Summary of the FTC's Recent Rule on Non-Compete Agreements
The Federal Trade Commission (FTC) has introduced a transformative rule that bans most non-compete agreements across various industries.1 Announced on April 23, 2024, following a 3-2 vote by the FTC Commissioners, the rule represents a significant policy shift aimed at increasing market competition and employee mobility. Scheduled to take effect on August 21, 2024, the rule prohibits the use of non-compete clauses in employment contracts, marking a fundamental shift in how companies could protect their competitive interests. The rule applies nationwide and preempts conflicting state laws. Importantly, the FTC indicates other common covenants such as non-disclosure obligations, non-solicitation obligations, and/or clawback provisions (e.g., training repayment agreement provisions (TRAPs)) may still be permissible.2 This regulatory update is poised to reshape strategies concerning intellectual property (IP) and trade secret management, as well as employee development & retention, compelling businesses to adapt to a landscape where traditional restrictive covenants are no longer enforceable.
Available Strategic IP Alternatives in the Wake of the Rule
Non-disclosure obligations, non-solicitation clauses, and clawback provisions have traditionally been used in conjunction with non-compete clauses. Now such provisions may have added importance to protecting proprietary information or function as quasi-alternatives to non-competes. In the wake of the FTC's ban, businesses must explore alternative approaches to protect their investments while aligning with evolving regulatory standards and fostering a conducive work environment.
The FTC's ruling could have profound implications for how companies manage their intellectual property and trade secrets. Historically, non-compete agreements have been pivotal in helping employers safeguard their business interests, including sensitive information, key developmental areas, and trade secrets, by restricting employees' activities after their employment ends. The primary aim has been to prevent employees from potentially transferring critical information to direct competitors or becoming a competitor themselves. However, with the new FTC rule coming into force, companies may need to increasingly rely on alternative legal mechanisms, such as patents and trade secrets, and do so in timely fashion, to maintain their competitive edge.
Increasing Reliance on Patent Protection:
Traditionally, non-compete agreements were utilized by businesses to complement their patent portfolios, serving as an additional layer of protection against competitors seeking to exploit similar technologies or innovations. With the new rule, companies may want to consider the strategic use of patents, and the timing advantages afforded by patent strategies, in order to safeguard their intellectual property assets. Patents provide a robust, legally enforceable right to exclude others from exploiting an invention, offering a layer of protection that does not rely on an employee's adherence to contractual post-employment restrictions. This protection can last up to 20 years—far outliving the historically acceptable time periods for non-compete agreements. Filing decision and timing may be a critical update to many corporation's filing strategies.
Confirming Assignment & Non-Disclosure Obligations:
Typically, employment agreements require employees to assign their inventive endeavors to the corporation. Thus, taking advantage of patent filings during the employee's tenure may result in a shift in timing, and an increase in overall patent filings as businesses strive to secure extensive protections for their innovations. Further, employment agreements can include provisions that require the employee assist the prior employer with procuring patents, or other intellectual property rights. Research supports this notion, suggesting that decreasing the enforceability of non-competes significantly boosts the number of patents filed, with the value of patents relative to firm assets increasing by about 31% when non-compete enforceability decreases (Zhaozhao He, 2023).
Non-disclosure obligations are also a very common clause of many employment agreements and protect proprietary information and provide a measure of recourse for misuse. These obligations remain a vital tool for safeguarding proprietary information and trade secrets. They serve as a crucial barrier against intellectual property theft and competitive disadvantage by requiring employees, contractors, and business partners to adhere to confidentiality obligations. In the absence of non-compete agreements, these obligations take on added significance, providing businesses with a means to maintain a competitive edge while fostering innovation and trust within their workforce.
Businesses may want to revisit current non-disclosure and assignment clauses given their greater importance moving forward to ensure they are effective, appropriately tailored, and resistant to legal attacks.
Enhancing Trade Secrets Protocols:
In view of the rule, corporations also may turn to more aggressively identifying and safeguarding trade secrets, as the rule may fundamentally alter the landscape of legal disputes surrounding proprietary information. Traditionally, non-compete agreements have been a cornerstone of trade secret protection strategies, providing employers with a legal mechanism to prevent former employees from joining competitors and misusing the trade secrets.
Companies might enhance their focus on internal security measures and robust confidentiality and other restrictive covenants to properly safeguard trade secrets. Ensuring that trade secrets and proprietary knowledge remain protected under the Defend Trade Secrets Act (DTSA) and state laws will require more stringent access controls, employee training, and potentially, more aggressive legal actions against breaches. The new landscape may necessitate bolstering permitted restrictive covenants that do not overreach in scope and duration yet provide effective protection for sensitive business information. As part of this, employers are cautioned to be more diligent in identifying trade secrets early in the process, so they can be properly protected as such in the event a key employee leaves the company.
Utilizing Non-Solicitation Clauses:
Non-solicitation covenants also remain a valuable means of safeguarding proprietary information and preserving business relationships. Non-solicitation agreements, which prohibit employees from soliciting clients, customers, or other employees of their former employer for a specified period after leaving the company, play a crucial role in preventing unfair competition and preserving client goodwill. By preventing departing employees from poaching valuable clients or skilled colleagues, non-solicitation agreements help businesses maintain continuity in their operations and protect the investments made in building customer relationships and nurturing talent. In the absence of non-compete agreements, non-solicitation agreements become even more critical for businesses seeking to protect their proprietary information and preserve their competitive advantage in the marketplace. Non-disclosure and non-solicitation covenants may often be used in together for greater protection.
Companies may want to revisit non-solicitation clauses to ensure they are not overly broad such that they function to prevent workers from seeking or accepting work, or operating a business to bolster their enforceability after the FTC ban takes effect.
Potential Challenges and Strategic Considerations
The shift away from the enforceability of non-compete agreements also raises questions about the balance between promoting competition and fostering innovation and protecting proprietary information. While increased employee mobility can indeed lead to a more dynamic exchange of ideas and innovation, it also poses risks of inadvertent or intentional disclosure of proprietary information. Companies will need to navigate these waters carefully with the tools available.
Moreover, the enforcement of IP rights and confidentiality agreements will likely become more contentious, as companies adjust to the new norm and test the boundaries of legal protections in place of non-competes. This may lead to an increase in litigation as businesses more vigorously defend their IP assets and trade secrets, as well as NDA's and confidentiality agreements, in the absence of non-compete clauses.
Conclusion
The FTC's ban on non-compete agreements is set to reshape the competitive landscape, prompting companies to reassess and strengthen their IP and trade secret strategies when it comes to employees. While this change is poised to boost innovation and worker mobility, it also compels businesses to enhance their reliance on timely patent strategies and meticulous management of trade secrets, ensuring they remain competitive within an increasingly open market.
Footnotes
1. The ban includes 4 exceptions:
- Non-competes for Senior Executives before the rule's effective date;
- Non-competes entered into by a person pursuant to a bona fide sale of a business entity;
- Non-competes related to causes of action that began before the rule's effective date; and
- Circumstances where there is a good faith belief that the ban does not apply.
2. Fed. Trade Comm'n, 16 CFR Part 910, Non-Compete Clause Rule at 77 (April 23,2024) ("This prong of the definition does not categorically prohibit other types of restrictive employment agreements, for example, NDAs, TRAPs, and non-solicitation agreements. These types of agreements do not by either terms prohibit a worker from or penalize a worker for seeking or accepting other work or starting a business after they leave their job and in many instances may not have that functional effect, either. However, the term 'functions to prevent' clarifies that, if an employer adopts a term or condition that is so broad or onerous that it has the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends, such a term is a con-compete clause under the final rule.") (available at https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.