In this article, J.J. Prescott and Evan Starr analyze the practical problem of how perceptions of contract enforceability can affect party behavior even when those perceptions are incorrect as a matter of law. Specifically, the authors tackle the difficult divide between the law on the books versus the law in action as famously described by Roscoe Pound.1 Under Pound’s formulation, the practical applications of law by parties in the real world will often diverge from the model of behavior upon which applicable laws regulating the parties’ conduct are based. As the divergence between reality and law increases, eventually either the law must adapt through development and adaptation of legal fictions to resolve the divergent applications or courts and legislatures must respond with new law.2 Subjective Beliefs about Contract Enforceability develops important observations regarding how parties actually respond to unenforceable contract obligations versus legal prohibitions on enforceability of certain contract terms and provides support for creation of new legal responses to address that divide.
The article approaches the general problem of perceptions of contract enforceability through the lens of employment contracts. In particular, the article analyzes the issue through the empirical question of how employees’ perceptions of the enforceability of non-compete clauses in their contracts affects their willingness to seek alternative employment even where state law prohibits enforcement of such provisions. The empirical project begins with the proposition that “[h]ow individuals behave in response to law depends on their particular and sometimes mistaken beliefs about the law’s content, including the probability of enforcement.” (P. 1.) As the authors note:
Our work is motivated by two recent findings that point to the possible influence of mistaken beliefs in this domain. First, employers use noncompetes heavily in states that explicitly refuse to enforce them. Second, noncompetes appear to influence employee mobility even in states where such provisions are unenforceable. While there are several reasons why employers might use and employees might comply with noncompetes even when employees know that a court will not enforce them (e.g., reputational harm or disutility from breaking a “promise”), one explanation for these results is that employees have mistaken beliefs about noncompete policies and that these beliefs matter to their choices. (P. 1.)
From these two initial motivations, the authors develop an empirical description of the degree of disconnect between the law – nonenforceability of noncompetes in particular jurisdictions – and the impact of employees’ mistaken perceptions of the law. Specifically, employees generally appear to be widely impacted by the presence of a noncompete term in their employment contracts, regardless of whether the term is enforceable under state law. At the same time, employees demonstrated relatively low awareness regarding the enforceability of noncompetes in their own states. Approximately 75% of employees in states that enforce noncompetes correctly believed such agreements are enforceable while approximately 70% of employees in states that do not enforce noncompetes incorrectly believed the agreements are enforceable. (P. 11.)
The impact of both noncompetes in general and mistaken perceptions regarding the enforceability of noncompetes appears to be significant. According to Prescott and Starr, employees who mistakenly believe noncompetes are enforceable “put less effort into searching for new positions at competing firms, necessarily limiting their ability to learn about the law governing their contract from competitors. This finding reminds us that certain mistakes – even mistakes about the law – may cause agents to refrain from activities that facilitate error correction and thus can become persistent.” (P. 14.)
Moreover, the data suggest that employers in states that do not enforce noncompetes still include those terms in employment contracts and have an incentive to maintain employee misperceptions regarding the enforceability of noncompete agreements. In comparing equivalent employees, one of whom receives an offer from a competing firm and one who does not, the authors found that “comparing two observationally equivalent employees (per our controls) who are subject to a noncompete and who have received job offers from competitors, an employee with an unenforceable noncompete is approximately 40 percentage points more likely to receive a reminder about their (unenforceable) noncompete (71% vs 32%, 34%) from their employers.” (P. 15.)
One note of optimism lies in the authors’ finding that educational outreach aimed at employees in states that do not enforce noncompetes may affect the willingness of those employees to seek alternative employment. (Pp. 16-19.) However, it is worth noting that there may be factors exogenous to the contract terms that create disincentives for employees to pursue alternative employment even after learning that their noncompete agreement is unenforceable.
Overall, this article provides an extraordinary insight into the real-world impact of noncompete agreements on employee mobility, as well as the in terrorem effects of such contract terms even if they are not legally enforceable. On a more abstract level, such empirical investigations into how contract law actually affects party behavior critically inform analysis of how legal institutions should respond (if at all) to both the substance of particular contract terms as well as whether one side in a particular transaction type is systematically exploiting informational and bargaining power advantages.
- Roscoe Pound, Law in Books and Law in Action, 44 Am. L. Rev. 12 (1910).
- See id. at 27-36 (describing cycles of tension between law in books and law in action as alternating periods of growth in law to respond to perceived practical problems and periods of stability and consolidation).
