An Ounce of Prevention May Save You a Pound of Trade Secrets
On January 5, 2023, the Federal Trade Commission proposed regulations that would outlaw most non-compete clauses in employment contracts, in both currently effective and future contracts. The ostensible justification for the proposal is to reduce the anti-competitive effects of such clauses and to facilitate the ability of workers to find new employment. The New York Law Journal published an article by my partner, David Azrin, discussing the FTC regulatory initiative, the justifications for it, and the interplay between it and action by state legislatures, which you can read here.
The FTC is only at the proposal stage, with interested persons having the right to submit comments until March 20, 2023. Many interest groups are gearing up to submit comments. If the FTC decides to proceed, the final regulation is likely to vary from the current proposal, possibly in significant respects. If adopted, the regulations will almost assuredly be challenged in court. Thus, we cannot predict if and when final regulations will be effective. Prescient employers should consider taking protective steps now to maximize the likelihood that they will be able to protect their trade secrets and customer relationships after the FTC takes final action.
The FTC proposal, as currently drafted, would render unlawful all direct or indirect non-compete obligations in employment contracts, save only non-compete covenants tied to the sale of a business. The proposal does not include exceptions for executive officer contracts or contracts for highly compensated employees.
The proposal does not outlaw an employment contract clause prohibiting a former employee from soliciting customers or disclosing trade secrets. However, the FTC commentary accompanying the proposed rule warns that such clauses would be outlawed if they are so unusually broad that they function as prohibitions on the competition by the former employee.
We recommend that all employers should proactively review all non-compete clauses, non-solicitation clauses, and prohibitions on the use or disclosure of trade secrets contained in existing contracts in advance so that they are not caught short if the FTC acts. Employers should not remove non-compete clauses now because the FTC may abandon its initiative or adopt final regulations that include expanded exemptions, such as for contracts for key employees or those who are highly compensated.
Instead of proactively removing non-compete language or omitting it from new contracts, the language should be included but separated from provisions protecting employer assets such as trade secrets and customer relationships. The protection of employer assets should not be so broad as to be the practical equivalent of a non-compete provision. The separation will help avoid the appearance that protecting trade secrets and customer relationships is, in truth, simply a disguised version of a non-compete clause. Employers should consider whether revisions are necessary to tone down existing language to maximize the likelihood that the protection will remain if and when the FTC proposal becomes effective.
Another important contract provision to include is what is known as a savings clause. A savings clause provides that if contract language is or becomes unlawful, it is automatically amended to reduce its scope so that it remains lawful, and if that is impossible, it is deemed deleted, but the remainder of the contract is saved. In this regard. Think of the maxim, “a half of a loaf is better than none at all.”
For example, a contract prohibiting an employee from soliciting any customers after leaving employment at Amazon might be unlawful because “everyone” is a customer of Amazon. However, such a non-solicitation provision might be lawful if limited to customers with whom the former employee dealt directly.
Even if a court were to outlaw all prohibitions on soliciting customers of a prior employer, a properly-drafted savings clause should preserve other important employer assets. Outlawing all non-solicitation clauses should not affect other clauses protecting employer assets if there is a properly drafted savings clause. For example, it may be of utmost importance to protect computer programs or algorithms that decide which products or services to recommend to customers, even if both non-compete and non-solicitation clauses are rendered unlawful.
The same drafting principles should guide employers in any new contracts entered into between now and the final FTC action. In addition, employers should not rely solely upon a non-compete provision to protect its trade secrets and customer relationships. There should be a separate provision protecting trade secrets and another protecting customer relationships. Even if the non-compete provision becomes unlawful, the other provisions will hopefully remain in effect to protect important company assets.
Employers should also be mindful that, at least in New York, overbroad non-compete clauses are already prohibited. For example, an employment contract for a teacher at a private primary school in Albany that draws its students from a twenty-mile radius should not prohibit competition throughout New York State, nor should it last for an unreasonably long period of time. Overbroad provisions should be revised now so that they are enforceable, regardless of whether the FTC acts on its regulatory initiative.
The attorneys at Gallet Dreyer and Berkey, LLP, have experience in drafting and litigating a broad scope of employment contracts. These involve executive officers in many different industries, from bank executive officer contracts as part of our Banking & Financial Institutions' practice to officers of the sellers of rare Japanese spirits being exported to the United States as part of our Food, Wine, Restaurant & Hospitality practice. We are available to assist you in protecting your business assets through appropriate employment contract provisions and in avoiding some of the adverse effects of the FTC regulatory proposal on non-compete clauses.