In late April this year, the Federal Trade Commission (FTC) issued a final rule banning non-compete agreements for employees who are not senior executives, on the basis that they reduce business formation, suppress wages and innovation, and erode the fundamental freedom of workers to change jobs. The rule will become effective on September 4, 2024 and existing non-compete agreements for employees who are not senior executives, who comprise the majority of employees, will no longer be enforceable after this date.
Traditionally, non-compete agreements have restricted employees from working for competitors after leaving. The FTC estimates that banning non-compete agreements will allow new business formation to grow at a rate of 2.7% per year, leading to approximately 8,5000 new businesses created each year and to increase earnings for workers, as well as the number of patents.
However, non-compete agreements can drive innovation by protecting trade secrets. Trade secrets are a form of intellectual property (IP) that encompasses a wide range of confidential information, from customer lists to software and technical know-how, that provide a competitive edge to a business. To qualify as a trade secret, the information must be valuable and not readily available elsewhere.
The FTC’s move is likely to encourage companies to re-evaluate their trade secret protection strategies. First, it may result in a heightened focus on trade secret enforcement. With employees now potentially free to join competitors, companies may face increased risk that trade secrets are leaked. This could lead to an increase in trade secret litigation against departing employees and potentially their new employers. Second, companies may need to implement more robust measures to safeguard their trade secrets. This might include access controls, password protection, encryption, and data loss prevention techniques. Confidentiality and non-disclosure agreements (NDAs) could still be used, as long as they don’t function as de facto non-compete agreements.
Looking Ahead: Increased Litigation and Strategic Use of NDAs
The FTC’s ban on non-compete agreements is also likely to spark an increase in trade secret litigation. But this would follow existing trends of steadily increasing numbers of trade secret lawsuits. The passage of the Defend Trade Secrets Act (DTSA) by Congress in 2016 encouraged more lawsuits, many of which involved million-dollar awards. Calculating damages from trade secret misappropriation remains a challenge, as seen in the Pegasystems Inc. v. Appian Corp., where a $2 billion jury award was challenged on appeal by the defendant, Pegasystems Inc., in May 2022 on the grounds that plaintiff, Appian Corp., never identified the trade secrets as the software that Pegasystems Inc. had implemented. This is further illustrated in the recent case, Versata Software, Inc. v. Ford Motor Company. Versata had sued Ford for misappropriation of trade secrets used in car configuration software. A jury initially awarded Versata nearly $105 million, but the court overturned the verdict due to insufficient evidence of damages. This case underscores the importance of clearly documenting and communicating trade secrets to employees and any potential licensees.
This changing legal landscape necessitates that companies stay informed about legal developments and adapt their strategies accordingly. A multi-pronged approach that balances both talent mobility and trade secret protection is essential for businesses to navigate the post-non-compete era.