The Jimmy John’s case: When doing what’s best for the organization means doing what’s worse for the economy

Usually, when you hear about staff being required to sign non-compete agreements as a condition of employment, it’s easy to assume that this only applies to the big-shots: executives, senior managers, people with intimate knowledge of corporate strategy, and so on, and surely not to a 19-year-old restaurant server or even a 24-year-old shift supervisor at a suburban fast-food outlet.

Think again. In a country where so many feel that “the little guy” is condemned to always end up with the short end of the stick that many have turned to Donald Trump or Bernie Sanders as would-be saviours, a news story appeared this past week that might just reaffirm their suspicions.

Illinois attorney-general Lisa Madigan filed a lawsuit mid-week against Jimmy John’s Gourmet Sandwiches, a Champaign, Ill.-based sandwich shop franchise, for requiring its employees until just last year to sign non-compete agreements. These agreements forbade employees from seeking employment with any other restaurant “that does at least ten percent of its business making sandwiches” within a two- or three-mile radius of any Jimmy John’s restaurant nationwide.

Under the agreement, the ban on working for even marginal competitors remained in effect for two years after leaving Jimmy John’s.

The non-compete agreement was almost certainly designed as a bluff to discourage staff turnover, not with the intent of actually enforcing it. Enforcement would have required:

a.) Keeping track of former employees’ whereabouts, or somehow finding out that the former employee had landed a job at Subway a mile and a half away, 15 months later (possible, but unlikely);

b.) Giving enough of a damn about the alleged breach to actually attempt to hold the former employee to the terms of the non-compete agreement (extremely unlikely for a low-wage job, and unlikely even in some better-compensated, mid-level jobs, if the path of least resistance was to just ignore the whole matter), and;

c.) If all else failed, convincing a court to enforce the agreement even though the courts have a history of overturning such agreements in all but the most serious of disputes.

Even Jimmy John’s conceded in a written statement that holding restaurant workers to non-compete agreements was a bit absurd:

“We made clear to the Attorney General that we would never enforce a non-compete agreement against any hourly employee that might have signed one. We offered to have our CEO sign a declaration to that effect, and pointed the Attorney General to an April 2015 ruling dismissing a federal claim against Jimmy John’s over the use of non-compete agreements, on the grounds that those agreements were not at risk of being enforced.”

Non-compete agreements are nevertheless popular. While the percentage of Canadian workers covered by non-compete agreements is not readily at hand, a White House analysis released just a month ago found that 18 percent of American workers are subject to restrictions on finding work elsewhere, including 14 percent of those earning less than $40,000 annually.

They even have their defenders. “Something strange is happening in the Beehive State,” law professor Nathan Oman wrote in Salt Lake City’s Deseret News this past March, as legislators were passing a new law banning non-compete agreements — a law Oman described as “a solution in search of a problem” and “a classic example of the legislative process run amok.” In defence of non-compete agreements, Oman wrote:

“In non­compete agreements, employees commit not to work for their former employers’ competitors if the employment relationship ends. This encourages employers to invest in their employees and share proprietary information. Everyone benefits, which is why employees and employers agree to the contracts in the first place.”

“In theory, such contracts could harm workers and consumers by giving monopoly power to employers. We solved this problem, however, more than a century ago. Like every other state, Utah law already requires that such contracts have reasonable limits on their geographic scope and duration. Indeed, any business that used them to monopolize a market would commit a crime under federal antitrust laws that have been in place since 1890.”

Others see non-compete agreements as being harmful to the overall economy even if they are beneficial for individual businesses by protecting secrets and calming competition.

On Twitter, I called the idea of requiring restaurant workers to sign non-compete agreements "asinine". Martin's response (in jest, I hope!) made my day. If you don't already do so, follow me on Twitter at @kevinmcdougald

On Twitter, I called the idea of requiring restaurant workers to sign non-compete agreements “asinine”. Martin’s response (in jest, I hope!) made my day.
If you don’t already do so, follow me on Twitter at @kevinmcdougald

A 2010 research paper by three academics from the MIT Sloan School of Management, the INSEAD global business school and the Harvard Business School found that non-compete agreements were economically harmful by encouraging former employees to move away in search of work and thus “stripping enforcing regions of some of their most valuable knowledge workers while retaining those of lesser value.”

“To the extent that one can draw normative conclusions from the above findings, policymakers who sanction the use of non-competes could be inadvertently creating a potential regional disadvantage. From a regional policymaker‘s perspective, the free flow of particularly high-ability talent to the best opportunities seems beneficial as long as it occurs locally . . . whereas such talented workers who take out-of-state jobs are a loss to the region. Regions that choose to enforce employee non-compete agreements may therefore be subjecting themselves to a domestic brain drain not unlike that described in the literature on international emigration out of less developed countries.”

[…]

“…[E]nforcement of non-compete agreements might act as a brake on labor pooling in two ways. First, regions that allow firms to enforce non-compete clauses against ex-employees drive some of their most highly valued skilled workers out of the region, decreasing the local supply of talent. Second, the interorganizational mobility of those workers who remain in the region is lower when non-competes are enforced. Given the role of labor pooling as a microfoundation of agglomeration, we should therefore expect more clustering in regions such as Silicon Valley where non-competes are unenforceable.”

This was supported more recently by a U.S. Department of the Treasury report which found that, while non-compete agreements can protect trade secrets and thus encourage innovation, reward employers for spending more on employee training and reduce staff turnover, they can also lead to lower wages, cause people to leave the careers in which they are most productive, and slow productivity growth.

The Treasury report recommended, among other things, that employers be dissuaded from requiring non-compete agreements unless there is a high probability that they could and would be enforced (i.e., not frivolously or as a bluff, as in the Jimmy John’s case) and requiring that employees continue to be paid at partial salary by their former employers in exchange for agreeing not to seek employment with competing organizations.

The Jimmy John’s case, and the evidence above, suggests that it might be a good use of legislators’ time in the U.S., Canada and elsewhere to limit the use of non-compete agreements. While those in the business and legal communities might see such agreements as useful from their point of view, it’s a benefit that comes at a cost to the wider community. It’s also an example that there’s a gap between what’s good for business (or labour, which has made its own case for competition-limiting measures at times) and what’s good for the economy. The two are not always the same, or even compatible.

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About theviewfromseven
A lone wolf and a bit of a contrarian who sometimes has something to share.

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