The 21st century success of Michigan’s new economy will depend on throwing off the shackles of 20th century thinking on employment non-compete agreements. In the highly skilled professions, alarmingly high numbers Michigan’s technical and professional workers are subject to forced “non-compete” agreements as a condition of employment (as high as 50 percent on some sectors). This predominately includes highly skilled workers in the new economy that Michigan wants – and needs – to build. Recent legal and business studies add to an increasing body of evidence showing how states that allow and enforce “non-competes” are at a competitive disadvantage in development of high-tech and highly skilled job sectors.
Given the name “non-compete” agreement, it should not be surprising that they hurt competition. These clauses that show up in employment contracts and handbooks (often sprung on a recruit on the first day of employment). But what they do goes far beyond the restrictions on your individual skills. Non-competes are hurting Michigan’s ability to compete in a new economy. Recent evidence clearly shows that states that allow and enforce non-compete agreement (even where limited to “reasonable” scope) show less mobility of talent, attract less venture capital, and have fewer startup ventures. Unfortunately, Michigan gets to be a case study.
What is a non-compete contract? It used to be called a “restrictive covenant” or a “covenant not to compete.” Michigan legislative changes opened the door to allowing enforcement of non-competes almost by accident in 1985. Until then this type of restriction was almost uniformly prohibited, as it had been in the common law of American Courts adopted from England going back to at least the 15th century. Most courts in the country started out with a predisposition to declare them void. Industrial era legislative enactments gradually changed the field over the 20th century. When the Michigan legislature adopted new uniform anti-trust law in 1985, provisions allowing non-competes slipped in without comment and some say unintentionally.
A true non-compete agreement prohibits an employee from working for a competitor or starting up a competing business for a period of time (usually one or two years) after leaving a firm. Often the prohibition will apply regardless of whether an employee is fired or voluntarily leaves. The exact terms will depend on what the language of a contract says and maybe on the scope of what a court decides to enforce.
Traditional non-compete agreements are different and distinguishable from “trade secret” protections. Trade secrets are prohibited by Michigan’s Uniform Trade Secret Protection Act even in the absence of a contractual arrangement. Sometimes employers require “trade secret” or “non-disclosure” agreements broader than what the law already protects. But these types of restrictions are different: they are narrowly targeted at protecting property rights.
Non-competes are also different from “non-solicit” agreements, which prohibit an employee from soliciting other employees from leaving a company, or sometimes prohibit an employee from contracting client leads for a period of time – depending on the language of the contract. “Good-will” agreements that permit business owners to buy or sell a business without the fear of the seller opening across the street are also easily distinguished or protected by more precise law. But it is the fear that these other types of violations may ensue is almost uniformly used to justify the legality and reasonableness of “non-compete” agreements that are uniformly deployed with a purpose to prevent mobility of talented people to competitors willing to pay more for the value of those skills.
Since Michigan’s 1985 legislative changes, non-competes have been enforced by the Michigan courts so long as they are “reasonable” in time and duration. Specifically, Michigan’s law on non-competes says:
An employer may obtain from an employee an agreement or covenant which protects an employer’s reasonable competitive business interests and expressly prohibits an employee from engaging in employment or a line of business after termination of employment if the agreement or covenant is reasonable as to its duration, geographical area, and the type of employment or line of business. To the extent any such agreement or covenant is found to be unreasonable in any respect, a court may limit the agreement to render it reasonable in light of the circumstances in which it was made and specifically enforce the agreement as limited. (MCL 445.774a (1))
The law itself is really just a general outline setting out broad contours and a “rule of reason.” Basically, the extent of the enforceability of a non-compete contract will be determined after the fact, based on the specific interests and facts involved, and based on a court’s decision about what is reasonable under the circumstances.
Typically, a one-year non-compete duration is considered reasonable, but sometimes up to three years. Sometimes a limited local geographic scope is found to be reasonable. Sometimes the entire country is considered a “reasonable” prohibition by the courts. The enforceability of a non-compete will mostly depend on the business sector, the job, and sometimes on the court or judge assigned to a case.
The law specifically allows a judge to determine –after the fact- what is or is not reasonable and to adjust the contract interpretation accordingly. If the judge decides it is not reasonable then he or she can then re-write the agreement to rule on a reasonable scope, known as the “blue line” rule. This approach is highly unusual in the law – which typically seeks to discern the original understanding of the parties to a contract – and thereafter decides whether that agreement is enforceable or void as a matter of public policy.
What rational professional is going to consider a new job offer or consider starting up the next great Michigan business if they have to pay a lawyer just to see whether an unknown judge will determine to what extent a non-compete restriction will be upheld as reasonable? This is one big reason why the struggling Michigan economy is littered with stories of good talent going elsewhere to greener pastures – employees, entrepreneurs and investors alike.
The game doesn’t just play out in the courts. In practice, it mostly does not. You can’t look at decisions of the courts and find answer to this problem – there is no clear guidance – there is no “reading the tea leaves.” If an attorney tells you they know how a non-compete is going to be interpreted by the court, they don’t know what they are talking about. This game plays out with individual people making decisions about their value in the market. It plays out with Michigan’s talent making decisions to move or to stay. It plays out with capital investors and startups looking for a fertile talent pool in Michigan …or elsewhere.
As an employment lawyer advising Michigan’s high-tech professionals, executives, and sales people on an almost daily basis, I have personally seen the disastrous effects for Michigan’s effort to build a new economy. I consult with technical professionals and sales people who look elsewhere because the talent pool is bigger in other states. I advise business startups who can’t hire the good talent (or are afraid of the legal costs involved) if they decide to grow in Michigan. I consult with executives and key players who are considering taking a career detour or just idling themselves in order to avoid the legal morass that could come along with taking a productive job where they add value and create wealth.
Practically speaking, the threat of a non-compete lawsuit is too often enough to scare an individual to take the sidelines and sit idle for a year or two until a non-compete runs out – referred to in the literature as “career detours.” Or the costs of litigation will also scare a new employer to fire their newly hired talent. Talented people are fleeing the state. New startups look for greener pastures where they have access to a pool of talented people without fear of a legal and financial quicksand caused by contract disputes. Legal wrangling over these prior restrictions drives up the cost and slows the pace of hiring and recruiting.
Change the restrictive landscape
It doesn’t have to be like this. In California, non-competes have been all but prohibited as a violation of public policy for more than a century. In Washington state, non-competes have been outlawed to maintain a competitive advantage for their already developed tech-sector. In Oregon, the law requires non-compete agreements be provided in advance of starting employment. In contrast, Texas has been one of the states that historically frowns on non-compete agreements, but the courts have now changed direction to allow non-competes, in what is sure to be fertile grounds for study for sociologists, business and law professors who are studying the effects of non-competes on new economy development. But Michigan should not sit idle and present itself as a study in what to do wrong.
What can be done to curb Michigan’s “non-compete” culture? So long as Michigan’s non-compete law is on the books it will be a drag on our ability to develop a new economy. It will be a block on our ability to attract and retain bright talent. It will be a deterrent for new investment and a roadblock for new startups.
There are a few things that can be done to combat Michigan’s “non-compete” culture and help the new economy at the same time. For Michigan’s new talent, you can maintain control of your skills and labor by refusing to take part in a “non-compete” culture. You can refuse to work for a company that uses non-competes (and there are a growing number that pledge to avoid them). At a minimum, you can ask to see all the employment terms (handbooks, benefits packages, confidentiality and non-compete agreements) in advance of accepting an offer – and you can negotiate on them (get value for the career limitations you accept).
For established firms and for those startups with the next big idea you can change your legal/employment culture or you can found your new business on a fundamentally American ideal of rewarding innovation and loyalty with the carrots of promotion or ownership interest rather than attempting to control limit the free market of Michigan talent with the shackle of a non-compete. Try it. You might like the new talent it inspires. It will reward your business with a long-term investment in building a robust talent pool in Michigan. And Michigan’s emerging new economy will definitely thank you.
For further reading:
Alan Hyde, Rutgers University School of Law, “Should Non-Competes Be Enforced?” (2010-2011).
Matt Marx, MIT Sloan School of Management, “The Firm Strikes Back: Non-Compete Agreements and the Mobility of Technical Professionals” (2011).
R. Scott Oswald, “The Evolving Status of Non-Compete Agreements” (2012).