“Whereas non-compete clauses can preclude a former employee’s opportunity to disseminate confidential or proprietary information, trade secret enforcement through civil litigation often only provides after-the-fact consequences once harm has already been done.”
In January 2023, the Federal Trade Commission (FTC) unveiled a proposed ban on non-compete clauses that prohibits employees from joining or forming competitive firms following the termination of their employment. According to the FTC, non-compete clauses unfairly and unnecessarily stifle employees’ ability to pursue better employment opportunities. While this criticism may ring true in the case of lower-wage workers, such as restaurant and warehouse employees, even the staunchest critics of non-compete clauses will typically acknowledge that they can — and often do — play a legitimate role in the protection of trade secrets. This is why the FTC’s proposed rulemaking is causing consternation in the intellectual property community.
President Biden made worker’s rights a prominent part of his presidential campaign, so it is of little surprise that his administration is now proposing rulemaking targeting non-compete clauses. However, many commentators hoped that any restrictions on non-compete clauses would only alleviate their enforceability against low-wage workers. The FTC’s proposed rule dampens those hopes, as it would categorically ban virtually all non-compete clauses, with only a limited exception for non-compete clauses between the sellers and buyers of a business.
Alternatives to Non-Competes Can Be Problematic
In the Supplemental Information to the proposed rule, the FTC acknowledges that protecting trade secrets is a commonly cited justification for non-compete clauses. For many businesses, trade secrets are one of their most valuable assets. This is especially true as certain types of information—including research and development activities, customer and supplier lists, business and marketing plans, and procedures or processes—are incompatible with other forms of intellectual property protection (e.g., patent, copyright, or trademark protection) and thus only provide a competitive advantage to a business if kept secret.
The FTC downplays the protection-of-trade-secrets justification for non-compete clauses by arguing that employers have alternatives available under trade secret law for protecting valuable investments. For example, the FTC identifies that nearly every state has approved the Uniform Trade Secrets Act (UTSA) and that Congress enacted the Defend Trade Secrets Act of 2016 (DTSA), both of which provide a civil cause of action for trade secret misappropriation. The FTC further emphasizes the proposed rule would still permit employers to use non-disclosure agreements to protect and enforce their trade secrets, so long as the non-disclosure agreement is not written broadly enough to serve as a de facto non-compete clause.
While trade secret law and non-disclosure agreements provide some recourse where former employees disseminate their prior employer’s trade secrets to a new employer, the protections offered are not without limitations. Whereas non-compete clauses can preclude a former employee’s opportunity to disseminate confidential or proprietary information, trade secret enforcement through civil litigation often only provides after-the-fact consequences once harm has already been done. Of course, the value of trade secrets is in their secrecy, and once that secrecy is lost, it cannot be recovered.
Courts in some states may prospectively enjoin a worker from performing a similar job for a competitor under the “inevitable disclosure doctrine.” However, this doctrine is not universally accepted, and even where the doctrine is recognized, such injunctions are considered an extraordinary remedy. Further, whether the “inevitable disclosure doctrine” would survive the FTC’s express inclusion of non-disclosure agreements that act as de facto non-compete clauses within the proposed rule is unclear.
Discovering the misappropriation of trade secrets is incredibly difficult, even after the fact. The former employer will typically only have limited information about its former employee’s activities in their new job. Further, the use of trade secrets may not be evident outside the new employer.
An additional difficulty arises in defining the trade secret—a key prima facie element of proving the misappropriation of the trade secret. While some trade secrets are easily identifiable (e.g., customer lists, formulations, and source code), other trade secrets (such as know-how and strategic planning) are less identifiable but potentially just as valuable. For example, the knowledge of what research was conducted and found unsuccessful by the former employer can give a new employer an unfair advantage by influencing the direction of its research. Similarly, executives exposed to their former employers’ strategic planning will undoubtedly be influenced by this knowledge when assisting their new employer in developing its strategic plans to compete.
Not a Done Deal
Notably, the FTC’s proposed rule is preliminary and currently in its 60-day comment period. Thus, the FTC’s proposed rule is not ensured to be enacted, much less enacted in its current form. The FTC is specifically seeking comments regarding whether the proposed rule should apply uniformly to all workers—as currently proposed—or whether there should be exemptions or different standards for different categories of workers. Under this alternative, different standards may apply to different workers based on the workers’ job function, occupation, or earnings. For example, the final rule could include an exemption allowing non-compete clauses for senior executives.
Even if the FTC’s proposed rule is never enacted, it is critical for businesses concerned with protecting their trade secrets to recognize that the enforceability of non-compete clauses already varies significantly from state to state. California, North Dakota, and Oklahoma long ago adopted statutes rendering non-compete clauses void in most circumstances (Cal. Bus. & Prof. Code sec. 16600; N.D. Cent. Code sec. 9-08-06; Okla. Stat. Ann. tit. 15, sec. 219A). Several other states have more recently passed restrictions on non-compete clauses based on the worker’s earnings or exemption status under the Fair Labor Standards Act. Even where non-compete clauses are permitted, they are generally considered “disfavored” and typically subject to a reasonableness inquiry.
Additional Steps to Protect Your Secrets
There has been a clear trend toward reducing the enforceability of non-compete clauses, even before the FTC’s proposed rule. With this in mind, employers should analyze their current non-compete clauses to ensure they comply with their state’s law. Even in states where non-compete clauses are not categorically void, they are more likely to withstand scrutiny when narrowly tailored to meet the business’s needs. This includes implementing non-compete clauses only on employees who are legitimately exposed to the employer’s confidential or proprietary information, specifying specific competitors if feasible, and ensuring the duration and geographic scope of the restraints are justifiable.
Further, employers should consider additional strategies beyond non-compete clauses to appropriately protect their trade secrets and confidential information. This includes the use of non-disclosure and non-solicitation agreements with employees. As addressed above, non-disclosure agreements can be challenging to enforce. Accordingly, non-compete clauses and non-disclosure agreements may be coupled with additional practices such as improved handling of trade secrets (e.g., password protecting and limiting the distribution of highly confidential documents) and employee retention incentives for key employees.
In summary, the FTC’s proposed ban on non-compete clauses would certainly weaken employers’ ability to protect their trade secrets when their employees seek to switch employment. However, the enactment of the FTC’s proposed rule is far from certain. Still, there is a trend away from the enforceability of non-compete clauses. As such, employers should narrowly tailor their use of non-compete clauses, adopt the use of non-disclosure and non-solicitation agreements, and consider the incorporation of additional policies to limit the access to trade secrets and retain the high-quality employees who have access to them.
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