Innovation-Killing Noncompete Agreements Are Finally Dying

One of the most stunning twists in the recent five-day crisis at ChatGPT creator OpenAI came when some 95 percent of the company’s hundreds of employees threatened to quit. The staff planned to follow CEO Sam Altman to develop successors to ChatGPT at Microsoft instead. The threat appeared to mark a turning point in Altman’s ultimately successful attempt to return to OpenAI—it was also a scenario that businesses have the legal power to block in most US states.

California, home to OpenAI’s San Francisco HQ, is one of a handful states that bar the enforcement of noncompete agreements in employment contracts, which can forbid employees from hopping jobs to a competitor, often for years. That picture is now set to change, as a raft of new legislation aims to make more places like California.

Until this year, Oklahoma and North Dakota were the only states besides California that outlawed the enforcement of noncompetes. Over the past several months, more states began to follow suit, motivated in part by new research revealing the negative impact of NCAs on innovation and wages.

So far during the 2023 legislative session, 38 states have introduced a whopping 81 bills aimed at banning or curtailing NCA enforcement, according to the Economic Innovation Group (EIG), a public policy organization founded by Napster cofounder Sean Parker. The proposed laws range from industry-specific prohibitions to more sweeping bans. In total, 10 states have enacted some form of limitation on the agreements this year.

According to research from the Universities of Maryland and Michigan, nearly one of five US workers are subject to noncompete agreements, and a third of those are presented after the worker has accepted a job offer. In tech, that number is significantly higher: 35 percent of people working in computer- and math-related vocations and 36 percent of engineers work under noncompetes, the highest share of workers in all industries alongside architects, according to the paper. If not for California’s ban, that number would surely be higher. More than half of US states even allow companies to use NCAs to bind employees after they have been laid off, according to an analysis by the law firm Beck Reed Riden.

Those numbers now look set to shift. In July, Minnesota became the first state in over a century to enact a near-total ban on NCA enforcement. (All the bans allow for a narrow list of exceptions, such as permitting an entrepreneur who sells their business from immediately starting a competitor.) Meanwhile, the EIC, labor groups, and antitrust advocates are pressuring New York governor Kathy Hochul to sign a ban that the state assembly passed this summer.

At the federal level, the National Labor Relations Board declared this year that noncompetes violate the National Labor Relations Act, and the Federal Trade Commission proposed a rule that would ban the practice nationwide. Bloomberg Law reported that the agency is expected to finalize the rule in April, although business groups are likely to challenge it. In February, lawmakers reintroduced the bipartisan Workforce Mobility Act into the Senate, which would outlaw noncompetes in all but a few scenarios. California even strengthened its ban this year, outlawing the enforcement of noncompete agreements signed in other states and making it illegal to require an NCA.

California’s noncompete laws have famously been credited with helping birth Silicon Valley. “The traitorous eight,” a group of employees of Shockley Semiconductor, a pioneer of silicon-based semiconductors, decamped to found rival Fairchild Semiconductor in 1957, then some of them left to start Intel a decade later. Steves Jobs and Wozniak left posts at Atari and HP in the mid-1970s and started Apple. In 2011, Eric Yuan quit Cisco after the company rejected his idea for a video conferencing system. That same year he founded Zoom. The list goes on. A national ban on noncompetes could open the door for new startups in states like Texas and Florida where tech companies have flocked in recent years.

If OpenAI was based in either of these states and Altman and its staff had signed noncompetes, they couldn’t have defected to Microsoft—certainly not to work on the same type of product. The allowable scope of NCAs varies by state, but they typically preclude workers from doing similar work for their employer’s competitor. Altman could not have launched an independent competitor either, as he was reported to be considering. In that world, he may have been left out of a job while OpenAI’s stopgap CEO, former Twitch boss Emmett Shear, helmed the AI revolution. It’s not unusual for noncompetes to require a worker or entrepreneur to sit out an entire industry for years. OpenAI did not respond to a request for comment.

Proponents of barring NCAs like to bring up David Neeleman, who left Texas-based Southwest Airlines in 1993 and founded JetBlue. But he had to wait five years because he’d signed a noncompete that prevented him from working for another airline. “It's not just a loss to him. It's a loss to consumers because he had all these wonderful ideas about how to innovate the commercial airline industry,” says Orly Lobel, a law professor at the University of San Diego who led the drafting of the recent law strengthening California’s ban. “Stuff we now take for granted like choosing seats online and having a TV on the back of the seats. These were innovations that he introduced, but could not deploy into the world because of noncompetes.”

The extent to which an NCA can limit someone’s job prospects is not set in stone, but governed by what a state court deems “reasonable” in duration, geography, and scope. Interpretations vary widely by state, says Lobel. In states like Texas, even before a case is decided, an employer can get an injunction to stop an employee from starting their new job, says University of Houston law professor Alissa Gomez. “So if you win that, you’ve kind of won the whole thing.”

Proponents of NCAs argue that they encourage a company to invest in their staff because managers don’t have to worry that employees will abscond with their specialized training. Evan Starr, a professor at the University of Maryland’s Smith School of Business who coauthored the study on the prevalence of NCAs, says that the agreements do correlate with greater investment. But overall, innovation still suffers: Employee mobility, entrepreneurship, information flow across firms, and the effort employees put into their work all suffer when NCA enforcement goes up, Starr writes in an October report for policymakers that summarizes noncompete research.

Earlier this year, researchers at Duke and the FTC analyzed state-level changes to the enforceability of noncompetes between 1991 and 2014 and found that an average increase in strictness led to a 16 to 19 percent reduction in patents over the following 10 years.

Research shows that NCAs also harm workers. Starr’s report points to several recentstudies which found that workers who labor under noncompetes earn less than those without them, and that when states enforce the agreements more stringently, wages fall. When employees bound by NCAs do change jobs, they often take professional detours or sometimes sever their professional networks out of fear of being caught potentially violating their noncompete, says Lobel.

Many employers still ask workers in jurisdictions where noncompetes aren’t enforceable to sign the agreements, and research shows they still have a chilling effect on employee freedoms. That’s why California recently strengthened its law to deter the practice.

Companies can still go after employees who leave for a competitor, even in states like California. Although it has one of the firmest blocks on noncompetes, it also has one of the highest rates of trade secret litigation, says Elizabeth Rowe, a University of Virginia law professor and expert on trade secret law. Companies can use that approach to try and protect just about any secret, she says, including business and marketing plans, customer data, code, and AI training data. Had OpenAI staff jumped to Microsoft to work on AI, they may have had to tread carefully.

Instead, Altman and his loyal staff were reunited at OpenAI. “It’s interesting to think about a world where Sam Altman did have a noncompete,” says Starr. “What would happen if he was fired and he had to sit out of the AI world for two or five years? We might all suffer because of that.” Perhaps. Although reasonable minds may differ.

Updated 12-5-2023 2:45 pm EST: Orly Lobel is at the University of San Diego, not UC San Diego.

Updated 12-5-2023 12:25 pm EST: Research on the enforceability of noncompetes was carried out by Duke and the FTC, but not Stanford.