Rising use of non-compete clauses provokes increasing scrutiny

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Jimmy John’s, a sandwich shop, promises “subs so fast you’ll freak.” But it was revelations that the company had made workers sign contracts promising not to swap their aprons for those of hoagie-making rivals that freaked out New York’s attorney general. Indeed, many policymakers now worry that the increasing prevalence of such non-compete clauses—traditionally agreed to by workers privy a company’s proprietary information—is unfairly restricting employees’ ability to earn a living.

Although Jimmy John’s represents an outlier in the aggressive use of non-competes, it also reflects companies’ growing interest in them. In May, the White House released a report estimating that 18 percent of American workers, and 14 percent of those making less than $40,000, are currently subject to non-competes. Proponents of such agreements argue that they protect companies’ intellectual property and encourage investment in their human capital. But critics argue that they depress workers’ wages and stifle market dynamism, concerns the White House’s report emphasized.

In North Carolina, the law looks upon non-complete clauses with disfavor, and courts will decline to enforce agreements that place overly broad restrictions on employees’ ability to find future work or fall afoul of other restrictions.

But the White House report noted that many employees may know little about the nuances of the law and simply assume that such agreements are enforceable. Attorneys refer to the constraining effect of such not-actually-enforceable provisions as the in terrorem effect.

“Some businesses want a contract that, if push comes to shove, they can take it to a judge and get an injunction and shut down a competitor,” said Steve Dunn, an attorney with Van Hoy, Reutlinger, Adams & Dunn in Charlotte. “But some companies may just want an agreement that will make an employee think twice before jumping to a competitor, and will use a boilerplate form, not because they ever intend to enforce the non-compete, but because they want to have that option.”

Court dockets would seem to bear that theory out—the amount of litigation involving non-compete clauses has also grown in the last decade, although at a noticeably slower rate than the use of such clauses in job contracts.

When the crew jumps ship

There are plenty of valid reasons for requiring employees to sign non-compete agreements, one of which is to prevent former employees who have built up a relationship with a company’s customers from stealing those customers away. Traditionally, non-competes were most common for salespeople who worked a particular geographic territory and would preclude the salesperson from working in that same territory for a competitor. Litigation will often hinge on whether the geographic scope of the area where a former employee is forbidden from working is unfairly extensive.

But today’s employees may have portfolios that stretch from Burlington to Bangalore, rendering geographic limitations meaningless. Instead, courts are focusing much more on whether an agreement protects the legitimate business interests of the former employer, such as protecting its customer relationships. Non-competes that put sprawling restrictions on an employee’s future endeavors may be tossed out even if the employee takes a job just down the street.

“If I’m in the motorboat sales business, and my employee goes to work for a sailboat sales company, even if that technically implicates our non-compete agreement, a judge would want to know, is that really hurting your company?” Dunn said. “Because if it’s not, there’s a good chance it’s going to be found to be overly broad and therefore not enforceable. If your agreement is preventing employees from doing things that really don’t hurt you, there is a really good chance that it’s not going to be enforced.”

Jon Wall, an attorney with Higgins Benjamin in Greensboro, said that in order to be enforceable, non-competes need to be narrowly tailored to serve those legitimate interests. That means that agreements need to reflect the signing employee’s specific job responsibilities.

“A lot of employers want to use the same one over and over again for different jobs, and in my mind, that’s a recipe for trouble down the road,” Wall said.

A covey of covenants

Another common reason for upholding non-competes is to protect a company’s trade secrets and other proprietary information. At the same time that statehouses across the country have been passing reforms to limit the reach of non-compete clauses (although a small minority have moved in the other direction), their laws concerning protection of trade secrets have typically been getting muscle enhancements.

As a result, attorneys said, companies are often seeking to protect their various interests in a more compartmentalized fashion. Employers will often draft separate agreements covering confidentiality of trade secrets and non-solicitation of customers, which give companies greater flexibility and aren’t subject to many of the restrictions imposed on non-competes.

Russell Beck, an attorney with Beck Reed Riden in Boston, said that the increase in trade secret litigation rose 250 percent from 2002 to 2013, while the volume of non-compete litigation appears to have plateaued after a smaller increase. That, he says, suggests that companies are not turning to non-competes as the main source of protection for their trade secrets.

Beck said that the White House report recognizes the further work needed in order to best balance the legitimate needs of employers against the potential negative effects of use—and misuse—of non-competes.

“Most companies are not using non-competes for employees who do not pose a risk to the employer should they move to a competitor,” Beck said. “In my experience, companies are generally trying to address ways in which they can protect their legitimate business interests, although sometimes companies are maybe misguided in what they believe they need.”

Golden State worriers

States have taken a widely varied range of approaches to non-competes. California’s general refusal to enforce them is sometimes cited as a key factor in the emergence of Silicon Valley as an innovation hub. But the vast majority of states enforce them, subject to various restrictions.

Attorneys said that North Carolina falls somewhere in the middle, and perhaps to the more skeptical side, of that spectrum. Unlike in some states, North Carolina requires employers to disclose non-compete clauses before employees begin work, or else offer some sort of compensation in exchange for employees’ signatures. This precludes an employer from sweeping in and requiring all of its employees to sign non-compete clauses after someone leaves to form a competing company—a scenario that attorneys said sometimes happens.

North Carolina also employs what’s known as the “blue pencil doctrine,” which limits courts’ abilities to rewrite non-competes to make them enforceable. The state’s Supreme Court ruled in March that an overly broad geographic restriction in a contract could not be narrowed by the courts, as some states would allow. Instead, the court ruled that since the provision was unreasonable, it had to be thrown out entirely. Proponents of such doctrines say they discourage companies from pressing their luck.

But Wall, the Greensboro attorney, suggested that North Carolina should push further, arguing that non-compete clauses are generally unfair to employees and bad for the state’s economy.

“A lot of times they’re used not really to protect a legitimate interest of the employer, but to keep an employee locked into the job he’s in so he can’t leave and can’t effectively negotiate terms because he has nowhere else to go,” Wall said. “With low-wage earners, that’s what it’s used for, really, not how to make a sandwich. There’s nothing secret or proprietary about what these low-wage workers are doing, so the only reason for having a non-compete is to make sure they can’t effectively move throughout the marketplace.”

Follow David Donovan on Twitter @NCLWDonovan