The effect of non-compete agreements on entrepreneurship: time to reconsider?

Author:Florence Shu Acquaye
Position:Professor of Law at the Shepard Broad College of Law of Nova Southeastern University
Pages:92-116
 
LABORAL
THE EFFECT OF NON-COMPETE AGREEMENTS ON
ENTREPRENEURSHIP: TIME TO RECONSIDER?
FLORENCE SHU-ACQUAYE
*
Introduction ......................................................................................................................................................... 92
I. Historical Background To NCA And The Policy Implications For Allowing Or Restricting
Non-Compete Agreements ....................................................................................................................... 95
A. General Current Trend of Non-Competes in the United States ............................................... 96
B. The Policy of the Federal Government on Non-Compete Agreements ................................... 97
II. The Pros and Cons of Non-Compete Agreements .............................................................................. 99
III. Some Jurisdictional Examples of Handling Non-Compete Agreements ...................................... 103
A. The Ohio Model and Approach ........................................................................................................ 103
B. The California Model and Approach ............................................................................................. 105
C. Modern Approaches to Enforcement of Non-Competes in an Evolving Market ................. 107
D. Law and Economy Approach to Non-Compete Agreements ..................................................... 111
E. Trade secrets and Non-Compete agreements ............................................................................... 113
Conclusion ........................................................................................................................................................... 115
INTRODUCTION
Covenants to not compete or non-compete agreements (“NCA”) are formal
contractual agreements between employers and employees relating to restrictions
on employees’ post-employment activities. Although there is limited empirical
research on the use of non-competes,
1
said covenants are not a new phenomenon
and they are increasingly used by employers to restrict an employee’s ability to
work for a competitor, start a competing business and, in some cases, to protect
valuable information such as trade secrets. NCAs may also deal with restraining
the employee from competing with the business after it is sold and/or from
soliciting clients of the former employer.
2
These contractual terms, often signed as
a condition of employment, could be embedded in the employment contract or
written as a stand-alone agreement.
3
*
Professor of Law at the Shepard Broad College of Law of Nova Southeastern University, where she
teaches the Business, International, Comparative and Commercial Courses. I would like to thank
my research assistants, Ms. Paige Applebaum for editing the footnotes, Ms. Mariah Sc hiff for her
research.
1
Norman D. Bishara, Fifty Ways to Leave Your Employer: Relative Enforcement of Covenants Not to Compete,
Trends, and Implications for Employee Mobility Policy, 13 U. PA. J. BUS. L. 751, 783 (2011) (States that a
statistical data on the actual number of non-competes in specific jurisdictions and industries are
missing a piece of non-compete research, given this information is hard to obtain because these
non-competes are generally not publicly reported or catalogued).
2
Norman D. Bishara, Covenants Not to Compete in a Knowledge Economy: Balancing Innovation from Employee
Mobility Against Legal Protection for Human Capital Investment, 27 BERKLEY J. EMP. & LAB. L. 287, 294
(2006).
3
Id.
University of Puerto Rico Business Law Journal
93
On the one hand, these non-compete agreements are beneficial to
companies. They protect human capital, intellectual property, interfere relations
and could increase productivity as companies would be more willing to invest in
training workers and developing new products and processes, if confident of being
able to reap the benefits of this investment.
4
Indeed, traditional economic theory
finds post-employment restrictions are relevant and necessary in constricting the
movement of human capital, as it assumes that, without such contractual
restrictions, employers would “underinvest in research, development and
employee training,” as there is a higher risk that such employees would leave and
use these acquired attributes as competitors.
5
However, on the other h and, the enforcement of non-compete agreements
may have negative effects, as it may hinder innovation, economi c growth and
entrepreneurships.
6
Kenneth Arrow argues that competition is what fuels
innovation, and, with reference to human capital, “mobility of personnel among
firms provides a way of spreading information.”
7
He believes such information
travels with workers between companies thereby resulting in even more
knowledge and consequently strengthening competition.
8
Professor Hyde, a
strong advocate for labor mobility, under a conducive legal structure that , among
other things, disallows non-compete agreements, has argued in favor of the
California approach, which essentially bans NCAs, as the state’s laws have enabled
a “high velocity” labor market where employees move quickly between jobs or
simply remain independent contractors. “Thus, technical information and
innovation are shared quickly, without restrictions and are “porous to outside
influence.” Hence the success of Silicon Valley.
9
Although non-compete agreements were originally considered
unenforceable because they were said to be in restraint of trade, a majority of states’
policies allow some degree of enforcement. Virtually all state courts today
employing one of three rules to determine enforceability: (1) the all or nothing
approach; (2) the blue pencil approach, and; (3) the judicial modification standard
approach, which could enforce, revise or strike out the non-compete agreement.
10
However, the states treat the enforcement of these covenants differently, thereby
making it complex to even discern a standard form language in the different
jurisdictions.
11
California statutes, for example, restrict courts to enforcing non-
compete clauses in very limited circumstances, with the California Business &
4
Sampsa Samila & Olav Sorenson, Noncompete Covenants: Incentives to Innovate or Impediments to Growth,
57 Mgmt. Sci. 425, 425-26 (2011).
5
On Armir & Orly Lobel, Driving Performance: A Growth Theory of Noncompete Law, 16 Stan. Tech. L. Rev.
833, 837 (2013).
6
Samila & Sorenson, supra note 4, at 425-26.
7
Armir & Lobel, supra note 5, at 846.
8
Id., at 837.
9
Bishara, supra note 2, at 308.
10
See Clark’s Sales & Serv., Inc. v. Smith, 4 N. E.3d 772, 783-87 (Ind Ct. App. 2014) (Where court
struck down a provision in its entirety because it was patently unreasonable).
11
Sye T. Hickey, To Compete or Not to Compete: Is that the Question?, 21 BUS. TORTS & UNFAIR
COMPETITION 18, 22 (2014).

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