A Brief Analysis of Noncompete Agreements: A Legal Perspective on the Trade-off Between Protecting Intellectual Property Rights and Labor Market Competition
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Although proponents of free market capitalism are often concerned that regulation allows for government overreach, the law plays a critical role in ensuring that American markets remain free and fair. This is particularly evident in the development and use of noncompetition agreements or covenants not to compete, widely known as “noncompete clauses.” Noncompete clauses are agreements between two parties, often employer and employee, in which the employee promises not to reveal “trade secrets or privileged information” to the employer’s competitors for a given period of time after separation. Noncompete clauses can therefore be understood in one view as a protection for firms’ intellectual property rights. Around 30 million workers, meaning nearly one in five Americans, are estimated to be subject to a noncompete.
Thought to have originated in English common law, noncompete clauses have a long and complex history. The first known use of a noncompete clause occurred with “Dyer’s Case” in 1414, when an English apprentice named John Dyer entered into an agreement barring him from practicing the trade he had trained in for six months in his town. In the United States, noncompetes have historically been within the purview of individual states. While the vast majority of states have allowed noncompetes in order to prevent “unfair competition,” three have essentially banned employee noncompetes: California, North Dakota, and Oklahoma. Noncompete agreements are thought to inhibit “economic development, wage growth, innovation, entrepreneurship, and competition.” This is exemplified by the unparalleled growth and innovation in Silicon Valley, which is subject to California’s noncompete bans.
Around 2007, as the technology sector came into vogue, other states like Oregon, Massachusetts, and Georgia began to reevaluate their noncompete laws as well. In fact, more than 37 states have reviewed their noncompete laws in the past two decades, with 66 noncompete bills pending in 25 states. Notably, no states have thus far fully banned compete agreements, although ten states have banned noncompete agreements for low-wage or low-skilled workers and seven have introduced notice requirements. This issue came into the public eye in 2014 with news that fast food chain Jimmy John’s was requiring its sandwich-maker employees to sign noncompetes.
This was considered irrational, as noncompetes were meant to protect trade secrets and establish temporary monopolies on the human capital of highly skilled workers, thereby protecting intellectual property rights. In the view of many Americans, noncompetes were not intended to prevent entry-level, lower-skilled workers—like Jimmy John’s employees—from working at other fast food chains. This resulted in settlements between Jimmy John’s and state attorneys general in Illinois and New York, and further momentum amongst states, attorneys general, researchers, and employees in cracking down on the abuse of noncompete agreements and advocating for reform.
With an influx of research on the effects of noncompete agreements on economic factors like wage growth, entrepreneurship, innovation, labor mobility, and competition, the Federal Trade Commission (FTC) implemented a new rule in 2024, banning noncompetes throughout the nation. This complements efforts in all 50 states to pose some kind of restriction or ban on noncompetes, as well as 70 noncompete bills being considered in 31 states in 2024 and at least 75 being considered in 35 states. The FTC’s 2024 rule aimed to protect workers’ freedom to move between jobs, increase innovation, and promote new businesses. The FTC estimated that the nationwide noncompete ban would increase new business formation by 2.7% each year, creating more than 8,500 new businesses per year, increasing earnings for the average worker by $524 per year, and lowering health care costs by an expected $194 billion over the next ten years. The noncompete ban is also expected to facilitate an average increase of 17,000 to 29,000 more patents per year for the next ten years, representing a significant surge in innovation.
The FTC’s 2024 rule would bar all new noncompetes and only allow existing noncompetes to remain intact for senior executives (less than 0.75% of the workforce). The FTC cited the negative effects of noncompetes on competition in labor markets as well as on new business formation and innovation in goods and services markets as justification. The FTC also found that noncompetes promoted increased market concentration and higher prices for consumers. The Commission suggested alternatives like trade secret laws, non-disclosure agreements, and efficiency wages in order to maximize employee retention and protect intellectual property rights without infringing on workers’ freedom to change jobs.
However, shortly after the FTC implemented the noncompete ban, it was blocked by a Texas federal court as an “arbitrary and capricious” action that extended beyond the Commission’s authority. Therefore, rather than the nationwide ban, laws surrounding noncompetes continue to vary from state to state, creating a high degree of uncertainty and complexity for firms and employees alike. Not only do limits on noncompetes differ between states, but even states permitting noncompetes only enforce them to the extent that they “protect a legitimate business interest and are reasonable in scope of time, geography and restricted activities.” “Reasonable” is an ambiguous term that may create legal confusion and unpredictability. For instance, an employee could move across state lines to circumvent a non-compete, as in the case of DraftKings v. Hermalyn in 2024.
In DraftKings v. Hermalyn, an executive who had entered into a Massachusetts noncompete moved to California to evade his noncompete and work for a competitor. His former employer filed a lawsuit in Massachusetts enforcing the noncompete, which was eventually supported by a First Circuit Court ruling that California’s legal interests were not “materially greater” than those of Massachusetts; essentially, Massachusetts law prevailed. Although in this case the noncompete was enforced over state lines, DraftKings v. Hermalyn still exemplifies the legal intricacies of noncompetes in the status quo, which are especially difficult to navigate for startups and other new or small businesses. While noncompetes are intended to promote business interests, they can actually advantage large corporations with extensive legal resources while harming small businesses and everyday Americans.
In the end, although the FTC’s federal ban failed, the Commission continues to monitor the labor market for practices that inhibit competition and fairness. Moving forward, the development of federal and state regulations surrounding noncompetes will continue to shape the economy, both through the labor market and through innovation and competition.
Aditi is a second-year studying Economics and International and Public Affairs at Brown University. She is a staff writer for the Brown Undergraduate Law Review and can be reached at aditi_bhattacharjya@brown.edu.
Ashley is a second-year studying Cognitive Neuroscience and Political Science at Brown University. She is an editor for the Brown Undergraduate Law Review and can be reached at ashley_h_park@brown.edu
Priyanka is a sophomore studying Cognitive Neuroscience with a certificate in Data Fluency. She is an editor for the Brown Undergraduate Law Review and can be reached at priyanka_nambiar@brown.edu.