To Compete or Non-Compete: Contracts That Make Michigan Less Competitive

Dug Song believes that his company, Duo Security, has a lot of competitive advantages when it comes to attracting professional talent: Company culture. Working in downtown Ann Arbor. Building cool technology. No non-compete contracts.

 

The last one is important in Michigan. While many key states have laws that make it difficult for companies to limit where their staff work post-employment, the inverse is true in Michigan: regulations favor the employers.

 

Some see Michigan's non-compete contract laws as a handicap on its fledgling new economy, staunching the free-flow of talent between local employers and the entrepreneurial ability to start new companies. Others see it as a necessary law to keep talented teams together and prevent the leaking of trade secrets. Song sees non-competes as, well, anti-competitive.

"I'm not afraid of competition," Song says. He adds, "If I can get asomeone here that has the motivation and drive to do their own thing and I can have them here for two years, that's perfect. If they have the drive and the ambition to scale then I want them to come here and learn how to do that on our dime."

The free flow of employees between companies and enabling them to create their own startups is a primary reason why places like Silicon Valley are centers for technology and cities like Ann Arbor lag behind, Song says. The CEO of Duo Security adds that chaining talent to companies just muddling along with things like non-competes aborts the entrepreneurial process early and often.

"It's more about the chilling effect these agreements have," Song says. "It might stop them from doing something different."

 

 

Non-compete contracts, also known as restrictive covenants, are typically an agreement companies require their employees sign mandating they not work for a competitor or start their own company in the field they are working in post-employment. Non-competes are usually in effect for a year or two after the employee's tenure ends at firm. They are typically employed where technology and expertise are paramount to the success of a venture but in recent years they have crept into other Michigan business sectors.

 

Ever wonder why a co-founder, executive or early employee at a successful tech startup decides to pursue a passion not in his/her's field of expertise or take a year off to spend with their family after leaving the company? Chances are a non-compete has something to do with it.

 

The rules governing non-competes range from state to state in the U.S. States like Washington (home of Micosoft and numerous other software firms) and Virginia take a narrow view of enforceability of non-competes, making them practically useless. California, where Silicon Valley fuels a substantial part of the state's economy, actually banned non-competes for all intents and purposes. Other states, however, have regulations that favor the employer.

 

Michigan is part of that latter group because its rules on non-competes are broader and tend toward vagueness. The Great Lake State's laws states: 

 

"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))

 

 

That's the type of law that is holding back Michigan's new economy, if you ask David Blanchard.

 

"That slows the whole process down," Blanchard says. "When you are slowing down the ability for people to work you're creating disincentive. You're hurting the new economy."

 

Blanchard is a shareholder at Nacht, Roumel, Salvatore, Blanchard & Walker, an employment and civil rights firm based in downtown Ann Arbor. Blanchard grew up in Ann Arbor, graduated high school from Community High School, undergrad from the University of Michigan and received his juris doctorate from U-M's Law School. He has practiced employment law for the last decade and is an expert on non-competes.

 

"It's always in the work we do," Blanchard says. "It's always present. People will come to us and say, ‘I've been sued. I was fired from my old company, went to work for another company, and my former employer sued me.'"

 

Or send a threatening letter to the former employee and his/her new employer claiming they are violating a non-compete contract. Blanchard says often the new employer finds it easier to fire the new employee and find another one rather than spend the resources fighting a non-compete lawsuit.

 

Non-competes are often signed by employees on their first day on job. They will be mixed in with various other paperwork they need to sign off on to work at their new jobs. Other times they are part and parcel of a stock-options and compensation package. The bigger the company, the more complicated the technology it develops, or the more money behind the startup then the higher the chances are that a non-compete will be part of the initial paperwork.

 

Because the law governing non-competes in Michigan favors the employers, it is easy for companies to abuse such contracts, limiting the employment options of former employees that have displeased them.

 

"People don't think about all the implications at the beginning. That's the real unfairness," Blanchard says. "A lot of people sign it thinking if they are fired then they are released. That's usually not the case with most of the contracts I have seen."

 

That can cause problems in the 21st Century economy where new companies are more project-based. Employees could realistically expect to spend an entire career at one employer in the 20th Century. That's become rare these days, when startups are created and acquired within a few years and many workers have a handful of careers at numerous employers. 

 

"To some extent this is new economy versus old economy," Blanchard says. "The old economy and old school sectors of the chamber of commerce will say, ‘No, no, no... We have to protect our secrets.' I don't buy that."

 

 

Terry Cross has made a career of investing in successful tech firms. Since 1962 he has made early stage investments in 57 companies, including a small software startup based out of Silicon Valley called Google.

"It's probably not good for the economy. But it's good for investor's interests."

 

"Looking at it from an investor's point of view, you want non-competes because it keeps key people in place," Cross says.

 

Cross wants non-competes used in any startup he is investing in. It's not a make-or-break requirement for him, but he is more likely to demand non-competes in tech startups that food-service small businesses. He points out that in his experience non-competes are tied to a startup employee's compensation package, providing incentive for them to see the startup through to a profitable exit.

 

Cross has seen those sorts of employees go on 1-2 year vacations from their careers because of non-competes. Cross is an active proponent of growing Michigan's new economy and is not a fan of that part of the non-compete equation. However, that is part of the reality he lives with in his home state.

 

"It's probably not good for the economy," Cross says. "But it's good for investor's interests."

 

Chris Rizik, a significant player in Michigan's venture capital community, falls somewhere in-between. The CEO of the Renaissance Venture Capital Fund believes non-competes play a role in helping businesses protect trade secrets and maintain expertise in their sector. He also sees how they can be open to abuse. In his experience Michigan's stringent non-compete laws haven't been used against it when it comes to attracting talent, but he sees how that could become an issue in the state's growing new economy.

 

"It should be used for competitive fairness," Rizik says. "It shouldn't be used for competitive advantage. It's important that talent is allowed to flow through the economy."