Gruntled Employees

Are noncompetes the new Sarbanes-Oxley?

We talked last week about the increase in noncompete cases over the last decade (see "The rising noncompete tide"). Over that period, the number of published noncompete decisions in state and federal courts nationwide has doubled. And over the past two years (2004 to 2006), the number of decisions has surged 37%.

Several people have asked for more information on how I got these numbers. My firm did a series of LexisNexis searches designed to find reported noncompete decisions for each year. The complete results are shown in the chart above.

What this doesn't tell you is the number of noncompete cases filed each year. Those numbers are much larger because most noncompete cases are decided at the trial-court level instead of at the appellate-court level. Most trial-court decisions go unpublished, particularly when the decision is just a ruling on a motion for preliminary injunction, which is how most noncompete cases end. (The old employer asks the court to stop — or "enjoin" — the new employer from hiring the employee who signed the noncompete.) The increase in the number of cases filed would be even more dramatic.

Why the growth in noncompetes? One reason for this surge is the increase in employees signing noncompetes, especially outside the IT industry. Another reason is the fiercer competition for top-level talent. It's hard to get good people, and companies don't want their rivals to take theirs.

Many in-house counsel will tell you that one of their biggest employment-law concerns is the rise in Sarbanes-Oxley whistleblower lawsuits. But compare the number of cases filed under SOX's Section 806 (the only part of the Act that allows an individual to sue) with the noncompete statistics above. According to the U.S. Department of Labor, only 130 SOX whistleblower cases were decided in 2006. (You can get more data on SOX cases at the DOL's website.) And while that number has risen over the four years since the Act was introduced, the number of those cases pales when compared to noncompetes.

Maybe noncompetes are the new Sarbanes-Oxley whistleblower bogeyman.

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Several talented writers have picked up on the story of noncompete mania. Evil HR Lady weighed in with this comment, and Charles Green at Trusted Advisor Associates had this to say. Over at OregonLive: At Work, Brent Hunsberger contributed "Noncompete clauses on the rise?" And Professor Paul Secunda over at Workplace Prof Blog adds "Non-Compete Legislation To Combat Increasing Number of Cases." The latter two posts discuss legislation pending in Oregon designed to stem the noncompete tide.

The rising noncompete tide

FinancialWeek's Frank Byrt has a great piece on the rise of noncompete litigation directed at top executives: "No place like home: Companies blocking more execs from jumping to competitors" (registration required, maybe). Frank's jumping-off point is the recent high-profile litigation between TJX and Pier 1. In that dispute, Alexander Smith left his job as a group president at TJX to become Pier 1's CEO. TJX fired off a lawyer-letter warning Smith that he was violating his noncompete agreement. Pier 1 then made a preemptive strike by seeking a temporary restraining order to prevent TJX from interfering with Smith's new employment.

As that battle rages, Frank notes the growth in noncompete litigation and the fact that top executives are increasingly becoming targets. Frank and I had a lengthy discussion about this, and some of that discussion made it into his article:

More and more employers — witness clothing retailer TJX Cos. — are threatening to sue to enforce non-compete clauses of executives’ employment agreements when they jump ship, and it’s no longer just to protect company secrets or customer lists.

Rather, companies are more frequently using non-compete litigation to try to block top employees from working for a competitor, said Boston attorney Jay Shepherd. “I think part of it is that it’s harder to get good top executives, so there’s a competition for that talent.

“Our non-compete litigation is growing like crazy,” he said of his employment law firm. The portion of non-compete cases it handles has grown to 65% of the practice, about double that of 2002.

Some of the new cases stem from the recent flurry of mergers and acquisitions. In these situations, typically the merged company doesn’t want departing executives, who have left of their own volition, trying to duplicate their success there with the competitor down the road, Mr. Shepherd explained.

“We’re definitely seeing more of this,” he added. “And people forget that companies can get emotional, too,” and will file lawsuits based on a sense of betrayal or disloyalty and, occasionally, out of spite.

And it's not just noncompete lawsuits against executives that are rising. Our own research tells us that noncompete cases have surged over the last decade. The number of published decisions in state and federal courts nationwide nearly doubled from 1996 to 2006. Over the past three years, the number of reported cases rose 32%. One reason is the increase in employees signing noncompetes, especially outside the IT industry. Another reason is the fiercer competition for top-level talent.

Bottom line: If you're thinking of hiring your competitor's top performer, be prepared to battle it out in court.

Issues raised by "lift outs"

Robert Weisman of The Boston Globe had a nice piece called "The business of lift outs," describing some of the problems companies face when they "lift out" a team of workers intact from another company. Rob describes lift outs thus:

The practice of scooping up talented groups of workers, once relatively rare and frowned upon as poaching, has become far more common and respectable. Headhunters have given it a more upscale name — "lift outs" — and companies in a range of sectors, from finance and technology, to healthcare and professional services, have embraced it as the quickest way to gain a foothold in a new market or region.

Although the term hasn't really gone mainstream yet, the phenomenon is quite common. At our firm, we deal with lift outs (or, if we're representing the former employer, "employee raiding") all the time. Rob called me to talk about some of the problems the company doing the lifting might face, and we chatted about litigation and corporate-culture problems:

But lift outs don't always go smoothly. Litigation is a popular option for jilted employers, especially at technology and life sciences companies where noncompete and nonsolicitation contracts are commonplace. Whether such contracts can be enforced hinges on many factors, including the type of new jobs the team is assuming, how employees were approached by the team leader, whether they seek to capitalize on customer relationships developed on the payroll of their former companies, and the judge or jurisdiction handling a lawsuit.

Even in the absence of legal challenges, lift outs can backfire. "People at a law firm can resent it if they're getting ready to become partner and new people are brought in above them," said Jay Shepherd, a Boston employment lawyer. "And while the team might work well together, they may not fit in well with the culture of the new firm."

The noncompete lawsuits that often result from lift outs are the more obvious and overtly expensive side effect. But the lifting company should not underestimate the integration problems that often arise when a clique of people — often receiving some special treatment — are suddenly thrust together with employees who've been around a lot longer. It might seem junior high schoolish, but the costs of the new kids not getting along with the old ones could end up being more severe than the expense of noncompete litigation.

Think hard before you lift out.

Ten mistakes employers make when using noncompetes

1. Making every employee — from the CEO to the mailroom guy — sign a noncompete.
2. Giving an existing employee a new noncompete without giving him or her something else in exchange for it.
3. Using a noncompete to protect anything other than trade secrets, confidential business information, and customer goodwill.
4. Misunderstanding what the heck "goodwill" is. (Hint: it's not your brand image; it's the customer relationships your employee is paid to maintain.)
5. Trying to use a noncompete in California.
6. Using noncompete enforcement as a strategy to scare employees out of leaving your company.
7. Failing to update a noncompete when the employee's job substantially changes.
8. Hoping that a court will scale back (but otherwise enforce) your overbroad noncompete.
9. Waiting too long to go to court to enforce a breached noncompete.
10. Trying to use a noncompete to protect against ordinary competition (as opposed to unfair competition).