This article was originally published in our 2022 Summer Business Edition: The Litigation Issue.
Employers beware: If the federal government gets its way, the noncompete agreement signed by the employee vital to your company’s success might be toast. President Biden recently issued an executive order tasking the Federal Trade Commission with enacting rules to limit or outright prohibit noncompetes nationwide.
Even if the feds don’t act, you might still be out of luck. Many states have passed laws curtailing such agreements in recent years, and the pandemic markedly boosted the chances that a court will not enforce yours. In light of all this, bet-the-company thinking requires employers to take proactive steps to ensure their confidential and trade-secret information is adequately protected by methods other than just noncompetes. Your company’s survival may depend on it.
Most states have similar criteria for enforcing noncompetes: The restrictions they contain must be reasonable and necessary to protect the legitimate interests of the employer. Stifling competition is not a legitimate interest; protecting confidential and trade-secret information is.
Historically, it was easy to convince courts that an employer had at least some confidential information worth protecting via a noncompete. Such information traditionally includes the identity of customers, vendors, and employees, business plans, pricing data, techniques, market research, and the ubiquitous yet ambiguous concept of “know-how.” Virtually every business—from tech giants to your local sandwich shop—has at least some proprietary information that could qualify as confidential under the law, and employers and their lawyers seize on this to enforce noncompetes against employees of all ranks.
In just the last five years, many state legislatures—no doubt responding to the perceived overuse and overenforcement of these agreements—have curtailed their enforceability through legislation. California and North Dakota have banned them altogether. Others, such as Massachusetts, have made them burdensome for employers to enforce by, among other things, requiring them to pay employees a portion of their salary for the duration of the agreement, restricting the pool of employees to which noncompetes can apply, and prohibiting enforcement when the employee is let go through no fault of his or her own. It’s a safe assumption that many other states will enact similar legislation in the coming years.
The pandemic further eroded the enforceability of noncompetes, although this time it was the judiciary, not legislatures, that showed newfound reluctance to enforce them. A number of state and federal courts declined to enforce these pacts between 2020 and this year for reasons directly related to COVID-19. It’s not difficult to see why: Millions of Americans were laid off and struggled to make ends meet. Employers who needed staffers had a hard time finding them. It was easy for courts to reject an employer’s argument that it had a “legitimate business interest” in putting a former employee out of work by enforcing a noncompete against someone it voluntarily laid off, or to conclude that an employee’s interest in feeding his or her family during a pandemic far outweighed whatever interests the employer was claiming.
The federal government, spurred by COVID-19’s effect on both employees and the economy (and likely influenced by states’ shifting attitude toward noncompetes), announced its intention to curtail them further through his executive order to the FTC. The White House also released a fact sheet stating that “tens of millions of Americans—including those working in construction and retail— are required to sign noncompete agreements as a condition of getting a job,” making “it hard for them to switch to better-paying options” and purportedly dragging down the economy as a result.
The president’s desired regulation is likely to face stiff opposition from both political and industry foes, and it’s unclear when—if ever—the FTC will adopt such rules, assuming it even has the authority in the first place.
Regardless of whatever action the federal government takes, employers should expect ever- increasing reluctance on the part of judges and state legislatures to enforce noncompetes and must bet on other means to protect their business in the long term from the threat of misuse of their confidential information and trade secrets. Employers with legitimate information in need of protection should ensure that their workers sign robust, carefully drafted confidentiality agreements at the outset of their employment, and not rely on haphazard documents pulled off the internet or thrust upon employees after they’ve been on the job (an occurrence likely to affect the agreement’s enforceability, a situation this writer has seen far too many times).
Employers should also take thorough steps to “off-board” employees at the conclusion of their employment and confirm, through forensic reviews if necessary, that they have returned or deleted any confidential information in their possession. Even the most well-intentioned employee can, and often does, have trade-secret company data all over his or her personal electronic devices.
Taking just these few commonsense steps can ensure that an employer can bring viable breach-of-contract and misappropriation of trade secrets claims against an employee who intentionally misuses confidential information. Indeed, although employers often use noncompetes as the preferred (albeit heavy-handed) method of protecting their information, the truth is that typically, they can adequately protect their secrets through these already existing legal remedies that will not be affected by subsequent noncompete legislation.
Employers must bet on other means to protect their business in the long term from the threat of misuse of their confidential information and trade secrets.”
As long as courts are willing (and authorized by law) to enforce noncompetes at least to some extent, employers should invest the time and money to have their existing agreements scrubbed for enforceability. Many noncompetes are vastly overbroad as written, and in the author’s experience it is the exception, not the norm, for a court to enforce a noncompete without at least some significant modification. This can lead to drastic consequences for the employer, aside from losing the protection of the agreement—including shifting attorneys’-fees provisions and absolute bars on damages.
Employers would therefore be wise to proactively draft or rewrite their noncompetes as narrowly as possible. Courts are far more likely to enforce agreements—even during the pandemic and attendant legislative crackdown—when employees are shut out from only a small slice of the market and not from gainful employment entirely. They should also ensure that their noncompetes are supported by adequate consideration, as more and more courts are invalidating these pacts because they were thrust upon workers in the middle of employment with no additional compensation or other satisfactory consideration.
Overall, it remains to be seen whether the federal government will follow through on President Biden’s wish to promote competition and stimulate the economy through the elimination or limitation of noncompetes. But reluctance on the part of courts and state legislatures to enforce them is only growing. With the company’s very future potentially at stake, employers should invest the time and resources to stay ahead of this rapidly evolving area of the law—and protect their confidential information and trade secrets through alternate means, or at least carefully tailored noncompetes.
As founder of the Houston-based law firm Mahendru P.C., Ashish Mahendru has built a legal specialty navigating complex disputes between business partnerships before state and federal courts. He focuses his practice on business and commercial litigation, employment litigation, high-stakes commercial contingency cases, contract and partnership disputes, trade secrets and non-competes.