Non-compete agreements: Retention tool or liability landmine?
Non-compete contracts, or restrictive covenants, have garnered a lot of media attention of late. Once considered applicable only to high-level employees, non-competes have trickled down the corporate ladder to the rank and file as companies try to protect their investment in staff.
The practice of using non-competes has become so widespread that in March 2016 the Obama administration issued a report citing overuse and abuse. The findings from the U.S. Treasury Department show how common the contracts have become:
- 18% of American workers (30 million) are covered by one;
- 15% of workers without a college degree are covered by one;
- 14% of workers who earn less than $40,000 a year are covered by one;
- 19% of California workers, where such agreements are unenforceable, are covered by one; and
- 37% of workers report having worked under one at some point during their career.
For some employees, signing the agreement is not a transparent process. Many don’t understand the terms or their implications. Some employees are only told about the required agreement after they’ve accepted an offer. And 37% of workers are required to sign the agreement on their first day or lose the job.
In October of 2016, the Obama administration issued a Call to Action, urging states to enact laws that limit the use of non-competes. Many responded with new laws, and others have proposals in the works.
Non-competes can have legitimate business purposes, but they must meet certain criteria to be enforceable. Companies often have to show that violation of the agreement would cause them substantial harm, for example. Additionally, there usually need to be some balance of fairness to both the employer and employee.
Courts ask what damages could arise out of the breach. Is there a calculable cost or would the harm be ongoing and irreparable? When looking at the balance of equity, they determine trade secrets, for example, and their value against the employee’s need to work.
Passing these tests, the agreements are often deemed valid. “The courts are very well equipped to deal with these cases, because the standards are built in," according to Clifford Atlas, co-leader of the non-competes and protection against unfair competition practice group at Jackson Lewis P.C.. "The system works to balance the business interests of the employer against the rights of the employee," he told HR Dive.
In 2016, Jimmy John’s sandwich shops were required to pay a $100,000 settlement over improper use of non-competes. The company required all its sandwich makers and delivery drivers to sign an agreement not to work in any store that earned most of its revenue selling sandwiches within a 3 mile radius of any Jimmy John’s in the U.S. for two years post-employment. The Illinois Attorney General filed the lawsuit, claiming the agreement was overly broad. The company has since eliminated the agreements for all employees.
This year, an Illinois Appellate Court decision found requesting a "connection" on LinkedIn did not violate a non-compete agreement. An employee sent a generic connection request to several former colleagues. The company argued this could lead to their seeing job postings on his profile page. The Court agreed the generic networking connection request did not violate the agreement. But in Michigan, a former employee’s posts encouraged others to leave — and that contract was upheld by the Courts.
Pending and existing law
Following the Jimmy John’s suit, The Illinois Freedom to Work Act took effect in January 2017. The law prohibits non-compete agreements for employees who earn less than $13.00 per hour.
In California, non-compete agreements unenforceable. “Not only are they unenforceable against California employees, they could give rise to a cause of action against the employer for trying to use them,” Steve Holden, principal at Holden Law Group, noted.
Other areas are considering similar moves. In New Jersey, a bill has been introduced that would impose a 10-factor test to determine whether or not an agreement is valid. And in New York City, legislation is pending that would prohibit the use of non-competes for any worker eligible for overtime pay under the federal Fair Labor Standards Act. Atlas says this could be problematic for employers, particularly “if an executive assistant of the CFO or someone who works in R&D has access to confidential or proprietary information.”
Tend your garden
A new trend in the U.S. that’s been widely used in the United Kingdom is "Garden Leave" pay. Employees are asked to sign an agreement to stay out of the workforce for a specified amount of time after they leave the employer. In exchange for not competing, they are provided Garden Leave pay – essentially time to stay home and tend to their garden.
Another option is to ask employees to provide an extended notice of resignation: again, they do not work, continue to be paid, but don’t take their services elsewhere.
“It’s an effective tool," Atlas said. "If the business is serious that moving to another company could cause irreparable harm, such agreements will keep the employee from claiming he or she cannot put food on the table.”
So are they a retention tool?
Non-competes generally shouldn't be viewed as a retention tool, experts say. Many employees bound by non-competes don't have the knowledge base or financial resources to challenge the contract, even if the law is on their side. Unfortunately, employers may be using that to their advantage.
Autumn Gentry, attorney with Dickinson Wright, believes non-competes should be used as a retention tool only when employers are protecting their interests and where state law allows. If there are trade secrets involved, or an investment in highly specialized training, they may be enforceable. But the length of the agreement has to be reasonable, too.
“For a CEO, a five-year non-compete might be legitimate. For a sales representative, one year might be more appropriate," Gentry said. "There has to be a balance between the business interest and the employee’s right to work. An agreement cannot be so broad it would prevent someone from working elsewhere for the remainder of their career."
Dealing with a past non-compete
With such widespread use, it’s worth asking a potential new hire if there are any restrictions on their working for you, including non-compete or non-solicitation agreements. For some positions, Gentry suggests going further, requiring verification in writing and asking that they sign an indemnification agreement.
"This verifies they have represented they are not under any such agreement and accept responsibility for any action taken by the former employer," Gentry said. "While it’s unlikely the former employer would sue the individual, the indemnification agreement could assure the new employee is being truthful about not being under a previous contract."
If you find an employee is bound by a non-compete, review the agreement to see if it’s valid. If it is, you may be able to employ the person in another capacity until the agreement is complete. Consult an attorney to review the contract and the laws in your state. “In some cases,” Atlas adds, “you may be able to ask the employee to request a waiver from their former company. Or it might be worthwhile to negotiate with the former employer and offer them a consideration for non-enforcement.”
Employers should take great care to use non-competes only where they serve a legitimate business purpose. When they are used, they have to strike a reasonable balance between the needs of the company and the ability of the employee to find appropriate work.
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