Competitive Intelligence

Non-Compete Agreements & the War Between the States

There was an interesting story in Forbes last month called “The Case for Servitude” all about non-compete agreements that I thought you’d enjoy a few excerpts from:

Your new employer shoves a piece of paper under your nose to sign. In it you promise not to work for any competitor for some period of time after leaving this job. Is such a contract, known popularly as a noncompete agreement, a fair deal? Is it enforceable?

Many executives are fans of BreakYourNonCompete.com, a popular site encouraging folks to do just that and pushing the line that noncompetes betoken servitude and inhibit healthy market forces. But economic theory says just the opposite. Noncompete agreements make sense. They are a boon to the economy. Most of the time they are even a boon to the executives constrained by them, and the main problem is not that they sometimes keep such characters from taking jobs they'd love to have, but that the agreements are hard to enforce. Mark Cheskin, a Hogan & Hartson partner who specializes in noncompetes, guesses that only half of the agreements being signed would survive a courtroom showdown.

So, why do we have non-competes if they’re essentially unenforceable – and even illegal in California?

The economic argument: Noncompetes give companies incentives to do more for their workers. "The competitive effects of noncompetes are almost totally benign," says David Henderson, an economist at Stanford's Hoover Institution. "The agreements make it possible for employers to invest heavily in talented workers. You just can't make those investments if the talent is free to take the acquired skills and march off to a competitor."

Except for California, which bans all such agreements, every state accepts that companies have "protectable interests" and can defend them via noncompetes. Unfortunately for companies aiming to protect their interests, the states differ wildly about what's required in the agreements. Texas, Georgia and New Jersey are among the states whose courts tend to be suspicious of the agreements and responsive to arguments that they restrain trade.

Connecticut, Florida, Indiana and New York are among the states somewhat more sympathetic to the view that noncompetes are legitimate business tools. The New York State Court of Appeals has broadened the "protectable interest" standard so that it covers what are called "unique individuals," who can be protected even when they have no managerial responsibilities or special customer contacts.

In a national job market, executives who want to break their noncompetes can play off one state against another, and if all else fails, they can skip to California. It really is a nutty system. If the executive is fast on his feet, he will begin his new career--possibly before telling his employer that he's leaving--by going to a California court and asking for a declaratory judgment that the noncompete is invalid. If he dithers even briefly, he's in trouble. Says Jay Warren, who works for Bryan Cave in New York City, specializing in noncompetes: "As soon as the guy walks out the door, I run to a New York court and ask for a temporary restraining order preventing him from going to work in California."

Think of that next time before you hand in your two weeks’ notice.

- Arik