Policies vs. Contracts: A Critical Distinction

Most employers should use company policies rather than employment contracts for their workforce. A contract requires both parties to agree to any changes. A policy can be updated by the employer at any time—and that flexibility is enormous as your business grows and circumstances change.

Contracts do have a role: they’re necessary when you need to bind someone after they leave the company. Policies only apply while someone is an employee. Once they walk out the door, your company handbook is irrelevant.

When You Need a Non-Compete Agreement

If employees or contractors have access to confidential information, trade secrets, or key client relationships, a non-compete agreement can prevent them from competing against you after they leave. Non-competes are separate contracts—standalone agreements or clauses within a larger agreement—that survive the employment relationship.

Non-competes are also commonly used when a business owner sells a company. The buyer doesn’t want the seller opening a competing shop across the street.

State Law Matters

Non-compete enforcement varies dramatically by state. Some states enforce them readily; others—like California—have largely banned them. You need to know the rules in your state before relying on a non-compete to protect your business. An unenforceable non-compete gives you nothing but a false sense of security.

The Key Question

Ask yourself: are the people working with you gaining access to information that could hurt your business if they competed against you? If so, determine whether your state allows non-compete provisions and get the right agreement in place before sharing that information.

Video Transcript

Key Differences in Work Structure and Pay

We have talked a lot about contracts with people outside of your company. We call those independent contractors. Now let’s talk about the relationship you have with people inside your company. We call those employees or employment law.

So A contractor has a temporary relationship typically with your company and a limited relationship where an employee is working on your team every day. Now the employee might be paid different ways. An employee might be paid hourly, or a salary, where they get a fixed amount per year. Maybe it is a bonus of some sort, or maybe it is a commission that is often used for sales, where you get a percentage of whatever you sell, or it could be a hybrid of those.

Why Policies Can Be More Flexible

Now, with employees, we have a lot of rules as business owners. We have a lot of expectations. We have a lot of terms and conditions, and where do we put all this stuff? Well, sometimes employers think, “Hey, I am just going to put it in one nice big contract.” But here is the problem with that: A contract requires two parties to change it.

But there is another option for you. As an employer, rather than having a contract that you both sign and then the employee has to authorize any change in the future, you can instead have a company policy. You have the right to change company policies at any time. This is huge. Now, of course, the policy only applies for the future, and of course the employee can leave if they don’t like the policy.

When Policies Fall Short

But the reason you want to have policies rather than contracts with employees is because With policies you can make changes to them over time as you learn and grow and encounter different circumstances. Whereas contracts require a renegotiation with the employee, the employee has to get something out of signing that contract.

So the big takeaway here is use policies rather than contracts most of the time. But here is the problem with policies like human resource policies or other company policies. They only apply to employees. Now you might say, “Well, I thought we were talking about employees. What happens if somebody leaves the company?”

Now they are not an employee anymore. It doesn’t matter if they violate company policy. They are not an employee. They are not bound to your company policy when they are not an employee. So, if you want to bind or restrict a person after they leave employment, you cannot use a company policy. You must use a contract. Again, only contracts are enforceable after somebody leaves the company. The company policy, or the employee handbook, is not enforceable when people are no longer employees.

Purpose and Protection for Employers

When does this come up most? With non-compete agreements. A Non-Compete agreement tells your employees for a period of time after they leave, they can’t compete with you. So, they might go to some other geographic area, some other line of work, some other industry, but they can’t immediately compete. And the idea here is you don’t want to be training a future competitor.

If you are going to share secrets with them about how your business works, train them in on your approaches and introduce them to customers. You don’t want them to leave and the very next day be using all of that against you. So in order to prevent an employee from immediately competing against you in your same industry and affecting your business, there is the concept called the Non-compete Agreement. It basically is where the employee says, “For a period of time, I won’t compete with you.”

Now, states vary in how they handle these. They are almost entirely banned in California and in Minnesota. There is an effort to ban them nationwide, but the attempt was to do that through the administrative law process rather than through Congress.

So basically, through the authority that the Congress had delegated to the President and the Presidential Departments. And there is presently a case on whether that actual authority was delegated, and so that whole nationwide non-compete ban is currently suspended. What that means is Non-Compete Agreements are permitted federally, and unless there is a state law banning the Non-Compete Agreement, it is enforceable in your state.

Overly Broad Restrictions

Now there are a lot of questions around whether certain non-compete provisions are enforceable. What about if employees already started work and then were required to sign it? Usually those are not enforceable. What about if the non-compete agreement says, “You can’t compete anywhere in the world, and it is not just in our industry but any industry.” Well, that is not going to be enforceable. That is way too broad. Courts basically say, “The geographic limitation and the industry limitation and the other limitations need to be reasonable.”

Balancing Employer Needs and Employee Rights

What is reasonable? They need to be calculated to actually protect a real concern of the employer and not just be a penalty preventing somebody from working, or we want people to earn a living. So the courts basically will say, “Look, if this employee can compete and earn a living without actually interfering or impacting in a significant way of the company, usually that non-compete agreement will not be enforced. But all of this is dependent on state law.” So it really depends on what state you are in and consulting with an attorney familiar with the non-compete law for your state.

Use with Independent Contractors and Business Sales

So non-compete agreements are often used with employees. You can use them with independent contractors unless it is prohibited by your state. And often, when a business owner sells and leaves the business, the new buyer doesn’t want the old business owner to compete. And so the business owner selling will sign a non-compete agreement.

So non-compete agreements are a valuable tool for you to either have as a separate agreement, a standalone agreement, or a provision in a much larger agreement with a company you are working with. So one thing to think about is, is it important that people you are working with who are having access to very important information be prevented from competing with you later? And if so, is that sort of provision allowed in your state?

Now, if you would like to know more about how to avoid trouble like this, I have a free resource at AaronHall.com/free. I provide information for business owners of small to mid sized companies on how to avoid common legal problems. That includes a PDF. It includes videos talking about important issues.

I am Aaron Hall. I am an attorney for business owners and entrepreneurial companies. If you would like, subscribe to this channel so you can get more educational content like this.