KEY POINTS:
- Non-compete clauses allow companies to maintain a competitive advantage and retain key talent who might otherwise leave for a better offer.
- In January 2023, the U.S. Federal Trade Commission (FTC) announced a proposal that would ban employers from imposing non-compete restrictive covenants on their workers.
- We need to structure restrictive covenants for intellectual property and trade secret protection in our contracts more than ever to ensure they are sufficient and enforceable.
Non-compete clauses are restrictive covenants that are commonly found in employment agreements, buy-sell agreements, and some services agreements. The goal of using this type of clause is to prevent employees from working for a competitor after leaving in order to ultimately protect their intellectual property assets and trade secrets.
In January 2023, the U.S. Federal Trade Commission (FTC) announced a proposal that would ban employers from imposing non-compete restrictive covenants on their workers.
The list of state jurisdictions joining the movement to limit the use of these restrictive covenants continues to grow, most notably and recently, Delaware. Notable due to its business-centric court system, this change in Delaware appears to indicate the future for non-competes across all states.
The big question for contract professionals: What does this mean for businesses and workers? In this article, I will provide an overview of why non-competes are becoming a less popular approach to protecting one’s assets, and some other types of restrictive covenants you can use to ensure protection going forward.
The Problem with Non-Competes
Non-compete clauses seem like the logical way for businesses to protect their intellectual property and trade secrets because they restrict employees from gaining valuable business insight only to leave for more pay to share those insights with a competitor. This allows companies to maintain a competitive advantage and retain key talent who might otherwise leave for a better offer.
Conversely, critics of these clauses argue that non-compete clauses are often too broad and restrictive, unfairly limiting workers’ abilities to seek better opportunities (limiting both earning potential and career growth) and stifling innovation (harmful to the economy). In fact, a 2016 report by the Treasury Department revealed that there are 30 million Americans bound by non-compete agreements.
In some cases, non-compete clauses are used on lower-wage earners, preventing fast food employees and janitors from seeking employment elsewhere in the same industry. This strict enforcement of non-compete clauses can trap workers in lower-paying jobs and limit their ability to advance their careers in meaningful ways, which is even more of an important societal issue considering the state of the economy in 2023.
For workers, the trend towards limiting non-compete clauses is a positive development, as it allows people to seek better job opportunities and advance their careers without fear of being held back by overly broad contractually binding restrictive covenants in non-competes. It is still very important to note that non-compete clauses are still valid and enforceable in many states, and workers should always carefully review any contract they are asked to sign before accepting a job and likewise, business owners, or those entering an M&A deal, should also carefully review those contracts.
These changes in legal decisions regarding non-compete clauses reflects a growing recognition that these restrictions can have negative consequences for both workers and businesses. While it’s unlikely that non-compete clauses will disappear altogether by tomorrow, it’s clear that since policymakers are rethinking their use and pushing for more balanced and fair contractual agreements, it is important that contract professionals stay ahead of this and draft contracts accordingly instead of waiting for the law to go into effect.
The Rise of Anti-Non-Compete Laws
Several states have already enacted or proposed laws to limit the use of non-compete clauses. States like California, North Dakota, Oklahoma, and Washington D.C. have already banned non-compete clauses entirely (with few exceptions). While states such as Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia, and Washington have banned non-compete clauses for employees earning under certain salary thresholds per year. More states are joining that list with varying caveats depending on the state.
To further grasp the quick change in outlook for non-competes, the FTC has been actively advocating for limits on non-compete clauses since as far back as 2019. In December 2020, Delaware’s Attorney General issued guidance recommending that companies limit their use of non-compete clauses to protect trade secrets and confidential information, rather than using them to prevent employees from working for competitors. In 2022 alone, five more states and the District of Columbia effected legislation to limit the use of non-competes.
The latest decisions coming out of Delaware indicate a broadening of its refusal to enforce restrictive non-competes with the expansion into in merger and acquisition transactions. Since Delaware is home to many corporations and a long-time leader in corporate law, contract professionals should keep track of what they’re doing and begin to set expectations for the future.
Alternative Protections to Non-Compete Clauses
These changes may be concerning for businesses that rely on non-compete clauses to protect their trade secrets and intellectual property. But it is important to note that there are still several ways to protect these assets. These updates simply mean that we need to structure restrictive covenants for intellectual property and trade secret protection in our contracts more than ever to ensure they are sufficient and enforceable.
Contract professionals can use alternative methods to protect confidential information, such as more specific non-disclosure agreements, non-solicit clauses, intellectual property assignment agreements, and other restrictive covenants. Be sure your templates are updated accordingly.
More Specific NDAs
One alternative to using a non-compete clause is to use specific and fair non-disclosure agreements (NDAs). You can really tailor these agreements to the specific needs of your business and provide clear guidelines on what information is considered confidential.
In particular, I recommend including the following four sections in your NDAs: 1) a clear definition of “Confidential Information”, 2) the purpose for which the receiving party may use such confidential information, 3) the duration of the confidentiality obligations (3-10 years is often fair depending on industry and type of confidential information), and 4) the exclusions from the confidentiality obligations such as publicly available information, information learned by receiving party through no wrong-doing by any other party, and information receiving party independently developed without any use of the confidential information.
The fourth item in this list is prone to redlines because companies usually want to maximize the breadth of the confidentiality clause. But I suggest trying to negotiate it in because not all information should be treated as confidential information. You don’t want an NDA that is overly restrictive either.
Non-Solicit Clauses
Non-solicit clauses prevent employees or former employees from soliciting clients, customers, or other employees of a company they once worked with for a specified period after their employment or contract ends. In a way, it prevents an employee from working with a competitor or client because it restricts the new company from poaching or soliciting the employee. On the other hand, it is less restrictive than a non-compete because the employee is free to apply for and take whatever job they want.
In particular, I recommend including the following three elements in your non-solicit clauses: 1) clearly define the prohibited activities, such as not soliciting clients, customers, or personnel away from the company in any manner, 2) define the reasonable time frame for these restrictions (anywhere from 6 months to 3 years is a good baseline for reasonableness here), and 3) define the geographic scope of the restriction.
This last point is important because if your organization is a global company and you say “anywhere the company operates” this could be found in a court of law to be overly broad and potentially unenforceable.
Intellectual Property Assignments
Another mechanism to consider using when intellectual property is of concern is an intellectual property assignment agreement or clause. These are used to protect a company’s intellectual property rights by ensuring that any inventions, designs, or creations made by an employee during their employment and within the scope of employment are automatically assigned to the company.
In particular, I recommend including these three elements in IP assignment clauses or agreements: 1) clearly identify the types of IP that will be assigned, 2) include a provision that requires employees to promptly (time frame optional depending on the company) disclose inventions or creations, and 3) require employees to help the company to secure and protect intellectual property rights.
Restrictive Covenants
Other restrictive covenants to help secure certain wishes of the company depending on the nature of the business and/or industry may include:
- Non-Disparagement Clauses: These clauses prohibit employees or former employees from making derogatory or negative statements about the company, its products, or its officers, representatives, or other employees.
- Non-Disclosure Clauses: These clauses can be included in employment agreements, severance agreements, contract, or independent contractor agreements to maintain the confidentiality of the company’s information, even beyond the termination of their relationship with the company.
- Non-Interference Clauses: These clauses prevent employees from interfering with a company’s contracts or other relationships with its customers, suppliers, partners, etc. These can also be a part of employment agreements, severance agreements, and contract agreements.
When considering how to protect your company’s assets without using a non-compete clause, focus on those specific business interests that need protecting. Be selective with which employees really need to sign certain agreements, know the law where your business operates, and ensure that these clauses are drafted as narrowly as possible to protect those specific interests.
