Non-Compete Agreements - Should Small Businesses Keep Using Them?

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Non-Compete Agreements - Should Small Businesses Keep Using Them?

July 18, 2018
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Non-compete agreements are commonplace in the marketplace. These are contracts in which one party (usually an employee) agrees not to engage in certain acts in competition against another party (usually the employer), within a limited geographic area. The logic behind these agreements recognize that during the course of employment, employees form business relationships with their employer’s clients and customers, and employees also learn about their employer’s confidential information and trade secrets.  Employers correctly have an interest in preventing the distribution of their confidential information to competitors as well as an interest in retaining their customers.  To this end, non-compete agreements are beneficial in that they encourage employers to invest in human capital while providing some assurance that an employee will not poach trade secrets or other confidential information with the intention of subsequently working in the same or similar job position for a close competitor.  

Non-compete agreements have historically been linked with highly compensated managerial and executive positions. Recently, they have become more common in lower-wage professions like restaurant servers and retail workers – none of whom are likely to have access to or possess sensitive information. A 2016 United States Treasury Department report cited research indicating that 18 percent of all workers and 15 percent of employees without a college degree are covered by a non-compete agreement. Some policymakers have taken the position that this practice limits workers’ access to job opportunities, particularly if they lack work experience.

California and North Dakota have rejected non-compete agreements.  Oklahoma law places significant restrictions on an employer’s ability to enforce a non-compete. Of the remaining states, a majority place time and geographic restraints on these agreements to ensure that the terms do not create an undue hardship to workers. 

At the Federal level, an Obama-era Executive Order from April 2016 directed government agencies to eliminate regulations that restrict competition without corresponding benefits.  In response, the U.S. Department of Justice and the Federal Trade Commission issued an “Antitrust Guidance for Human Resources Professionals,” which outlined a policy promising to investigate and punish employers (including individual human resources employees) that enter into unlawful agreements concerning the recruitment or retention of employees. Shortly thereafter, the Obama administration issued a “Call to Action” to states to act to reduce the misuse of non-competition agreements.  In January 2018, the Trump administration voiced support of the Antitrust Guidance portion of the policy.  It remains to be seen how the current administration will address the Call to Action.

Non-compete agreements and other restrictive contracts vary, as do the reasons why small business owners should use them. In some situations, the value of a company depends on a process or technology remaining a secret to the general public.   Non-compete agreements are a useful tool in situations in where employees have access to trade secrets, confidential or proprietary information that could harm the business if disclosed to a rival.  The contract can act as a deterrent to keep employees from taking and using the employer’s confidential information to start a competing business.

Employers beware

Not every piece of information withheld from the public by the employer can be kept secret. Information shared with all employees will likely not be confidential or amount to trade secrets.  Additionally, information that was already known to the employee prior to his or her employment will likely not constitute confidential or proprietary information. Trade secrets, confidential, and proprietary information include, among other things, financial information, research and development, business plans, processes, technical documents, vendor information, employee pay rates, marketing strategies and the like that the owner has taken reasonable measures to keep secret and are not generally known or readily available to the public. Additionally, non-compete agreements may be beneficial in situations where employees establish significant customer relationships during their employment and can steer those clients to a competing company after they leave. Generally, employers should identify a legitimate business reason for a non-compete and the agreement must be reasonable to be enforceable. An overly-broad, excessively burdensome agreement will be unenforceable.

Other options

 A non-compete agreement is just one option employers can pursue to protect their interests.  A non-disclosure agreement is another choice in which the employer agrees to disclose to the employee confidential information about its business, technology or products. In exchange, the employee promises not to share this information with anyone else for a specific period of time. Non-disclosure agreements specify the information that must remain private and information that can be shared or released to the public. In some situations, the value of the business depends on employees who can generate business from new or existing company clients. In these situations, employees gain access not only to the client’s or customer’s contact information, but they also gain access to the customer’s business needs, strengths and weaknesses as well as those clients who can influence business decisions. A non-solicitation agreement, a contract whereby the employee promises not to solicit the employer’s clients for a specified period of time, is a less restrictive way of preventing an employee from luring clients from a company after they leave.  The up side of non-disclosure and non-solicitation agreements are that they protect company interests without restricting the worker’s market flexibility. 

There are many considerations an employer should take into account before making a final decision on whether to require an employee to sign a non-compete.  For example, how the applicable state laws will affect enforceability, the impact on employee morale, and the ramifications in the event an employee refuses to sign the agreement. For further guidance on non-compete agreements, employers are encouraged to consult with an employment attorney.

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