Winners and Losers If Non-Compete Agreements Are Banned

by | Apr 10, 2023 | *Financial Awakenings, Business Owners, Education, In The News, Life Aspiration Planning, Weekly Column

If the U.S. Federal Trade Commission (FTC) is successful in getting a new rule enforced, non-compete agreements may soon become illegal in all 50 states. This potentially gives employees reason to celebrate, while employers may feel despondent. Not surprisingly, while the change may make sense on the surface, the unintended consequences may go much deeper.

According to a February 7, 2023, report by The Flip Side, nearly one-fifth of employees in the U.S. are asked to sign a non-compete. My financial planning firm has required non-competes for 40 years.

A non-compete agreement is a legal contract whereby an employee agrees to not go to work for a competing company when they leave the employer. Most non-competes are limited to competitors within a certain geographical area and for a specific length of time.

Why would an employer ask for, and an employee agree to, such a restriction? Because both have something to gain. The employee gains a job, of course, but usually the real incentives to sign a non-compete are specific training and experience that will enhance the employee’s skill set and value in the marketplace. Employers are primarily concerned with wanting a return on their (often significant) investment in training a new employee. If an employer invested time and money training an employee to master a job, obtain a master’s degree, or achieve professional certification, they would likely not benefit from their investment if the employee quit the day after they graduated to go work for a competitor across the street.

When used appropriately, the spirit of a non-compete is inherently a win/win. Unfortunately, some employers turned the agreement into a win/lose by making the restrictions so draconian that employees who left the company for any number of reasons could not support themselves financially.

Courts have increasingly refused to uphold non-compete agreements that are unreasonable. For example, almost no court would enforce barring a MacDonald’s employee from working in any fast-food restaurant within 250 miles for 10 years. However, a non-compete that limits a highly skilled employee from working for a competitor within 10 miles for two years may be considered reasonable and enforceable.

The reasonability depends largely on a number of variables. Currently, states control what is reasonable and unreasonable with non-compete agreements. California bans them, for example, while South Dakota allows them based on them being reasonable.

What’s the downside to a nationwide ban? Certainly, employees will benefit from the increased freedom to quit and immediately take any job they would like. However, employers may become more reluctant to pay for employee training or education. Many companies give annual allowances for continuing education to help employees keep certifications and licenses active. Those allowances, which often run to thousands of dollars a year, could become the responsibility of the employee.

In addition to non-compete agreements, some employers require employees to sign non-solicitation agreements or non-disclosure agreements. These prohibit former employees, for a certain amount of time after leaving the company, from soliciting the company’s clients or current employees or from sharing proprietary secrets of the company. The spirit and intention of these agreements is much the same as the non-compete.

I suspect the FTC will be successful in banning non-compete agreements based on the abuses of a few bad players. It’s the same old story. The result will be a win for the lower wage earners whose employers have no business holding them to a non-compete agreement. The losers are likely to be budding professionals who may well lose support from their employers for investing in their education. The resulting costs will hinder both individuals’ career growth and the development of their professions.

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