The FTC has a plan it says would empower workers with an additional $300 billion in wages per year. While the proposal remains in the public-comments phase, corporate America has already begun chiming in, with most business leaders criticizing the proposal. It remains to be seen whether the new rule will survive, but as Steve Carey, Sarah Hutchins and Tory Summey of Parker Poe discuss, now is the time for companies to evaluate their use of noncompetes.
The FTC’s proposal to ban noncompete agreements has provoked an Edvard Munch-type scream from business leaders in essentially every industry sector. The reaction makes sense, as noncompetes have become a key part of many businesses’ strategy to protect themselves from loss of personnel and information to their competitors.
If the FTC is ultimately successful in banning noncompetes — and that is a big “if,” as we will discuss below — other defensive options remain. Companies that are overly reliant on the protections afforded by noncompete agreements should take the time to reconsider their strategies even if the ban does not take effect. Aside from the FTC’s current posture, a number of courts across the country are already more reluctant to enforce noncompetes. Some existing state-level legislation also targets these agreements, making other protective agreements and information practices critical in many areas of the country. Further, as noncompetes become subject to more limitations, we anticipate competition litigation to increasingly center around other activity, especially trade secret misappropriation.
A proposal by the FTC to ban noncompete agreements in employment has been widely criticized by business groups, with the U.S. Chamber of Commerce threatening a lawsuit if it goes into effect. But, as Seyfarth Shaw’s Robert Milligan discusses, the potential noncompete ban is just the latest in the agency’s self-described crackdown over what it views as unfair labor practices, so companies need to take a clear-eyed look at their contracts.Read more
The proposed ban and its exceptions
In early January, the FTC published a proposed rule that would declare most U.S. noncompetition agreements unlawful, with limited exceptions. The rule would proactively prohibit employers from entering into noncompete clauses and require employers to rescind all existing noncompete clauses. It would also preempt all inconsistent state and local laws or regulations.
While the proposed rule would invalidate a multitude of agreements, it also includes important exceptions. The definition of a noncompete clause would not include ordinary nondisclosure agreements or client/customer non-solicitation agreements. Additionally, the rule would permit noncompete agreements between the buyer and seller of a business in order to protect the value of a business acquired by the buyer. While these exceptions would be important to businesses in the merger and acquisition space or those intent on protecting key business relationships, the rule clearly contemplates putting an end to the traditional employee noncompete agreement.
A relatively new law (the Defend Trade Secrets Act) aims to give businesses a legal framework to fight against theft of trade secrets by insiders. María Amelia Calaf of Wittliff Cutter explains the nuances of the law and discusses how businesses can prevent misappropriation of valuable trade secrets.Read more
Implementation of the rule and likely challenges
The FTC says it has the authority to implement that rule through its power to regulate “unfair methods of competition” under Section 5 of the Federal Trade Commission Act. Whether that authority exists will be a major focus of litigation should the rule move forward, as many question how the agency only recently discovered a superpower hidden in Section 5 after enforcing it for over 100 years.
That said, challenges to the rule will face hurdles. Those include finding plaintiffs who have proper standing to challenge the rule, as well as attempting to secure a nationwide injunction against it. The judicial process may take time to play out and could reach the U.S. Supreme Court, so it’s possible that businesses will need to operate under the rule for a period.
The public has until March 20 to comment on the rule. After that, the FTC will publish a final rule and may attempt enforcement within 180 days after the publication of that final rule.
How to protect your company
The FTC made it clear that the rule will not bar several other options businesses use to protect their competitive edge, including nondisclosure agreements, non-solicitation agreements and trade secret protections. Many businesses already use those tools, and they should sharpen them ahead of the potential ban going into effect.
First, businesses can require non-solicitation agreements for employees responsible for key relationships, such as with clients, customers, referral sources and vendors. Those agreements prevent departing employees from poaching — or encouraging those key relationships to join them at their new employer.
Those agreements, however, are not without limit. Typically, state law requires that they be reasonable in time and focused on the relationships the employee was directly involved in and maintained close to the employee’s departure. A non-solicitation agreement cannot, for example, apply to every client your business has ever had.
Second, businesses can require nondisclosure agreements for all employees with access to proprietary information. The more specific the agreements are in identifying confidential information, the more likely courts will be to uphold them. In conjunction with these agreements, businesses should take practical steps to protect the described confidential information, including restricting access to information and implementing access and dissemination protections.
Courts across the country generally look more favorably at those agreements because they are already targeted by their very nature at a legitimate business interest — an existing relationship for the non-solicitation agreements and existing private and valuable information for nondisclosure agreements.
Instead of preventing employees from competing or working in their field, these agreements merely keep them from breaking up a professional relationship that was already existing or disclosing information they learned from their previous employment. That being said, a business should be clear that its goal is protecting the company and not preventing future employment. To avoid any argument to the contrary, nondisclosure and non-solicitation agreements could include language specifying they do not functionally prevent working elsewhere.
While a nondisclosure agreement provides good protections against the disclosure of confidential information, the law also provides additional protections to the narrow universe of trade secrets, enforced by civil and in some cases criminal liability. The Defend Trade Secrets Act offers protection at the federal level, and most states have adopted comparable protections. In fact, case law in some states has established a duty of loyalty or good faith and fair dealing that could be implicated when, for example, an employee starts a competing business using trade secrets.
To avail themselves of those trade secret protections, businesses must first take steps to ensure the information is kept secret. That starts by identifying the trade secrets with specificity in agreements or when discussing the information internally.
It continues with due diligence. Policies and training should be implemented to ensure employees know what is secret and that it may not be disclosed. That can be coupled with some protective data hygiene, including limiting the secrets to a subset of employees who truly need them to do their jobs. Businesses could also apply safeguards to prevent the export of those secrets. File-tracking software can be particularly useful in that regard, as can restrictions on certain types of cloud access and prohibiting external devices on company hardware. If, notwithstanding those protective measures, an employee walks off with trade secrets or takes them to a competitor, a business can sue to enforce its rights and even seek an injunction against further misappropriation.
Finally, from a practical perspective, businesses can implement several actions to enhance the legal protections for their key information and relationships. Robust onboarding and offboarding procedures to ensure valid agreements, protection of data and the return of information upon departure are essential. Think of the written agreements as the first step. The next step is putting controls in place to ensure employees understand them and do not violate them. Additionally, having strong controls as part of the onboarding process can significantly reduce the risk of inadvertently benefiting from another company’s proprietary information and becoming the target of a lawsuit from a competitor.
The combination of the agreements, laws and practices described above can be especially potent. Our experience in litigation is that judges are much more willing to enforce contractual rights when there is evidence of strong information protection measures, coupled with brazen trade secret misappropriation.
How litigation — and costs — may shift
If the FTC’s ban goes into effect, businesses may need to anticipate an increase in trade secret litigation. Without a noncompete to enforce, businesses may increasingly use as a weapon alleged infringement of their confidential information or trade secrets by departing employees. That is especially likely in jurisdictions with strong case law on the inevitable disclosure doctrine. That doctrine says, in essence, if employees know the secret sauce and go to a competitor, they will inevitably disclose it.
However, the use of trade secret litigation in place of noncompete litigation may come with a higher burden on the business filing the claim. If an employee is subject to a noncompete and goes to a competitor, that’s easy to prove. But with trade secret misappropriation, the burden is on the victim to show it had a trade secret, protected it and that it was taken or disclosed. Much of that evidence is not available until the damage has already been done, while a business can move earlier and prevent harm by enforcing a noncompete. If that burden shifts, it will be even more important for companies to lay the groundwork to move quickly on trade secret claims, including through some of the best practices we described in the previous section.
The increase in trade secret litigation would also result in more business-to-business lawsuits, while the focus of noncompete lawsuits is typically on the employee. That could increase legal costs for businesses, as they would face increasing liability and, in many cases, a longer process to litigate a trade secret misappropriation claim. That claim may never have been brought in the first place if the victim business could file a noncompete claim.
In fact, using the threat of imposing legal costs against competitors allegedly misappropriating trade secret claims could become a new strategy. Businesses could claim the employee was hired to steal their trade secrets, and if that lawsuit makes it past a motion to dismiss, it would become expensive to defend. In that way, banning the more straightforward noncompete agreement could create a perverse incentive for deep-pocketed companies to bring lawsuits that may not have the strongest facts behind them but will impose significant costs on their competitors, thus creating a new deterrent to hiring their employees.
Even if the FTC’s proposed rule gets scrapped, now is a good time to consider all available competitive defenses at your disposal. States already increasingly view noncompetes with skepticism, with California, Oklahoma and North Dakota, for example, passing laws strictly limiting such clauses. The FTC’s proposed rule will likely get the attention of other state legislatures, who may use parts of it as a blueprint for their own laws. There are also numerous courts that have curtailed the reach of noncompetes, often ruling they are too broad.
For those reasons, companies should be thoughtful about the restrictions they are using right now and what other tools they should consider.