Shaky Ground Under Non-Compete Agreements – Changes Afoot?

Non-compete agreements have been a fixture in the employment relationship at tech companies for a long time. Most involved have accepted these agreements as a normal part of doing business in the tech industry. Recently, legislatures and others have started to scrutinize the economic effects of non-compete agreements. Many of the people who have looked at the question have advocated elimination or restrictions on non-competes. They argue that non-competes often run afoul of basic fairness and that they are inhibitors on the economic progress of a state.

How did these agreements come into being in the first place? When a company hires someone the new employee is brought into the company and is brought into a circle that has access to special knowledge and know-how. The company has invested time and capital into the creation of that knowledge and know-how. Therefore, it’s reasonable that the company can forbid you from using that know how against the interests of the company.  Courts have protected this interest long before the advent of the technology industry.

At the same time, the courts have never given companies unlimited power with regard to non-competes. It’s always been necessary to make sure that these agreements are limited as to time, geographic scope and industry classification. But even these types of “reasonableness” tests have been questioned of late. Since non-compete agreements limit the ability of a person to pursue a trade or profession they can actually limit the amount of competition in specific labor market sectors.  Studies suggest that non-competes suppress wages by at least a few percentage points. There are enough questions to ask whether non-compete agreements should be used as heavily as they are today.

California is perhaps the most innovative state in the U.S. Non-compete agreements are essentially impossible to enforce in California. In the tech industry this fact has created one of the world’s most fluid and dynamic labor markets. Companies in Silicon Valley compete very hard to lure and maintain the best talent. The inability to impede the movement of workers between firms forces firms to keep their employees happy. This ability to move between companies also facilitates the dissemination of many types of specialized “know how”, making all the companies in a sector stronger as that knowledge is spread and put to use. Some theorize that this is one of the factors behind the creation and growth of the Silicon Valley.

According to the Wall Street Journal, as of May 2016 47 out of the 50 states allow non-compete agreements “most or all of the time”. How did California avoid this policy and end up with the world’s most impressive innovation engine with its borders? Part of it is sheer good fortune. In 1847 the State of New York engaged an attorney to codify the laws of the courts in that state. This codification was never adopted in New York but a a newly-admitted state California wanted to enforce standard laws across its territory. It adopted the New York codification. Part of it was the predecessor to California Business and Professions Code Section 16600 which provides:

16600.  Except as provided in this chapter, every contract by which
anyone is restrained from engaging in a lawful profession, trade, or
business of any kind is to that extent void.

Obviously, a non-compete restrains a person from engaging in a lawful occupation. For more than a century and a half this has been unlawful in California.