Legal Alert: What the FTC’s Ban on Noncompete Agreements Means for Trade Secrets

On April 23, the Federal Trade Commission (FTC) issued a final rule that would ban the use of noncompete agreements in most employment contracts nationwide. Hailed by the Commission as a measure to promote competition, protect worker freedom, and increase innovation, the rule provides that noncompete agreements are unfair methods of competition in violation of Section 5 of the FTC Act. While the rule will have the most immediate impact in the employment law context, its effects will reverberate into intellectual property (IP) law.

Trade secret owners who use noncompete agreements as a part of their trade secret protection strategy should act now to reduce the risk of misappropriation when the rule goes into effect.

Key takeaways

• The FTC’s rule would ban noncompete agreements in many circumstances.
• The rule would eliminate a tool many businesses use to protect their trade secrets, which likely will result in an increase in trade secret litigation.
• The rule likely will lead to an increase in new business formation and a corresponding increase in patents issued.
• Other contractual methods for trade secret protection, including nondisclosure and non-solicitation agreements, remain available.

Who is affected by the FTC’s ban?

The FTC voted 3-2 to ban most non-competes for U.S. employees and independent contractors. The rule does not apply to banks, savings and loan institutions, federal credit unions, common carriers, air carriers and foreign air carriers, and persons and businesses subject to the Packers and Stockyards Act. Outside of those industries, the major exceptions include (1) existing agreements for “senior executives,” (2) non-competes entered into in connection with the bona fide sale of a business, and (3) non-competes enforced where the cause of action accrued before the rule’s effective date.

Historically, noncompete agreements have blocked employees from forming competing startup businesses. With noncompete agreements out of the way, employees now may be more likely to strike out on their own. The FTC estimates that the ban on noncompete agreements will lead to new business formation growing by 2.7% per year, or about 8,500 new businesses annually.

Expect an uptick in trade secret misappropriation litigation

Employers have long used noncompete agreements as a tool to protect their trade secrets. By prohibiting former employees from immediately working for competitors, noncompete agreements direct employees away from the businesses where the employer’s confidential information would be most useful. And by the time former employees can work at such companies, any confidential information they have will be stale and less valuable to competitors. Without the protection of noncompete agreements, the risk of trade secret misuse — whether intentional or unintentional — increases, as does the likelihood of trade secret misappropriation litigation.

IP owners may be at a greater disadvantage when attempting to enforce their trade secrets than their noncompete agreements. The enforceability of well-drafted noncompete agreements is generally straightforward; unambiguous terms regarding the identity of the competition, the geographic scope of the restriction, and the term of the agreement set clear boundaries for former employees. And IP owners can readily detect breaches. In contrast, pursuing a trade secret misappropriation claim is more nuanced. To demonstrate the existence of a trade secret, the burden is on the IP owner to show that the information is (1) secret, (2) derives economic value due to being unknown by others, and (3) has been subject to reasonable measures to maintain its secrecy. The IP owner must then show misappropriation, which involves disputes over whether and how the trade secrets were used.

While we expect an uptick in trade secret misappropriation litigation due to the FTC’s rule, it is unlikely to be drastic. Many existing noncompete agreements apply to hourly workers with limited access to trade secrets or to industries where IP is not central. Nevertheless, the demise of noncompete agreements could create ambiguity at the termination of the employer-employee relationship, and ambiguity often leads to litigation.

Will the ban lead to more companies relying on patents instead of trade secrets?

Many trade secrets are not eligible for patent protection. For those that are, the loss of noncompete agreements as a tool to protect trade secrets may now tip the balance in favor of patent protection. We may also see an uptick in patent filings due to more former employees starting their own businesses unencumbered by noncompete agreements and pursuing their own innovations.

Other contractual approaches to trade secret protection

Noncompete agreements are merely one tool among many that trade secret owners can use to protect their valuable IP assets. Two other contractual approaches trade secret owners can use as part of their protection strategies are nondisclosure and non-solicitation agreements.

Nondisclosure agreements

Nondisclosure agreements (NDAs) are one of the most common tools for protecting trade secrets. Companies that do not currently have NDAs in place should act swiftly to execute them, and those that have them should revisit their terms to ensure that they protect what they are intended to protect. When drafting or updating NDAs, be sure to include trade secret-related whistleblower provisions as required by § 1833(b)(1) of the Defend Trade Secrets Act. Also keep in mind that the FTC's rule applies to any employment agreement that “functions to prevent” worker mobility. The Commission contemplates that NDAs could meet that definition where they span such a large scope of information that they act as de facto noncompete agreements.

Non-solicitation agreements

Trade secret owners may also consider drafting non-solicitation agreements to address trade secret theft or disclosure. When drafting or updating non-solicitation agreements, ensure compliance with applicable state law. And like NDAs, pay close attention to the scope of the agreement; overly broad non-solicitation agreements may also “function to prevent” worker mobility in the FTC’s eyes.

Trade secret protection steps to take now

Regardless of whether you use noncompete agreements in your trade secret protection plan, trade secret owners should take the FTC’s rule as an opportunity to revisit those plans and make updates where necessary.

• Limit access to trade secrets, both physically and technologically. Allow access to trade secrets only on a “need to know” basis. Restrict physical access to high-security areas and require an NDA for entry. Consult with IT professionals to implement measures that make it technologically challenging to access prohibited information.
• Update trade secret-related contracts. NDAs and non-solicitation agreements remain available for use provided they are not overly broad. If necessary, update their provisions to specifically address trade secrets.
• Review employee manuals and training materials. Make sure that employees know they’re being entrusted with trade secrets and what the expectations are for how they should handle them.
• Reevaluate your IP protection options. If certain information qualifies for either trade secret or patent protection, add the noncompete ban into the calculus for determining which form of protection to pursue.
• Look to other jurisdictions. As of this writing, California, Minnesota, Oklahoma, and North Dakota ban noncompete agreements, and several other states severely restrict them. Investigate how companies in those jurisdictions have navigated trade secret protection without noncompete agreements.

For more information about protecting your trade secrets in an age of rapidly expanding employee mobility, please see our webinar “Protecting and Enforcing Your Trade Secrets in a Global Economy.”