The FTC’s Ban on Non-competes and Alternatives to Protecting Proprietary Information
Understanding the Impact of the FTC Rule on Non-compete Agreements
In April of this year, the Federal Trade Commission (FTC) issued a final rule banning post-employment non-compete agreements or clauses between employers and employees. While the FTC is certain to face legal challenges and the long-term efficacy of the new rule remains to be seen, employers and employees alike are best served to understand the Impact of the FTC rule on non-compete agreements, slated to take effect on September 4, 2024.
Definition of “Non-compete” Clause Key to FTC Ban of Non-competes
As defined by the FTC, a “non-compete clause” is “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking 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) operating a business in the United States after the conclusion of the employment that includes the term or condition.” Such clauses often limit the scope of future employment for a stated period of time or a specific geographic area (i.e., within “x” miles of the former employer). Historically, noncompete agreements have been used to temporarily restrict employees from working for a competitor or starting a competing business after leaving an employer in order to protect a company’s intellectual property (including trade secrets) by prohibiting employees from taking and/or disclosing proprietary information, such as customer lists, to competitors. From a legal perspective, when an employee who has signed a noncompete agreement leaves his or her employment and joins a competitor (or otherwise takes steps prohibited by the non-compete), a company can choose to bring a lawsuit for breach of contract. A claim for breach of a noncompete agreement can result in an award of injunctive relief, giving a company a fast and effective remedy. And unlike a misappropriation of trade secret claim, a claim for breach of a non-compete agreement does not require a company to prove the existence of its trade secrets.
Traditionally, the validity and enforceability of non-compete agreements has been a matter of state law, with some states like California, Minnesota, North Dakota, and Oklahoma enacting a full ban on non-competes while others such as Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia and Washington, as well as the District of Columbia, impose salary thresholds, prohibiting non-competes for lower- wage earners. On the opposite end of the spectrum, twelve 12 states place no restrictions on non-competes at all. Against this convoluted backdrop, the FTC seeks to create a uniform rule nationwide.
FTC’s Stated Rationale for Banning Non-competes
According to FTC Chair Lina M. Khan, “Non-compete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once non-competes are banned.” So, what exactly is included in the new rule and how will it impact employers and their ability to protect confidential or trade secret information going forward? The rule itself is relatively straightforward: as of September 4, 2024, non-compete agreements are unenforceable nationwide with a limited exception for senior executives who make more than $151,164 and hold a “policy-making position.” Current non-compete agreements with senior executives will remain in force even beyond September 4, 2024, but no new agreements may be executed—even with senior executives—after September 4. The new rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity and does not impact causes of action related to a non-compete that accrued prior to September 4, 2024. And while the final rule does not explicitly ban non-disclosure agreements, customer non-solicitation agreements, or employee non-solicit agreements, it makes clear that these other forms of restrictive covenants are invalidated if they have the same functional effect as non-compete clauses.
While the enforceability of the new rule remains unclear—and protracted legal battles are to be expected—employers should be motivated to explore alternatives for protecting their proprietary information. Almost any type of proprietary information can be maintained as a trade secret, so long as the information is valuable because it is not generally known. Trade secrets can include technical information, manufacturing processes, strategic business plans, financial and marketing information, chemical formulas, recipes, specialized know-how, test data, customer lists and data, price lists, supplier information, and any other commercially valuable secret information. As noted above, employers could and should continue to protect these types of secret information using confidentiality and non-disclosure agreements so long as those agreements do not function as a non-compete. These agreements should be carefully drafted to specifically prohibit the disclosure of confidential, proprietary, and/or trade secret information both during and after employment and prohibit any future use of the information outside the confines of the current employment.
“Garden Leave”: an Option for Employers to Work Around the Non-compete Ban?
Another option that may see greater use is the “garden leave provision,” which extends the employment relationship for a short period (rarely longer than six months) during which the employee continues to receive a salary (and sometimes benefits) but cannot accept employment elsewhere. During this short period of time, the employer can relieve the employee of all responsibilities and remove or exclude them from the workplace, prevent communications with staff, co-workers, customers and clients and limit or eliminate their access to computer systems, email, and other sensitive documents and information. Importantly, during garden leave, the employee’s duty of loyalty (and sometimes fiduciary duty) continues, which can serve as an additional safeguard for proprietary information. Garden leave is much more common in Europe and other international locations than in the United States, where it has largely been limited to the financial industry. Consequently, caselaw regarding the enforceability of garden leave is much less developed from state to state. Some courts have deemed garden leave provisions generally enforceable, while others have been reluctant to enforce due to concern over the forced continuation of at-will employment. Depending on the industry, and the state where a business is located, garden leave provisions may become more common as a means of providing a buffer of sorts between current and future employment and preventing the disclosure of trade secret information from a former employer to its competitor. Even if the FTC rule is overturned, garden leave provisions could prove useful in states that have banned, or significantly restrict, non-competes.
Legal Challenges to FTC’s Ban May Restore Non-compete Agreements
Legal challenges to the FTC rule have already been filed in the Northern District of Texas, the Eastern District of Texas, and the Eastern District of Pennsylvania, each seeking a nationwide stay/injunction of the FTC’s rule. The Chamber of Commerce lawsuit in the Northern District of Texas was stayed to let the first-filed case, Ryan LLC v. FTC, proceed in the Eastern District of Texas and the Chamber has intervened in the Ryan case. The Ryan Court has indicated that it will issue a decision by July 3rd, while the Eastern District of Pennsylvania case has set a tentative hearing date for July 10, 2024 and has indicated that it will issue a decision on the merits by July 23rd. Regardless, a decision by either court is almost guaranteed to be appealed such that there is unlikely to be a clear resolution in advance of the September 4 effective date, and employers are best served to begin exploring alternatives to non-competes in order to ensure the protection of proprietary information regardless of the ultimate outcome.
For more information about employment agreements and non-compete litigation, see the Klemchuk PLLC Industry Focused Legal Solutions page.
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This article is provided for informational purposes only and does not constitute legal advice. For guidance on specific legal matters under federal, state, or local laws, please consult with our IP Lawyers.
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