Do Noncompetes Stifle or Encourage Innovation? Should you care?

The New York Times published an article yesterday discussing the increased use of noncompete agreements in nontraditional industries. The article starts by talking about a 19-year-old college student who had a job offer to work as a summer-camp counselor withdrawn as a result of a noncompete agreement she signed at another camp:

Colette Buser couldn’t understand why a summer camp withdrew its offer for her to work there this year.

After all, the 19-year-old college student had worked as a counselor the three previous summers at a nearby Linx-branded camp in Wellesley, Mass. But the company balked at hiring her because it feared that Linx would sue to enforce a noncompete clause tucked into Ms. Buser’s 2013 summer employment contract.

The article also talks about a lawn-maintenance person, an entry-level social-media marketer,  and a hairdresser, all of whom had to sign restrictive covenants.

As more and more employers require restrictive covenants, there has been increased push-back. Against the backdrop of Massachusetts’ proposed ban on noncompetes, the article goes on to discuss arguments for and against employee restrictive covenants. Some argue that noncompetes stifle innovation:

“Noncompetes are a dampener on innovation and economic development,” said Paul Maeder, co-founder and general partner of Highland Capital Partners, a venture capital firm with offices in both Boston and Silicon Valley. “They result in a lot of stillbirths of entrepreneurship — someone who wants to start a company, but can’t because of a noncompete.”

Employers argue that the opposite is true:

“Noncompetes reduce the potential for poaching,” said Mr. Hazen, whose company makes scratch lottery tickets and special packaging. “We consider them an important way to protect our business. As an entrepreneur who invests a lot of money in equipment, in intellectual property and in people, I’m worried about losing these people we’ve invested in.”

There has always been a dispute about restrictive covenants’ effect on macro-level economic health. From my perspective, I am more concerned about using restrictive covenants to my clients’ benefit, as opposed to resolving this dispute; the policy implications of restrictive-covenant law are irrelevant to companies trying to protect their proprietary information. But the article leaves out a real-world benefit: increased certainty for employers and employees.

When permitted to use restrictive covenants, employers and employees have a better understanding of what will happen when the employer/employee relationship terminates. Employers can more comfortably share proprietary information with their employees, knowing that the restrictive covenants protect the employers’ interests. And employees know the precise limitations on their future employment, which can better inform their employment-related decisions.

Regardless, as I’ve discussed over and over, companies seeking to protect their proprietary information need to consider whether to require restrictive covenants. As long as the applicable jurisdiction permits them, restrictive covenants are often a company’s most powerful weapon to prevent unwanted disclosure.

4 responses

  1. Whenever I encounter these provisions (usually in the context of two negotiating organizations), they are not typically narrowly tailored in scope or duration. They are also often completely inappropriate for the nature of the transaction begin negotiated. However, in that context the parties have equal bargaining power. It is because of this balance of power that the language that tends to remain (to the extent it does) actually make sense for the context of the transaction and is tailored to the satisfaction of both parties. If you drop these same terms into an adhesion contract, with an organization on one side, and a private individual, trying to make a living in a soft labor market on the other side, these provisions are usually unconscionable.

    To your point on certainty, ‘certainty’ is a misleading value, when the referenced certainty is a positive certainty for your client and a negative certainty for every employee.

    If the business case for these clauses is really to protect its trade secrets and to avoid poaching of employees, one can use finer instruments. You can protect trade secrets with a strongly worded NDA. If poaching is really the problem, then these clauses shouldn’t apply in the case that a company terminates an employee. However, most of them apply regardless of the nature of the separation.

    When enough attorneys advise their clients without considering the aggregate consequences of abusive practices, states like California, North Dakota, and now, potentially Massachusetts pass laws against the practice altogether. If the abuse of this tool continues, you may loose it everywhere, and then where will your clients be?

    I am not making the argument that there aren’t circumstances in which these provisions are both useful and justified. I am making the argument that when their use becomes shocking and inequitable, then the legal profession has a problem.

  2. The non-competes I’ve seen most often are provisions that cover individual employees and a medium to large sized business. They are broadly worded and prevent the employee from working, even if that employee is fired. In California, a court might strike those provisions, but they are adhesion provisions that can be used as a brutal club rather than the shield that they were originally intended to be. If they are used appropriately worded narrowly to protect the company against poaching or other issues, then I’m for them. If they are used as weapon to scare employees, I think they are bad for employers and employees.

  3. In California, the courts most definitely will strike a non-compete provision and in some instances may strike the entire employment contract as unconscionable. Using common trade secret protections, like non-disclosure agreements, password protection and distribution on a need to know basis and thorough exit interviews is a better way to protect trade secrets and poaching of employees.

  4. Most noncompetes are nothing more than efforts to prevent competition by employees who have no special knowledge of trade secrets or processes and who are prevented from seeking better opportunities elsewhere. I have seen them for employees such as hair dressers, dance instructors, and even bus drivers. Their employers refuse to provide reasonable advancement and then use the noncompete to keep them from moving on in their career. It is nothing more than a modern form of slavery, although in a way that has been created to look like something else. The only place where they make rational sense is with a very high ranking manager such as a President or VP or a department manager with knowledge of the innermost secrets and plans of a company. Noone else shoud be subjected to such provisions.

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