The U.S. Department of Treasury recently released a study on the effect of non-compete agreements, taking a hard line with respect to their social and economic benefits and purported harms. Specifically, while the authors of the study acknowledge that in some cases non-compete agreements can promote innovation, they ultimately conclude that the potential harm of misuse by employers outweighs those benefits.
According to the study’s authors, recent research suggests that about 18 percent of American employees, amounting to nearly 30 million people, are currently covered by non-compete agreements; and nearly 37 percent of workers report having worked under one at some point during their career. Workers bound by non-compete agreements are not just limited to the highly educated or compensated. In fact, 15 percent of workers without a four-year college degree and 14 percent of workers earning less than $40,000 per year are bound by them.
Purported Costs vs. Benefits of Non-Compete Agreements
Although the authors of the Treasury Department study acknowledge that non-compete agreements can have social benefits in some situations, such as (1) protecting trade secrets, thereby promoting innovation; (2) reducing the probability of employees resigning, thereby increasing employers’ incentives to provide costly training; and (3) allowing employers with historically high turnover to use non-competes to match with workers who have a low desire to switch jobs in the future, they place greater emphasis on what they believe to be serious downsides to non-compete agreements as well. Specifically, according to the authors, non-compete agreements can (1) result in lower wages after the agreement is signed; (2) discourage workers from re-entering their field in its entirety once they are terminated, thereby foregoing accumulated training and experience in certain fields; and (3) reduce job churn, which helps raise labor productivity by achieving a better matching of workers and employers.
The authors go on to express concern that a growing body of evidence suggests that employers are taking advantage of their employees’ incomplete understanding of such agreements, resulting in a purported lack of transparency and fairness. For example, employers often require workers to sign non-compete agreements in states that refuse to enforce them, such as California. Other employers fail to inform candidates about the existence of such agreements in their job offers. Further, according to the authors of the study, only 10 percent of workers with non-compete agreements report bargaining over the terms of their non-compete agreements, with 38 percent of those not even realizing that they could have negotiated the agreement.
The authors of the Treasury Department study also suggest that while protection of trade secrets undoubtedly seems to be a legitimate justification for these agreements, about 18 percent of workers bound by non-compete agreements are in fields like personal services and installation and repair, in which such purportedly should not be a concern. The authors of the study question the legitimate business purpose of imposing non-competes on employees such as fast food restaurant workers, as it is not likely that they will possess any trade secrets or proprietary training. Along those lines, we recently reported on a case in which a trial court struck down a beauty salon’s non-compete agreement because it lacked a legitimate business purpose.
These characteristics, the authors of the study suggest, may have a negative impact on the national economy by reducing job mobility, and lowering wage growth and initial wages. According to the authors, research has shown the stricter the non-compete enforcement to be in a particular state, the lower the wage growth and initial wages. Given that job switching is generally associated with substantial wage increases, the resulting increased difficulty of switching jobs would purportedly reduce wage growth over time.
The Study’s Recommendations
Based on the foregoing, the authors of the Treasury Department study recommend that (1) policy makers should inject more transparency into the world of non-compete agreements; and (2) employers should only use enforceable non-competes, align them with legitimate social purposes like the protection of trade secrets, and require consideration for workers to be bound by such agreements, such as severance packages. This would purportedly better protect the employer’s business interests, limit the harm to workers, but most important it would preserve the more socially valuable agreements and chip away the least valuable, as employers would be hesitant to incur costs on them. Of course, other than the additional consideration piece (in many states continued employment is sufficient), these are all things that we recommend to our clients, and on which most non-compete agreements are generally based in any event (at least those that are enforceable in most states).
The study only addresses the effects of non-compete agreements, not other types of restrictive covenants, such as customer and employee non-solicitation or confidentiality agreements. It is unclear what, if any, effect this Treasury Department study will have on policy makers, but we will certainly report on anything that comes of it.