Noncompete clauses: are they part of the grand theme of the crisis of innovation?

One of the more interesting developments regarding IP have been attempts to link it with a grand theme. For the last decade or so, the most prominent example has been that the patent system is inimical to innovative activity, at a time where innovation is seen as in decline. [Merpel directs Kat readers to Professor Robert Gordon’s much-discussed new book, The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War.] It would seem that it is not only the patent system that is under scrutiny. According to Justin Fox, as set out on Bloomberg.com (“The Tyranny of the Noncompete Clause”), there is another gremlin nipping away at the heels of innovation and entrepreneurship, namely the noncompete clause.

Strictly speaking, the issue of noncompete clauses falls under the law of restraint of trade. However, as most IP practitioners can attest to, a noncompete clause usually arises in the context of an employer-employee relationship, when it is expected that the employee may be involved in the creation of IP. In such a situation, the employee will often be called upon to agree to a noncompete clause, which is itself bundled with non-disclosure obligations regarding the company’s trade secrets. More often than not, it is the IP practitioner who is called upon to opine on this entire contractual bundle. Fox suggests that the extent to which a noncompete clause is enforced within a given jurisdiction may be a major reason why some places do better than others in spawning a successful high-tech ecosystem.

The focus of his comments is on the California experience. It turns out that already in the 19th century, the California legislature chose not to allow enforcement of a noncompete clause. Quoting Professor Ronald Gilson of the Stanford Law School--

“The California prohibition dates to the 1870s, a serendipitous result of the historical coincidence between the codification movement in the United States and the problems confronting a new state in developing a coherent legal system out of its conflicting inheritance of Spanish, Mexican, and English law. The existence of this anachronistic legal rule at the time that Silicon Valley developed solved the collective action problem associated with encouraging employee mobility within the district.”

Fast forward to the end of the 20th century and the pre-eminence of Silicon Valley over Route 128 in Boston as the leading U.S. eco-system for high tech innovation. In explaining this, Professor AnnaLee Saxenian of the University of California, at Berkeley, argued in her influential 1994 book, “Regional Advantage”, that a key factor was that workers tended to move from company to company in Silicon Valley, while in Route 128 they tended to remain with their employer. As Saxenian explained to Fox in a 2014 interview--

“People start companies, they fail, they succeed, they move on. And that seeds new companies, and those people carry on the knowledge and the know-how but it gets recombined with other skills and technology. Whereas you can think about the 128 company as being autarkic. The company was the family was the unit, and everything stayed within the company.”

As Saxenian further observed—

“Early efforts to take legal action against departed employees proved inconclusive or protracted, and most firms came to accept high turnover as a cost of business in the region.”

Fox also points to the research of two scholars, Professor Orly Lobel of the University of San Diego and Professor On Amir of the University of California at San Diego, who argue that the alleged corrosive effects of a noncompete clause are not limited to the employee’s potential for future external employment. Lobel and Amir claim that the restrictions imposed by a non-compete clause diminish the employees “perceived ownership” of his or her job, resulting in lower employee motivation both to carry out their current job as well as to continue to develop their skills. Somewhat contrarily, Fox also mentions a study by Professor Evan Starr of the University of Maryland, arguing that a noncompete clause might actually encourage employer investment in employee training.

So what does this Kat make of Fox’s piece. Three points come to mind:

1. Fox may be overstating the capacity of a noncompetition clause per se to inhibity employee mobility. It is this Kat’s experience that even where such provisions are enforceable, courts tend to construe such restraints strictly, on the basis of reasonableness, with respect to scope, duration and territory. Each of these elements may be judicially cut back by the court, or the entire clause might be disallowed. Even when they are upheld, the erstwhile employer might be required to pay the ex-employee compensation during the duration of the noncompete period. Admittedly, there may be costs to both the employee (and employer) in sorting all of this out, but it suggests that describing them as a form of employment “tyranny” is overstated.

2. This Kat wonders to what extent noncompete provisions are sometimes conflated with an employee’s obligations to maintain in confidence the trade secrets of his or her ex-employer. Professor Saxenian is reported by Fox to have observed that Data General, once a leading computer firm on Route 128, “repeatedly sued competitors and former employees to prevent the loss of proprietary corporate information.” With all due respect, what seems to have been going here was an attempt by Data General to protect its trade secrets as much as enforcing a noncompetition clause per se. One can argue about the proper legal metes and bounds for trade secret protection and how it impacts on an innovation ecosystem, but such a discussion is legally separate from the noncompete obligation.

3. In light of (1) and (2), and circling back to the beginning of this blogpost, this Kat wonders whether Fox is not prone to the same tendency for hyperbole that characterizes the discussion on patents and innovation. Innovation is a worthy grand theme, and the present concern about the decline of innovative activity is an important, even crucial issue, for our time. How far, though, one can link restraint of trade in the form of a noncompetition clause to the grand theme of the strength of innovation within a given high tech ecosystem may be overwrought.