Imagine That IP Law Blog

On May 7, 2024, the Federal Trade Commission published a final rule banning the enforcement of nearly all non-compete clauses in employment agreements nationwide (89 FR 38342). This new rule will have sweeping effects across all sectors of the economy, if it survives court challenges that have already been filed (see, e.g., Chamber of Commerce of the United States of America et al. v. FTC, 6:24-cv-00148 (E.D. Tex., April 24, 2024).

What is the new rule?
The FTC’s new rule makes it an unfair method of competition to enter into new non-compete clauses or enforce existing non-compete clauses after September 4, 2024 (120 days after publication of the rule in the Federal Register), with very limited exceptions: existing non-compete clauses with senior executives can remain in force, though new ones are not allowed, allowing for a sunset period; and non-compete agreements tied to the sale of a business entity can remain valid. Causes of action for breach of a non-compete agreement accruing prior to the September 4 deadline can still be enforced, and the FTC does not consider it an unfair method of competition to attempt to enforce a non-compete where there’s a good-faith, though erroneous, basis to believe the rule is inapplicable (such as disagreements over whether an employee qualifies as a “senior executive”, which is defined in the rule as a worker earning a salary of at least $151,164, placing them in the top 15th percentile nationally; and who is in a “policy-making position”, typically an officer of a corporation or with similar authority).

The FTC estimates that this rule will affect one-in-five American workers, or approximately 30 million existing employment contracts, a shockingly high number given that many states have restrictions on enforceability of non-compete clauses. However, as state laws generally do not prohibit employers from requiring employees to sign overbroad non-competes, workers may be unaware of their current legal rights. To address this, the new rule also requires that employers provide notice to workers with existing non-compete clauses that they are no longer enforceable.

Non-compete agreements have been used to protect trade secrets
Traditionally, non-compete agreements (along with non-disclosure agreements, employee confidentiality agreements, and diligent security measures) have been used to protect corporate trade secrets. The Uniform Trade Secrets Act (UTSA), which has been adopted by 48 states (excepting North Carolina, which enacted a similar statute, and New York, where trade secret claims are based on common law), the District of Columbia, Puerto Rico, and the U.S. Virgin Islands, defines a trade secret as:

[i]nformation, including a formula, pattern, compilation, program, device, method, technique, or process that:

(i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

This broad definition has been applied to everything from pharmaceutical test data, manufacturing processes, and internal software systems, to soft drink formulas and fried chicken spices – and crucial to the new artificial intelligence-driven economy, machine learning training data. Trade secret protections also apply to business information, including product development plans, customer and supplier lists, and marketing and distribution strategies, as well as corporate “know-how”. Non-compete agreements are particularly helpful here, as business information typically is unpatentable and may be easily reproduced, and copyright infringement may be difficult if not impossible to prove. While the FTC’s ban does not apply to current agreements with senior executives, it does apply to lower level employees including department heads and middle management, who may have significant access to trade secret information, and will include senior executives going forward.

The loss of non-compete agreements will create an increased risk of trade secret misappropriation. While a competitor may obtain a trade secret legally through reverse engineering or independent discovery, it may be much easier in many instances to simply recruit highly skilled or knowledgeable employees. Companies may still be able to bring claims for misappropriation where trade secrets are obtained through improper means, but this may be difficult to prove. The UTSA defines improper means as “theft, bribery, misrepresentation, breach or inducement of a breach of duty to maintain secrecy, or espionage through electronic or other means,” but only the duty to maintain secrecy may apply in many cases when employees move between competitors. While employee confidentiality agreements may be valid and enforceable after an employee’s departure, the FTC noted that a broadly written non-disclosure agreement could be functionally equivalent to a non-compete agreement, and would be similarly anti-competitive and unenforceable.

While it is a best practice to have employees sign non-disclosure agreements during on-boarding and review them periodically, not every company may be diligent in this area. Additionally, initial non-disclosure agreements may necessarily be broadly written, as it may not be clear as to what information an employee will have access to on day one. As an example, the FTC noted that a non-disclosure agreement that bars a worker from disclosing “in a future job, any information that is ‘usable in’ or ‘relates to’ the industry in which they work” or “any information or knowledge the worker may obtain during their employment whatsoever, including publicly available information” would be functionally equivalent to a non-compete. If employees have not yet signed non-disclosure agreements or the only agreements in place are potentially too broad, companies may want to get new agreements signed prior to the FTC’s rule taking effect. In particular, the rule requires providing explicit notice to every employee under a non-compete agreement that such agreements are no longer enforceable by September 4, 2024, and this may make employees reluctant to sign a new non-disclosure agreement without additional compensation.

Patents offer a viable alternative to protecting technical information
While it may be growing more difficult to protect business information with the FTC’s non-compete ban, patents can provide strong protection over technical innovations, regardless of whether the inventor stays with the company or leaves. A patent provides the right to exclude others from making, using, selling or offering for sale, or importing into the country the patented invention for a term of up to twenty years from filing. Unlike copyright, patents do not require that an infringer have access to the original, and can protect against independent invention. And unlike trade secret misappropriation, patent infringement does not require any “improper means”, making infringement much easier to prove.

Fundamentally, though, patents and trade secrets are at odds: trade secrets require secrecy, while patents require public disclosure (via the patent specification). In fact, the very purpose of patents is to encourage the destruction of trade secrets. A little over 600 years ago, the first patent was granted in Florence to the Italian engineer and architect Filippo Brunelleschi, giving him a time-limited exclusive monopoly on the manufacture and use of an improved boat for transporting heavy loads of marble by river, in exchange for publishing his plans so that other merchants could do the same once the invention had reverted to the public domain. This was an open attack by the Florentine Republic against the medieval merchant and artisan guild systems that jealously (and sometimes violently) guarded their proprietary knowledge, and as a result grew into huge and powerful monopolies. As a result of the incentivized public disclosure of new inventions, Florentine industry exploded with increased competition and growth, arguably ushering in the Italian Renaissance. The FTC may be hoping to see a similar result, particularly in industries that have traditionally relied on trade secrets for protection.

Technical information that can be protected by patents include any novel and non-obvious process, machine, article of manufacture, or composition of matter, or a novel and non-obvious improvement in one of these categories. While there are some judicially created exceptions (namely abstract ideas, mathematical algorithms, and laws of nature), the practical implementations of these exceptions that provide a technical solution to a technological problem are frequently patentable. If your company’s internal technical processes may be easily brought to competitors by departing employees, the benefits of patents may be worth the loss of trade secret protections.

Patents are a multi-pronged tool for protecting and utilizing your technical innovations
As noted above, patents provide a right to exclude others from making or using your invention, and can be a strong deterrent to existing competitors and barrier to entry for new enterprises. A robust patent portfolio can be a huge litigation threat and convince others to seek greener fields. However, patents also have other uses, which may be particularly beneficial to litigation averse companies.

For example, broad patents that are applicable to many industries may be licensed, not just to direct competitors, but to non-competitors in other fields who may derive a benefit from use of the patented technology. Granting exclusive licenses with field-of-use restrictions to those non-competitors may allow for easy revenue generation and provide licensees with deterrents against their own competition without impeding the core business of your company.

Additionally, where a technology may be of broad interest to an industry, a company can use free or low-cost licenses to encourage its adoption as a new standard. This can be beneficial for marketing purposes, for ensuring compatibility interoperability with others’ products, and potentially reducing costs through economies of scale.

Is a patent the right protection for you?
As mentioned above, patents can only protect technological innovations and not trade secrets such as customer lists or product roadmaps. Additionally, to prevent inventors from artificially extending their patent monopoly by only applying for a patent on a secret technology once the secret becomes known, 35 U.S.C. §102(a)(1) prevents patenting when an invention has been in “public use” more than one year prior to the application’s filing date. Internal secret use of an invention by a company may still qualify as a public use if it is commercially exploited. For example, if a product on sale to the public is manufactured via an innovative and efficient secret process, those sales may create a bar to later patenting of the process.

Patents are also expensive to obtain, as well as expensive to maintain. A typical patent may cost between $15,000 and $30,000 or higher, depending on the complexity of the invention, how close relevant prior art is, and whether prosecution requires one or more appeals. Additionally, to encourage companies to let patents lapse earlier than their 20 year duration, the Patent Office requires payment of maintenance fees at 3.5 years, 7.5 years, and 11.5 years after issuance of the patent, in amounts that increase from $2,000 to $7,700. For a company with a large patent portfolio, these carrying costs may represent a significant capital expense.

However, where exclusivity of an invention is important to achieving your company’s goals, strategic patenting may provide strong protection that can replace the loss of trade secrets. Some relevant considerations include how likely competitors are to independently develop (and potentially patent) the technology, whether infringement can be detected from publicly available information about a product or the product itself, and what cost would be involved in keeping the technology secret even without non-compete agreements, including IT expenses in monitoring and preventing information exfiltration, sequestering software developers in “clean rooms”, or other such physical and virtual security measures.

Conclusion
Non-compete agreements are going away soon, and trade secrets will have less protection, particularly in fields where mid- and even high-level employees move frequently between companies. According to a 2022 study by the Pew Research Center, around 2.5% of workers switch jobs on average each month. Across the private sector, the average employee stays with a current employer for just 3.7 years, though this varies by industry, from 4.2 years for the information sector to 3.5 years for professional and business services; as well as age, with Millennials and Gen Z employees changing jobs at a rate more than double that of workers over 35, and these numbers are only likely to grow more extreme under the new FTC rules, if they survive the inevitable court challenges.

But patents may provide a way forward, enabling strong protection of your technological innovations and allowing you to exploit your company’s economic differentiators, despite changes in the employment legal landscape. Citing a study by Zhaozhao He, the FTC’s notice notes that the value of patents to a company increases by about 31% when non-compete enforceability decreases. The FTC further estimates that the annual count of new patents will rise by up to 5,337 in the first year after enacting the rule, and up to 53,372 in the tenth year, noting that “[b]y alleviating barriers to knowledge-sharing that inhibit innovation, and by allowing workers greater opportunity to form innovative new businesses, the final rule will increase innovation.” Given the short time frame before September, companies should review their intellectual property strategies and consider strengthening their patent portfolios.