The problem with non-compete clauses

Businessman, seen through a window decorated with dots, crosses a street in Tokyo

Non-compete clauses (NCCs), which prohibit employees from leaving for other jobs with competitors, have been a fixture of American work life for many years. Those in senior management positions usually have their NCCs negotiated by an attorney before joining an organization, and may get paid substantially for doing so.

But non-compete clauses are not just used for high-skill, high-paying jobs. Not so well known is that they are increasingly common in lower-level positions—in many states, people in all types of jobs and at all levels of compensation can be “asked” to sign an agreement—even after they agree to take a job. Their reward is often little more than they get to keep their jobs, although they may receive some compensation if they are fired without cause.

NCCs are hundreds of years old and occur all over the world. For example, an English common law court in 1414 chose not to enforce such an agreement, claiming that it represented restraint of trade. A watershed 1711 case, Mitchel v. Reynolds, validated non-competes at least with regard to compensation for compliance after being terminated. Globally, India allows the use of such clauses only when it is judged to be in support of trade and commerce. European countries generally allow them for certain time periods (two or three years) and limited geography. The United Kingdom allows them only if there is a legitimate business interest other than merely competition. In the US, all but a handful of states allow them, but with a variety of laws and legal interpretations.

Making the arguments

The argument for NCCs goes something like this: When people move from one organization to another, they take with them what they have learned as well as their skills. If they are senior enough, they may also take trade secrets (although those are covered by NDAs, non-disclosure agreements, close relatives to NCCs). In certain industries in which startups are relatively easy, such as hair salons, NCCs are said to make sense, especially if there is a tendency to start competitive businesses in the same market. (That helps explain why 30% of US hair stylists are required to sign NCCs even though their compensation levels are relatively low.) Perhaps most important, the existence of an NCC is said to encourage organizations to make investments in employees in the form of training and education.

What may surprise you is how far down into the organization NCCs can legally extend. Some states only disallow them for workers making less than $13 per hour. One of the first states to exempt workers from non-competes, Oregon, freed only those making less than the median income for a family of four.

 In many states, people in all types of jobs and at all levels of compensation can be ‘asked’ to sign an agreement. 

The case against NCCs, particularly for lower-level positions, is that they can unnecessarily restrict an employee’s upward mobility and reduce wage and benefits competition among employers. According to statistics cited by the US Senate Committee on Small Business and Entrepreneurship, 12% of workers earning less than $20,000, and 15% of workers earning between $20,000 and $40,000, are subject to non-compete agreements.

Because laws regarding NCCs represent a patchwork among states, a question continually arises about their enforceability across state lines. One solution advanced by unions and public advocacy groups is to ban such clauses at the national level. US Senator Marco Rubio supports the notion. But his proposal would cover only those making less than $23,360 per year (those eligible for overtime pay under federal law). In reality, how many employers are going to try to enforce non-compete agreements against workers at those pay levels?

It stands to reason that NCCs restrict movement of employees from one job to another. Those who can move tend to make more money than those who stay with one organization. In a study of Oregon’s plan, the rate of job mobility and pay for employees exempted from NCCs went up rapidly.

California stands alone as a state that has prohibited NCCs for many years. Many argue that it hasn’t hurt business in the state. After all, Silicon Valley, with all of its training and talent, has been able to thrive without NCCs, although California does enforce non-disclosure agreements related to trade secrets.

According to this argument, if it can work in California, why not extend the practice nationally? Should non-compete clauses be prohibited throughout the US? What do you think?

This article originally appeared in Harvard Business School’s Working Knowledge.

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