Will the Extinction of Noncompetes Lead to More Trade Secrets Litigation?
7.29.2024
One major purpose for noncompete agreements is protecting a company’s trade secrets and other proprietary and confidential information. By preventing former employees from working with competitors, noncompete agreements can be an effective tool in preventing the dissemination of trade secrets and other information to those competitors. Due to a new rule recently promulgated by the Federal Trade Commission, noncompete agreements are effectively extinct. Companies will now need to reevaluate the tools they use to protect their trade secrets and other proprietary and confidential information from competitors.
Since 2021, the Biden administration has taken a firm stance against noncompete agreements. On July 9, 2021, the Biden administration issued Executive Order 14036, the Executive Order on Promoting Competition in the American Economy, in order to increase competition in the U.S. economy.[1] One of the major goals of that executive order was to “[e]ncourage[] the FTC to ban or limit noncompete agreements” and “[e]ncourage[] the FTC to ban unnecessary occupational licensing restrictions that impede economic mobility.”[2] Notably, the executive order did not mention trade secrets and the importance of noncompete agreements in preventing misappropriation of trade secrets.
In line with the executive order, on April 23, 2024, the FTC voted to approve a rule that will largely bar noncompete agreements; this is known as the “Noncompete Clause Rule.” It essentially bans any clauses in employment agreements that prevent former employees from working for competitors. The rule was originally proposed on Jan. 19, 2023 and on May 7, 2024 and was published in the Federal Register.[3] The rule will go into effect on Sept. 4, 2024, so companies still have time to prepare for the rule and adjust their practices.
Several cases have already been filed to challenge the legitimacy of the Noncompete Clause Rule. On July 3, 2024, the district court in one of those cases found that the rule was invalid and issued a preliminary injunction barring the FTC from enforcing it against the parties involved in that specific case.[4] While these cases are pending, companies should prepare for all outcomes – one in which the rule is upheld and one in which it is overturned by the courts. If the rule survives these court challenges, trade secrets will become even more important in filling the void left by noncompete agreements. In preparing for that outcome, the following suggestions can help companies prepare for the extinction of most noncompete agreements if the rule goes into effect later this year.
The FTC’s New Noncompete Clause Rule
Under Section 6(g) of the FTC Act, the FTC has the power to issue rules and regulations to “carry out[] the provisions” of the FTC Act. Within that regime, the FTC’s authority to issue the Noncompete Clause Rule falls under the authority delegated to it by Congress under Section 5 of the FTC Act, which has been interpreted to allow the FTC to promulgate certain rules that prevent unfair methods of competition.
The Noncompete Clause Rule defines a “noncompete clause” as “[a] term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from” (1) “[s]eeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition” or (2) “[o]perating a business in the United States after the conclusion of the employment that includes the term or condition.”[5] The rule prohibits such noncompete clauses, regardless of the type of agreement in which they appear.
The Noncompete Clause Rule has two parts – one directed to future noncompete clauses, and one directed to existing noncompete clauses. For future noncompete clauses drafted after the effective date, the rule considers all such clauses to be prohibited as a violation of Section 5 of the FTC Act. For existing noncompete agreements, the rule treats “senior executives” differently than other employees.[6] Existing noncompete agreements for senior executives will remain enforceable, but all other existing noncompete agreements are retroactively banned.
How Will the New Rule Affect Trade Secrets?
By essentially eliminating noncompete agreements, the Noncompete Clause Rule will likely make trade secrets even more important for companies in maintaining their competitive edge. The extinction of noncompete agreements leaves a gap in companies’ armor that needs to be filled. Noncompete agreements certainly prevented some former employees from stealing their former employer’s trade secrets. Without that type of restriction, those employees may now be emboldened to take trade secrets that they would have left behind when faced with noncompete clauses.
One way for companies to fill that gap in their armor is by asserting their trade secrets more often and more aggressively. If companies cannot prevent former employees from working for competitors, they can still choose to sue those former employees or their new employers for misappropriation of trade secrets. Since the FTC’s ban on noncompete agreements is intended to increase the mobility of employees, the potential for misappropriation of trade secrets will likely increase too. Thus, one would expect that increased employee mobility would lead to an increase in what is known as “employee mobility” litigation – cases where companies sue former employees for sharing trade secrets and other proprietary information with new employers. Employee mobility litigation is especially prevalent when the new employer is a direct competitor with the former employer. Choosing to assert trade secrets more often and more aggressively may also have a deterrent effect on other employees who are considering leaving a company and on competitors who are thinking about hiring those employees.
What Can Companies Do To Prepare for the Noncompete Clause Rule?
With this major change in employment law and trade secrets protection, it is imperative that in-house counsel are proactive in adjusting to the Noncompete Clause Rule. Below are several issues that in-house counsel should consider in reformulating their strategies with former employees. In addition, companies should prepare to provide proper notice to their employees about which noncompete agreements are no longer enforceable, as required by the rule.[7]
- Review Your Employment Agreements
One of the first things a company should do is review its employment agreements and figure out which agreements are subject to the Noncompete Clause Rule and which are not. Part of this process should involve determining which employees are considered “senior executives” under the rule’s definition in order to identify noncompete agreements that can still be enforced. Another part of this process should also involve determining whether any other agreements, besides typical noncompete agreements, intentionally or unintentionally include “noncompete” clauses under the rule’s definition. For example, non-disclosure and non-solicitation agreements are not noncompete agreements per se but could still contain restrictive language that would be considered a “noncompete” clause.
- Consider Updating Your Non-Disclosure and Non-Solicitation Agreements
With noncompete agreements largely off the table, companies can focus on other types of agreements to protect their trade secrets and other proprietary information. In particular, companies should revisit their non-disclosure and non-solicitation agreements and ensure that those agreements specifically cover the ways in which former employees are prohibited from using proprietary information and customer contacts at new employers. And, of course, companies should ensure that non-disclosure and non-solicitation agreements do not contain noncompete clauses.
- Take Stock of Your Trade Secrets
There is an ongoing debate about whether companies should inventory their trade secrets and, if they do, how specific and detailed they should make the inventory. The potential downside to inventorying trade secrets is that the inventory may affect future litigation of a company’s trade secrets if the inventory is inaccurate. But, as discussed above, the extinction of noncompete agreements will likely make trade secrets even more important for the protection of proprietary information, and companies may need to assert their trade secrets more often to fill the gap left by the Noncompete Clause Rule. In order to assert trade secrets effectively, companies need to understand (1) which trade secrets were disclosed to former employees and (2) whether former employees left with information containing trade secrets. Companies need to have a sufficient understanding of their trade secrets in order to make those determinations and effectively monitor former employees. One way to understand your trade secrets is to take some sort of inventory of them.
- Look to the Lanham Act and Other Statutes
In addition to relying on other types of agreements to fill the gap left by the Noncompete Clause Rule, in-house counsel should also look to other enforcement avenues. One of those enforcement avenues is the Lanham Act, which includes causes of action for both false advertising and unfair competition. While a company may not be able to prevent a former employee from joining a competitor, the Lanham Act can be used as a tool to take action if former employees are using proprietary information in a way that falls under the false advertising or unfair competition provisions of the Lanham Act.
Besides the Lanham Act, unfair competition laws from individual states can be useful to fill the gap left by the Noncompete Clause Rule. The rule preempts state laws that conflict with the final rule, so preemption is likely focused mainly on state laws that currently allow noncompete agreements. But the rule will likely not displace state unfair competition laws, such as California’s Unfair Competition Law. Under those state laws, it may still be unlawful for an employee to move to a competitor and engage in activities that are considered unfair or anticompetitive.
- Monitor Pending Litigation Challenging the Noncompete Clause Rule
In-house counsel should closely follow the cases challenging the Noncompete Clause Rule. That litigation may determine whether the rule is valid, whether the effective date is delayed or stayed and how certain provisions of the rule are likely to be interpreted by the courts.
Conclusion
As with any new rule or law, it will take time for the true contours of the FTC’s Noncompete Clause Rule to emerge. For example, it will be interesting to see if any non-disclosure or non-solicitation agreements are interpreted as quasi-noncompete agreements and deemed to violate the rule. We will also have to wait to see how often the rule is enforced by the FTC and whether the FTC focuses on enforcing the rule against any particular industries or types of companies. In the meantime, despite the pending cases challenging the rule, in-house counsel should prepare their employees and companies for the coming extinction of noncompete agreements.
Jonathan Barbee is counsel at MoloLamken with a focus on intellectual property and technology-related litigation. He serves on the Executive Committee of NYSBA’s Corporate Counsel Section and is editor of its publication, Inside.
This article appears in a forthcoming issue of Inside, the publication of the Corporate Counsel Section. For more information, please visit NYSBA.ORG/IPS.
Endnotes
[1] FACT SHEET: Executive Order on Promoting Competition in the American Economy, White House, July 9, 2021, https://www.whitehouse.gov/briefing-room/statements-releases/2021/07/09/fact-sheet-executive-order-on-promoting-competition-in-the-american-economy/.
[2] Id.
[3] Noncompete Clause Rule, Federal Register, May 7, 2024, https://www.federalregister.gov/documents/2024/05/07/2024-09171/noncompete-clause-rule.
[4] Ryan LLC v. Federal Trade Commission, No. 24-cv-986 (N.D. Tex. July 3, 2024).
[5] 16 C.F.R. § 910.1.
[6] “Senior executives” are defined as employees who are in a “policy-making position” and earn at least $151,164 in compensation. 16 C.F.R. § 910.1.
[7] 16 C.F.R. § 910.2(b).
