Companies on Notice as White House Releases Report on Non-Competes
On May 6, the White House released a report entitled: “Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses” (the “White House Report”). This report comes on the heels of the United States Department of Treasury’s Office of Economic Policy releasing a similar report about non-competes in March 2016 (the “Treasury Report”). While the U.S. economy has recovered since the last recession, the Obama Administration has identified a decline in competition for workers as a structural problem worth tackling in its final months. The Administration believes that non-competes restrict workers’ ability to move between jobs. Both reports rely heavily on a study performed by three economics professors and draw on popular news stories to show the potential downsides of non-competes. While the reports take a largely dim view of non-competes, they do provide some ideas employers should consider when drafting and implementing non-compete agreements and also highlight some of the benefits of non-competes.
Both reports consider protection of trade secrets a “beneficial” use of non-competes, but believe there are very few alternative justifications for non-competes. This view establishes non-competes as a “problem” in the economy because “[o]nly 24 percent of workers report that they possess trade Secrets.” (White House Report at 4). The characterization of non-competes, however, may be one instance where a lack of understanding of real world conditions informs the Administration’s view on the subject. The White House Report does not consider client lists or relationships in its discussion of noncompetes and instead relies only on trade secrets as a legitimate business interest worth protecting; the Treasury Report acknowledges them, but does not afford them any weight. “For instance, a trade secret involving intellectual property may be the product of expensive investments. If the investment had not been made, none of the benefits of the property would have been realized. By contrast, the client, and their need for a good or service, presumably exist independently of any investment made by the employer.” (Treasury Report at 7n.5).
The problem with this view is that it fails to acknowledge that businesses invest time and money into client relationships. Those investments deserve a degree of protection, especially from a potentially disloyal employee who might attempt to leave a company and take valuable client relationships with him. Thus, most non-competes, often in the form of non-solicitation provisions, recognize that for some period of time after the employment ceases the former employee cannot solicit or service clients of a company. Courts in many states routinely enforce these types of agreements, while carving out any pre-existing client relationships as falling outside the scope of the employee’s non-compete. There are incentives for employers to hire individuals if the companies know that workers who they hire and enable to establish client relationships will not be able to steal such clients when they leave. Thus, non-competes help align incentives between the employer and employee. Both reports recognize this fact as they acknowledge the strong correlation that non-competes have with increased worker training. Where an employer is less worried about employees leaving, the employer is incentivized to provide on the job training for employees.
The White House Report identifies other problems with the way non-competes are implemented and employers should consider these factors in their hiring process: 1) workers often do not understand they have signed a non-compete, 2) workers are asked to sign a non-compete only after accepting the job offer, and 3) many firms ask workers to sign unenforceable non-competes. (White House Report 7). All of these issues are problematic from a legal perspective. Basic issues of contract law, consideration, modification or a meeting of the minds, could be grounds for an employee to use the legal system to disregard non-compete obligations. Thus, employers should be cognizant of when and how the issue of non-competes is presented to new employees, and must also consider the jurisdiction in which the company operates when crafting the provision. Courts in many jurisdictions will not enforce overbroad restrictive covenants.
The White House Report pointed to a turning tide against non-competes, especially for low-wage workers. Many states have recently passed some sort of prohibition or limits on them, including Hawaii, New Mexico, Oregon and Utah. (White House Report at 7). Recent news stories have also highlighted when use of a non-compete by an employer seems burdensome and unfair to workers. As the Obama Administration moves into its final months, the Report mentions that it plans to “convene a group of experts in labor law, economics, government and business to facilitate discussion on non-compete agreements and their consequences.” (White House Report at 3). In light of this push, companies should evaluate whether their use of non-competes complies with best practices, focusing on the necessity of the clauses in protecting a legitimate business interest.