The wrong tool for the job: the IP problem with noncompetition agreements.

• Author: Moffat, Viva R.
• Position: Intellectual property

ABSTRACT

This Article argues that employee noncompetition agreements ought to be unenforceable. It begins by recognizing that there is momentum for change in the law of noncompetes: a number of states and the American Law Institute (ALI) are in the process of reconsidering noncompete doctrine, and recent empirical studies provide evidence as to the mostly negative effects of the agreements. Existing critiques have focused on the problematic nature of noncompetes within the employment relationship. This Article synthesizes those critiques, adding support from empirical studies, and then examines noncompetes from a new perspective.

Commentators have neither recognized nor evaluated the role noncompetes play in the intellectual property (IP) system. Upon closer examination, it becomes clear that the primary justification put forth in support of noncompetes is an IP justification: the arguments in favor of enforcement of the agreements revolve around the need to protect intangibles and the need to provide incentives for invention and investment. The IP justification is pervasive and rhetorically powerful but ultimately flawed. First, trade secret and other IP protections are intentionally limited to provide a certain amount of, but not too much, protection. Allowing enforcement of noncompetes in order to protect IP thus interferes with the contours of IP protection. Second, even to the extent that IP law is insufficient--that is, unintentionally limited--noncompetes are not the right tool for the IP job. A prohibition on the enforcement of noncompetes would thus serve a channeling function, directing efforts to protect intangibles to the IP regimes and encouraging the development of the appropriate IP balance, which is, of course, a work in progress.

TABLE OF CONTENTS INTRODUCTION I. THE CLASSIC PROBLEMS WITH NONCOMPETES A. The Standard Justification for Noncompetes B. Undermining the Freedom of Contract Rationale 1. Noncompetes Are the Product of an Inherently Flawed Bargaining Process 2. Noncompetes Restrict Employee Mobility and the Free Flow of Labor II. THE FAILURE OF THE IP JUSTIFICATION A. The Misplaced IP Justification for Noncompetes 1. The IP Justification for Noncompetes 2. Intellectual Property Policy B. Noncompetes Fail as an IP Tool CONCLUSION INTRODUCTION

As intangible assets have become more valuable and increasingly difficult to control, business owners have turned to a variety of mechanisms to protect these assets. They have adopted a "belt-and-suspenders" approach. In addition to taking advantage of IP, contract, and tort law tools, firms have increasingly been asking employees to sign noncompetes (1)--contracts in which employees agree not to compete with the employer after the termination of the employment relationship. (2) As the use of noncompetes has become more widespread, controversy over these agreements has also increased. In the last few years, at least six states have reconsidered the doctrine concerning enforceability of such agreements. (3) Currently, noncompetes are enforceable in a majority of states, (4) but a few states simply refuse to enforce the agreements. The California Supreme Court roundly condemned noncompetes on public policy grounds in a recent opinion reaffirming that state's blanket rule against enforceability. (5) The ALI is in the process of drafting a Restatement of Employment Law that includes a provision permitting enforcement of noncompetes. (6) The stark differences in state law have made it possible for scholars to undertake empirical projects concerning noncompetes, (7) and these studies do not provide support for continued use of the agreements. (8) The results of these recent studies on noncompetes and the momentum for reform indicate that the time is ripe for a thorough reexamination of the use of and justifications for noncompetes.

Employment law scholars have paid a great deal of attention to two aspects of noncompetes: they have critiqued the agreements as the product of a flawed bargaining process and as being fundamentally unfair to employees. (9) Few scholars, however, have paid attention to another aspect of noncompetes--the fact that they are widely used to protect IP and IP-like assets. (10) Taking a fresh look at noncompetes requires both a reevaluation of the agreements as a part of the employment relationship and an understanding of the agreements in the context of IP regulation.

The existing critiques are powerful. Employment law scholars have explored some of the problematic aspects of noncompetes, focusing their attacks on the freedom of contract rationale for enforcement of the agreements. (11) In particular, they have emphasized that noncompetes result from a deeply flawed bargaining process and impose significant restrictions on employee mobility. (12) These critiques, which recent empirical studies of the effects of noncompetes on individuals and the broader labor market support, have led to suggestions for a variety of doctrinal fixes. (13)

What has gone virtually unnoticed, however, is the primary argument put forth in favor of noncompetes--the IP justification. It proceeds as follows: noncompetes are necessary to protect trade secrets or other IP assets, or they are necessary to provide an incentive for firms to invent and invest. (14) The main thrust of the justification is that other forms of protection, primarily trade secret law, are too weak and that noncompetes are necessary to supplement IP rights, or as an alternative to these rights. (15)

The IP justification, whether explicit or implicit, fails in the context of employee noncompetes. To some extent at least, trade secret law and other forms of protection for intangibles are intentionally limited, performing a channeling function by directing some inventions to the patent regime and others to the public domain. (16) Even to the extent that trade secret law is unintentionally weak, the IP justification for noncompetes is not compelling because noncompetes are not a good tool for achieving the purposes of IP protection. (17) In either event, a refusal to enforce noncompetes would serve a channeling function, directing efforts to protect intangibles to the IP regimes, rather than allowing an end run around these regimes with a tool that is so problematic in other ways.

Neither employment law scholars nor IP scholars have explored or challenged the understanding of noncompetes as an IP tool. Taking into account both the long-standing view of noncompetes as the product of a flawed bargaining process and the new understanding of noncompetes as misguided efforts to protect IP, there remain no persuasive arguments in favor of enforcing the agreements.

This Article proceeds as follows: In Part I, I describe the freedom of contract rationale in the context of employee noncompetes and summarize the critiques, primarily from employment law scholars, that undermine that justification. These critiques focus on the flaws in the bargaining process and the restrictions on employee mobility. In addition, recent empirical studies support the theoretical arguments against noncompetes, demonstrating the weakness of the freedom of contract rationale. In Part II, I turn to the largely unexamined IP justification for noncompetes and argue it is much less compelling than the rhetoric would imply. Noncompetes should be understood as used primarily to protect intangible assets, but they are simply the wrong tool for the job. Finally, I conclude that the arguments in favor of noncompetes are so weak that use of the agreements cannot be justified. Although the long-standing critiques of noncompetes undermine the arguments in favor of enforcement, it is the failure of the IP justification that leads to the conclusion that the agreements should simply be unenforceable. State legislatures, rather than courts, however, must implement this reform.

1. THE CLASSIC PROBLEMS WITH NONCOMPETES

   Firms are increasingly using noncompetes to restrict the postemployment activities of current employees, limiting the type, location, and extent of subsequent employment. (18) They may be stand-alone agreements or part of a broader employment agreement, and they may be entered into at the outset of the employment relationship, in the midst of it, or at the termination of employment.

   In many jurisdictions, the agreements will be enforced if they are deemed necessary to protect an employer's "legitimate interests" and are "reasonable" in terms of the restrictions imposed upon the employee. (19) Notably, however, noncompetes are simply unenforceable in a few states, regardless of the employer's "interests" and the reasonableness of the provisions. (20) These differences in state law are the result of the conflicting public policy concerns raised by the use of these agreements: the free flow of labor and freedom of contract.

   The increased use of noncompetes, along with the conflicting policy concerns they implicate, has led to controversy over their use and effects. State courts have been tinkering with the doctrine, a number of legislatures have considered or passed noncompete statutes, and the ALI is drafting noncompete provisions as part of its Restatement (Third) of Employment Law. (21)

   Thus the time is ripe for a reevaluation of the use and enforceability of noncompetition agreements. A fresh look at noncompetes requires a reevaluation of the existing scholarly approaches. These have primarily come from employment law scholars focused, understandably, on the operation of noncompetes as part of the employment relationship. In this Part, I briefly describe the freedom of contract rationale and the extent to which critiques from employment law scholars and the results of recent empirical work erode that justification in the context of employee noncompetes.

   1. The Standard Justification for Noncompetes

      As with all contracts, a fundamental justification for noncompetes is the freedom of contract principle. (22)...