6 Questions About the Impact of Noncompete Agreements on Businesses and Employees

Against the backdrop of a still-looming pandemic and a serious worker shortage, business leaders consistently cite recruiting and retaining properly skilled talent among their biggest priorities. That need, however, dovetails with a movement among state and federal regulators to enact laws that ban or curtail the use of noncompete agreements, putting these widely used but little understood contracts not only at the forefront of hiring and workforce planning discussions among business leaders but also in national headlines.

At the most basic level, noncompete agreements are contracts where employees agree to not compete with a former employer for a specified period after leaving the company. Critics of noncompete agreements insist that the restrictive covenant harms competition, stifles employee mobility, and is a superfluous tool in protecting confidential information.

Proponents argue that proper uses of noncompete agreements are necessary, protect consumers, foster competitive interests, and protect businesses’ secret sauce where trade secret laws and nondisclosure agreements can’t.

The reality, however, is somewhere in between. If used inappropriately, noncompete agreements can certainly harm the career prospects of employees, for instance. But employees subject to a noncompete agreement can also negotiate a higher salary, more benefits, or other incentives as a condition of signing as well. Below is a breakdown of the current state of play around noncompete agreements and how they can benefit employers and employees alike when used transparently and appropriately.

Which employees are subject to noncompete agreements?

In states without restrictions on noncompetes, any private employer and employee can enter into a noncompete agreement. That said, if the purpose of a noncompete agreement is to protect proprietary information, then noncompete agreements would be best entered into with employees who have access to this information. According to Brookings, employees that are knowledgeable of trade secrets are 25 percent more likely to be in a noncompete contract.

What is being done about the use of noncompete agreements for employees that don’t have access to trade secrets or other intellectual property information?

Unfortunately, some companies require low-wage workers and other employees not privy to proprietary information to sign noncompete agreements. But states are already addressing this issue. As of June 2021, more than half of U.S. states have placed limits on noncompete agreements, 10 of which have specifically prohibited low-wage/hourly employees from entering into such contracts. Another 16 states only allow agreements that are not so broad in nature as to excessively restrict employee career prospects. The District of Columbia is close to joining Oklahoma and California in broadly banning noncompete agreements for all employees with very few exceptions. Before implementing noncompete agreements, be sure to check the applicable laws in the states where your business operates.

Moreover, as part of the Executive Order aimed at promoting competition in the U.S. economy, President Biden recently encouraged the Federal Trade Commission (FTC) to consider banning or limiting noncompete agreements.

Do reasonable noncompete agreements stifle competition?

No. In fact, the U.S. Chamber recently submitted comments to the FTC arguing that reasonable noncompete agreements protect an employer’s unique and competitive information—employee training, trade secrets, client lists—from being used against the employer to unfairly advance the interests of a competitor or new business.

To be sure, noncompete agreements are not only entered into with employees but also with owners of businesses being sold. This is a critical safeguard for a company acquiring another. There have been cases in which a business owner sells their company, only to open a secondary business, often in the same location, with the same product, knowledge, client lists, and newly obtained capital. Without a noncompete agreement, the buyer of the original company must unfairly compete with the original owner of the company.

It is important to note that noncompete agreements are limited by time and geographical place. Thus, those bound by noncompete agreements are not indefinitely prohibited from working for or operating as a competitor in the restricted field.

What are some ways noncompete agreements can benefit employees?

Noncompete agreements can be presented to both new employees during the hiring process and to existing employees. New hires to whom noncompete agreements are proposed have the potential to negotiate the terms of the contract and higher wages. Existing employees have an even stronger hand. In this case, the existing employee must receive something of value for the noncompete agreement to be enforceable. A change in job title, compensation, or benefits are valuables that could be negotiated by the existing employee.

Additionally, businesses may be more inclined to invest in employee training and education, resulting in greater innovation, if they have the confidence that the investment will be secure. Because of the noncompete agreement, the business can expect the training and education to benefit the business for as long as the worker is employed without the threat of a competitor immediately capitalizing off the investment. In turn, the employee who received the education and training will benefit from the investments long after their noncompete expires.

Why would banning noncompete agreements hurt rather than help employers’ recruiting and retention efforts?

Considering the worker shortage and need for properly skilled talent, noncompete agreements are a way for employers to signal the value of an employee to the organization and the key role that employee plays in the business’s performance. In practice, noncompete agreements can prevent competitors from poaching top talent and senior executives. The business can incentivize these highly compensated employees to stay by offering bonuses, stock options, and long-term rewards.

What is the difference between noncompete agreements and trade secret laws and nondisclosure agreements?

Non-disclosure agreements (NDAs) can include trade secret provisions, and when enforced, can impose severe penalties. As a result, trade secret litigation is expensive, time-consuming, and often happens only after information has been shared.

A key difference between nondisclosure agreements and noncompete agreements is their applicability. In theory, an employee under an NDA could leave the current employer and utilize the information learned on the job to compete with the business without ever disclosing proprietary information. Finally, NDAs and trade secret protections are not limited in time, unlike noncompete agreements. So, noncompetes may be preferable to the employee in many situations.

About the authors

Stephanie Ferguson

Stephanie Ferguson is the Director of Global Employment Policy & Special Initiatives. Her work on the labor shortage has been cited in the Wall Street Journal, Washington Post, and Associated Press.

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