The Risk and Reward of Using Noncompete Agreements

Noncompete agreements help protect employers from employees looking to join competitors. However, using these contracts bears both risk and reward to all parties involved.
noncompete clause contract

Noncompete clauses are designed to protect employers from employees leaving to compete with their business, bringing trade secrets with them, recruiting away talent and more. But are such arrangements necessary? Moreover, do noncompetes have an adverse effect on the free flow of talent?

“Current employers like it, but competitors don’t,” said Norm Bishara, associate professor of business law and ethics at the University of Michigan’s Stephen M. Ross School of Business. Advocates for businesses likely think noncompetes are great, while advocates for workers probably disagree, Bishara said. Still, the debate isn’t that simple.

“Reduced job churn caused by noncompetes is itself a concern for the U.S. economy,” according to a U.S. Treasury study, which cited Bishara, as well as University of Maryland business school professor Evan Starr and Michigan law school professor J.J. Prescott’s study, “Noncompetes in the U.S. Labor Force.” Job churn raises labor productivity rates, the researchers write, and noncompetes likely contribute to a lower churn. Their research also found in 2014 that 18 percent of workers they studied worked under an agreement, including 14 percent of workers making less than $40,000 per year.

Impact on Employers

Naturally, companies need to protect their assets, and covenants not to compete, non-solicitation agreements and nondisclosure agreements are among the legal tools they use in this regard. “For any business to not have these sorts of policies in place, it’s like leaving the door open and saying, ‘take my business,’ ” said David Ritter, partner and head of the labor and employment practice at the Chicago office of law firm Barnes & Thornburg LLP. Creating effective agreements doesn’t come easily, however. Because rules on noncompetes vary by state, enforcement becomes tricky for national companies.

As a result, Ritter said firms should take a closer look at which of the agreements they use. “Know what your restrictive covenants say,” Ritter said. “Know what they mean. Don’t use the same one in every situation, because it may not work.”

It’s also important for employers to not overreach in the language they use in their noncompete clauses, which must be reasonable in time and scope. In other words, employees need to be able to work somewhere in a reasonable amount of time, so contracts can’t limit them too much. However, Ritter said that the clauses should always include limitations on workers taking confidential information and trade secrets. Finally, Ritter said that for any contract to be enforceable, there must be considerations, or something of value, that employees receive. In the end, employers should find lawyers who understand the subject matter and necessary litigation proceedings.

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There’s another risk to using noncompete agreements. The fear of litigation and the limitations that noncompetes put on workers might actually drive talent away from working for certain companies, Bishara said. There can be a bad taste in the mouths of employees at the start of their employment should they be asked to give up a right in the future. And it can go even further than that. “If the employees have enough bargaining power to go someplace else, they may say, ‘I’m not interested in signing this noncompete that’s going to restrict me later on,’ ” Bishara said.

Impact on Employees

The limitations placed on employees mean they are likely the ones to lose the most in noncompete agreements. If too restrictive, workers could face troubles with finding future employment quickly. And even if these clauses aren’t enforceable in their state, some employers still require them, Bishara said. “They are using the existence of these contracts — even if not legally enforceable — to influence employee choices,” he said. Enforceable or not, employees might be too afraid of legal repercussions to leave their current employers, locking them into a job that they dislike and limiting their opportunities. When seeking greater compensation, noncompete clauses can also limit employees’ bargaining power. Employers simply hold all the cards.

However, it’s not all doom and gloom. Noncompetes can in some instances benefit the workers. “In theory, what they do is these contracts give the employer some security to increase the investment in the employee,” Bishara said. This might lead them to keep employees longer and offer them more lucrative compensation arrangements.

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Rather than focusing on noncompete clauses, the pressure should be on the employers to make a desired company culture for their workers by reducing turnover and creating positive employer-employee relationships. With products becoming increasingly service-based, the workers who create and sell them become more valuable. “So much is tied up in human capital,” Bishara said.

Jeff Immelt, CEO of General Electric Co., said in a press conference recently that employers that worry too much about noncompetes are likely to end up with talent issues. “When a good person leaves GE, I don’t blame them, I blame their manager,” Immelt said. “So I think it’s up to us to create the kind of workplace that people want to be at.”

Lauren Dixon is an associate editor for Talent Economy.

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