The Federal Trade Commission (FTC) on April 23, 2024 issued a rule banning future non-compete agreements with limited exceptions. The FTC rule bans virtually all non-compete agreements for employees and independent contractors. Pre-existing non-compete agreements with senior executives remain enforceable, but new non-competes with senior executives are not. Likewise, non-competes entered into pursuant to a sale of a business or person's ownership stake in a business are exempt from the FTC rule. Legal challenges are ongoing. For a more thorough treatment of the FTC rule please see my colleagues Robin McGuffin and Zachary Losey's excellent article here.
Should the FTC rule survive legal challenge in its current form, it has the potential to significantly impact an employers' ability to protect its proprietary information when an employee is terminated or resigns to work for a competitor or even to start a competing business. Businesses are therefore well-advised to consider alternatives to non-compete agreements before the implementation of the FTC rule. In addition to traditional intellectual property protections (patent, trademark, and copyright), one additional alternative that should be considered relates to trade secrets of the business.
What are trade secrets?
Trade secrets are an often overlooked type of intellectual property which can be as if not more important to many businesses as patents, trademarks, and copyrights. As the name implies a trade secret is any information that provides a competitive edge, and which derives its true economic value to a business from not being generally known by others. Trade secrets can include formulas/formulations, data, industrial processes, laboratory notebooks, technical know-how, blueprints, computer software that cannot lawfully be reverse engineered, training manuals, supplier identity, pricing/financial information, customer lists, and others. Trade secret status provides protection only against misappropriation, i.e., improper acquisition and/or use of the information by others. Others may discover a trade secret by fair means (independent discovery, permissible disclosure by another, reverse engineering, or other lawful means).
What do I do if my trade secrets have been misappropriated?
A number of enforcement mechanisms in state and federal court are available for employers whose trade secrets have been misappropriated. Causes of action for trade secret misappropriation can be brought under:
Common law tort/unfair competition. There are three fundamental elements to a trade secret tort claim. First, the subject matter involved must qualify for trade secret protection. Second, the trade secret owner must establish that reasonable precautions were taken to prevent disclosure of the subject matter. Third, the trade secret owner must prove the information was misappropriated or wrongfully taken.
U.S. courts have widely adopted basic principles of trade secret law that were set forth in the Restatement of Torts (1939), which lists six factors to be considered in determining whether information constitutes a trade secret:
- Is the information known outside the business?
- How many employees and others involved in the business know the information?
- What measures have been taken to keep the information secret?
- What is the value of the information to the business and its competitors?
- How much effort or money has been spent to develop the information?
- How easily could others legally acquire and duplicate the information?
Uniform Trade Secrets Act (UTSA) of 1985. Forty-eight states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands have enacted some version of the UTSA, with state-to-state distinctions that require careful consideration. State courts generally have jurisdiction over UTSA claims but standalone UTSA claims can be filed in federal court if diversity jurisdiction requirements are met. Civil remedies for trade secret misappropriation under the UTSA include injunctive relief, payment of reasonable royalties for continued future use, and monetary damages.
Economic Espionage Act (EEA) of 1996. The EEA is primarily directed to industrial espionage, is the first federal law criminalizing trade secret misappropriation, and imposes criminal sanctions relating to theft or misappropriation of trade secrets. Fines and prison sentences may be imposed according to severity of the infraction for misappropriation of trade secrets with the knowledge or intent that the theft would benefit a foreign power (economic espionage) and for the misappropriation of trade secrets related to or included in a product that is produced for or placed in interstate or international commerce with the knowledge that the misappropriation would injure the owner of the trade secret (commercial theft).
Section 337 of the Tariff Act of 1930 provides a mechanism for trade secret owners to file trade secret misappropriation claims at the U.S. International Trade Commission (ITC). The statute prohibits unfair trade/unfair competition in importation and sale of imported articles. The ITC is authorized to issue Exclusion Orders to stop importation of products that harm U.S. industry and are made using misappropriated trade secrets. Relief can be granted even if acts of misappropriation take place outside the U.S. Monetary damages are not offered.
Defend Trade Secrets Act (DTSA) of 2016. The DTSA is a civil cause of action that allows uniform nationwide application in Federal court to address trade secret misappropriation when the trade secret is "related to a product or service used in, or intended for use in, interstate or foreign commerce." Misappropriation under the DTSA requires wrongful acquisition of a trade secret and also wrongful use or disclosure of a trade secret. This is the acquisition of a trade secret by a person who knows or has reason to know that the acquisition was made by improper means, followed by the use or disclosure of the trade secret by one who: (1) used improper means to acquire the secret; or (2) knew or had reason to know that the secret was: (a) derived from a person who used improper means to acquire it; (b) acquired under circumstances giving rise to a duty to maintain its secrecy; or (c) derived from or through a person who owed a duty to the owner to maintain its secrecy.
There are key provisions in DTSA relating to employer/employee relationships. Employers are required to provide notice of the DTSA's immunity from disclosure provisions in any contract or agreement with an "employee" (traditional employees, independent contractors, and consultants) relating to use of trade secrets or other confidential information. Alternatively, the employer can in a non-disclosure agreement reference a policy document provided to employees and setting forth a formal reporting policy for suspected violations of law.
What do I do to protect my business trade secrets?
Take early and ongoing steps to identify sensitive business information. Once proprietary information of a business has been identified, employers should consider how to best protect that information, such as by traditional patent, trademark, and copyright protections. If traditional intellectual property protections are not appropriate or feasible, a good practice may be for the employer to implement a company-wide practice of compartmentalizing, i.e., restricting access to potentially sensitive or confidential business to only employees who require access to such information to perform their duties. If the information is not appropriate for traditional intellectual property protections and has been kept secret, trade secret protection may be appropriate. Many employers are unaware of the broad scope of information, in-house procedures, etc. that can and should be protected as trade secrets, and fail to take the needed steps to protect their rights in the first place.
Clearly establish the importance of preserving trade secrets to existing, new, and prospective employees. In addition to including proper notice of trade secret confidentiality provisions in employment agreements, employers should be diligent in reminding soon-to-be former employees of their duty to maintain trade secret confidentiality in exit interviews, and in requiring such employees to sign Employee Separation Agreements or Termination Statements listing business information known to the employee to be trade secrets and acknowledging the employee's obligation to maintain the proprietary nature of the trade secrets.
Employers should also consider requiring employees and new hires, particularly employees who will require or may have access to sensitive business information while performing their duties, to sign non-disclosure agreements (NDAs) as a condition of employment. A well-drafted NDA addresses at least the following points:
- Who are the parties to the NDA? In this situation the parties are typically the employer and the employee/new hire.
- What information is deemed to be sensitive, confidential, or proprietary? Is all information disclosed to the employee deemed confidential or only information so marked? Does the information have to be specifically marked "Confidential" to fall under the scope of the NDA? Is the confidentiality restricted to written disclosures, or is orally disclosed information also subject to confidentiality provisions? If confidential information is to be disclosed orally, what are the specifics of how the confidentiality of the information is conveyed? Conventionally, oral information can be deemed confidential if the employer confirms in writing to the receiving party that the information is confidential. The NDA should clearly delineate how confidential information is to be identified by the employer.
- The NDA should clearly define the obligation of the receiving party to: 1) keep the disclosed confidential information a secret; and 2) take reasonable steps to prevent access to the confidential information by third parties.
- What is excluded from the obligation of confidentiality? Typically information is excluded if it is: 1) already known to the recipient; 2) already public information, as long as the recipient was not the person who disclosed the information to the public; 3) independently developed by the recipient without use of the confidential information of the employer; 4) disclosed to the recipient by a third party who has no obligation of confidentiality to the employer; or 5) disclosed by the recipient as a requirement of a legal process.
- What is the term of the agreement? While certainly the employer would like the NDA to remain in force forever, this must be balanced against the reality that courts do not favor perpetual obligations and in any event most information has a limited shelf life. The term of a "reasonable" term of an NDA will vary by industry, although 2 to 5 years is common.
- Other potential clauses in a well-drafted NDA may include: specifying jurisdiction, i.e., in what court(s) can action be brought to enforce the NDA; specifying availability of injunctive relief to the employer to stop a breaching act rather than solely relying on monetary damages after the act has occurred; and specifying that the disclosure of information by the employer does not in any way represent a transfer of any rights to the employee.
A periodic audit to identify confidential business information including trade secrets, reviewing procedures put in place to preserve trade secret confidentiality, and putting NDAs in place to discourage misuse of such information by employees are great investments in a business's future, particularly in view of the FTC's stance on non-compete agreements.
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.