, not to mention expense, to lose out on getting key employees, don't you think?
"In recognition of our currently dismal economy and the need to permit people to work, some courts -- even in states that generally enforce noncompete agreements -- have demonstrated a reluctance to enforce these agreements."
Beck, Russel. Computerworld. Beyond the Non-Compete. June 2, 2009.

"But, MBR," you say, "the employee chooses to accept the NCA. They willingly and freely signed it in exchange for employment."

But, consider this: "The [employer] will always be at least weakly better off with a non-compete agreement so that it is optimal for her to impose such a clause when there is no incentive problem." Krakel, Matthias. Governance and the Efficiency of Economic Systems. Should you Allow Your Agent to Become Your Competitor. The employer will always be better of with a non-compete. Moreover, NCA's are effective in reducing wages over the term of employment since the employer only needs to offer enough money to get the employee, not keep the employee, since the NCA prevents the employee from leaving. Id.

Moreover, the risk to the economy at large can cause shifts in industry dominance. A classic example is Silicon Valley, where NCAs are not enforced. It is widely agreed that one of the primary drivers of the development of Silicon Valley and proliferation of high-tech jobs in California, rather than Boston (the home of MIT and nearby Dartmouth and Cornell), is the non-enforcement of NCAs. Samila, Sampsa. Copenhagen Business School Summer Conference 2009. Non-Compete Covenants: Incentives to Innovate or Impediments to Growth. June 17-19, 2009. In the case of Silicon Valley, the non-enforcement of NCAs allowed employees to spin-off new companies and hire others from the same general area working on the same general problem. Id. This led to a boom in the high-tech industry there creating a number of industry giants, even amongst the companies most often raided for talent (e.g., Google, Apple, Yahoo!, Oracle, etc.). Thus, there is a strong economic growth incentive to the non-enforcement of NCAs.

Finally, NCAs hurt the employers. First, the existence and requirement of an NCA limits the potential pool of employees, especially where NCAs are not industry standard. Consider the following situation: Industry A has a surplus of potential employees for the job availability, job turnover is relatively high, and spin-off is likely. Thus you have a situation where a large pool of people is applying for a relatively small pool of unstable jobs. As an employee you will prefer a firm without an NCA. You will delay accepting a job with the firm requiring the NCA as long as possible to see if there is anything else. For the firm, this means not only will the best employees (the ones that all firms want) not come to your firm, but will delay coming to your firm as long as they possibly can.

Morevoer, imposing the NCA hurts the firm by preventing experimentation with employees. Simply put, not all employees are a good fit with every firm. However, the NCA impedes the employer's ability to remove imperfect matches. "In the absence of perfect information, anything that adds friction to the movement of employees across firms ... will obstruct the trial-and-error process and increase the odds of a poor match." Id. So not only are firms left with only those employees that would agree to the NCA, but the odds of being stuck with a poor match are particularly high, as well.

So, the practical reality is this:
If an employee finds himself in a situation where he has found a new job, but signed a non-compete agreement with his prior employer, he may still be able to take the new job. The employee should generally not disclose the existence of the non-compete until later in the interview process, when the potential new employer has expressed a strong interest in the job candidate. That way, the employer will be more likely to work with the employee to find a way to hire him.
Gokli, Illinois Business Law Journal. In other words, the NCA is meaningless without enforcement. Employees could sign them and simply break them, forcing the old and new employer to fight it out (and probably settle). In such a case, the NCA has not only decreased the quality of the employees, but added to your legal bill as well (first in drafting it, then in enforcing it). And the end result is that the employee probably works for a competitor anyway, or at the very least the court re-writes your NCA.

Or, you could just save yourself the money and headache and provide a great enough workplace that your employees don't want to leave.
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ps. This is not legal advice, if you have any questions regarding non-competes and their enforceability please speak to an attorney.

5 comments:

  1. Did this turn into "Madison Law Review" without me noticing?

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  2. I have to correct the quote from the Illinois Business Law Journal listing states that always ban noncompetes. The only states in which noncompetes are per se unlawful are California, North Dakota, and Oklahoma. While noncompetes are indeed generally disfavored by courts in almost all states, they may be enforced in Alabama, Colorado, Delaware, and Massachusetts. I'm a lawyer in Boston, and I have litigated many noncompete cases on behalf of both employers and employees. If the company seeking to enforce a noncompete can show that the noncompete is narrowly tailored to protect a legitimate business interest (i.e., trade secrets, confidential business information, or customer goodwill), a Massachusetts court will likely enforce it. My understanding is that the same holds true in Alabama, Colorado, and Delaware.

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  3. Was this post inspired by a certain homebrewer here in Madison?

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  4. In my experience, Stephen Reed's rule of "if the noncompete is narrowly tailored to protect a legitimate business interest (in geography, time, and job scope), it will be enforced" is generally true. I think that in the beer world it is usually geography and job scope that matters. If I were to work in a brewpub in Minneapolis, can I be prohibited to working for one in Madison or Chicago? In what capacity in each? And are these fit for this industry? California's laws reflect (or maybe caused) the software industry located there, and attorneys can't have them because it affects clients too much. Does the brewing world work better with more flexibility for moving or less? I don't know, but I do know the narrow tailoring is key if you are going do it especially here in Wisconsin.

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  5. Palmer, no it was not inspired by any homebrewers.

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