It’s unclear what the final noncompete rule will look like when it’s released by the Federal Trade Commission, but by getting a handle on your trade secrets now and knowing who among your employees needs to sign confidentiality or non-solicit agreements, you can best position yourself for the new regulatory landscape, attorneys say.
The FTC in January proposed a ban on noncompetes as part of the Biden Administration’s sweeping antitrust agenda to protect the labor market from artificially low compensation that can result from widespread use of the agreements.
The ban would also sweep up confidentiality and non-solicit agreements to the extent they function as noncompetes, complicating general counsel’s ability to plan for contractual changes that could protect their company’s trade secrets without running afoul of the federal government.
“Before the FTC started rulemaking, I would have said non-disclosure and non-solicits would take care of your problem if you can’t use noncompetes,” Debbie Berman of Jenner & Block told Legal Dive. “You probably can protect most of what you want to protect between those two types of agreements. But the FTC has said if a non-solicit or confidentiality agreement acts as a noncompete, they’re going to invalidate those too. So, it's not so clear right now.”
Despite the uncertainty, said Berman, it can make sense for general counsel to oversee due diligence on exactly what trade secrets need protecting and who among the company’s employees could take those secrets with them were they to leave for a competitor.
“Companies should know what their trade secrets are anyway,” said Berman, who co-chairs her firm’s trade secrets and unfair competition group.
Once you have a good understanding of what you’re trying to protect, you can start looking at your confidentiality and non-solicit agreements to see if they can be narrowed to just what’s needed to protect those secrets from high-risk employees.
“The old days of having the broadest agreement you could have to cover anything that basically keeps someone from leaving are gone,” said Berman.
That could mean looking at the CEO or an engineer or someone else among those who would need to sign new agreements, she said.
Going through the exercise doesn’t mean you start changing your contracts right away; it’s better to wait until release of the final rule so any changes can align with the new regulatory language, but it can still make sense to go through the exercise now.
“You can be ready to implement them if you have to,” she said.
Uncertainty will likely continue even after the FTC rule comes out because litigation is expected, so the landscape will be in flux for years.
In the meantime, states are coming out with their own bans, making compliance something companies must be on top of now.
Minnesota last month became the latest of several states to ban noncompetes completely, and New York, where a ban has passed the legislature and is waiting for the governor’s signature, could be the next state.
These bans generally apply prospectively, complicating compliance with the FTC’s approach as proposed, which envisions applying the ban retroactively.
Preparing for the impact of the FTC rule on mergers and acquisitions will present its own challenges, because a ban on noncompetes would raise valuation questions, along with other issues.
“Noncompetes are a material part of many transactions,” Jason Bradford of Jenner & Block told Legal Dive. “You’re going to have a lot of uncertainty about what you’ve actually purchased if a noncompete was part of a transaction that occurred before the rule is no longer valid, particularly where part of what you were trying to buy was a noncompete with somebody selling you a business.”
It can make sense to start thinking about how a buyer and a seller can align incentives for a deal in a new world where the buyer can’t make the sale contingent on the seller signing a noncompete, Bradford said.
He recommended looking at deferred compensation agreements or earnouts as two possible ways to get the buyer and seller on the same page.
“These new types of agreements will also fundamentally change the nature of the transaction,” Bradford said.
It can make sense to engage tax counsel, because if you try to align incentives with deferred compensation or earnout agreements, among other things, that will likely change the tax picture for the seller in a way that could make the deal more attractive.
“If you’re requiring the owners of that company to continue working for some period of time, or have some sort of deferred compensation, instead of putting that value in the shares, that can be earned income and that’s going to be taxed at a different tax rate,” he said. “That’s going to change the value of the deal.”
Those types of considerations apply where a buyer would otherwise want a seller to be subject to a non-compete, but where the seller doesn’t own 25% of the company. The proposed rule generally allows non-competes for sellers that own more than 25% of a company.
Bottom line, regardless of how the final FTC rule comes out, it can make sense to start looking at your trade secrets now and who has access to them to devise narrow confidentiality or non-solicit agreements to put you in the best position for justifying your agreements should you be challenged on them.
And on the sale side, start looking at ways to align incentives between buyer and seller to offset lost value if the buyer can’t make a noncompete a condition of sale.
“In-house people want to get ahead of this,” said Berman. “The less your agreements look like noncompetes, the better argument you’re going to have.”