Earlier today, the Federal Trade Commission announced it has issued a proposed rule banning noncompetes. This development should come as no surprise since President Biden issued an executive order in July 2021 authorizing the FTC and other agencies to investigate the unfair use of noncompetes and other restrictive covenants and curtail their use. I expect that most of the commentary will focus on noncompetes and the ability of the FTC to effectively legislate over a body of law reserved for the states for over a hundred years. However, what should be of particular concern to the trade secret community is that the proposed FTC rule also potentially targets nondisclosure agreements (NDAs) that are “written so broadly” as to amount to “de facto noncompetes.” In other words, employers in California, Oklahoma and North Dakota–states that forbid noncompetes–may find that their employee NDAs could qualify as de facto noncompetes under the FTC’s new rule. As explained below, this post briefly describes how we got here, what the proposed rule addresses, and suggests some actions employers can take to protect themselves in the meantime.
Quick History: As followers of this blog already know, President Biden issued an Executive Order that was short on detail and simply encouraged the FTC to take unspecified action against unfair noncompetes and other agreements limiting employee mobility. On its face, the Executive Order focused on “unfair” agreements which have generally been understood to mean non-competes imposed on lower-wage workers. However, there was concern in the employment community that the FTC might take a more aggressive approach to ban all noncompetes.
The FTC has not traditionally regulated these agreements, as the dissenting FTC commissioner Christine A. Wilson notes. To date, the FTC had only taken action against employers that it believed had unfairly used noncompetes against former employees (see Russell Beck’s blog post earlier today talking about actions the FTC had initiated against Prudential (a security guard company, not the insurer), Owens-Illinois and Ardagh and their executives).
What Does the Proposed Rule Prohibit? At a high level, the proposed rule bans noncompetes which it defines as “a contractual term between an employer and a worker that prevents the worker from seeking or accepting employment with a person, or operating a business, after the conclusion of the worker’s employment with the employer.” It also purports to ban other agreements which amount to de facto noncompetes, including NDAs between and employer and employee “that [are] written so broadly that [they] effectively preclude[ ] the worker from working in the same field after the conclusion of the worker’s employment with the employer,”
The proposed rule concludes that it is an “unfair method of competition” to:
(a) enter into or attempt to enter into a noncompete with a worker,
(b) maintain a noncompete clause with a worker, or
(c) represent that a worker is subject to a noncompete clause.
To remedy any of those unfair methods of competition, the proposed rule requires an employer:
(1) to rescind its noncompetes by a compliance date to be determined, and
(2) to provide a notice to current and former workers that its noncompete is no longer effective within 45 days of that compliance date.
Significant Potential Problems for NDAs. My focus in this blog post is on the impact that this proposed rule may have on NDAs, which are routinely used by employers throughout the United States to protect their trade secrets. Please note that this post is my initial reaction, and I will likely supplement it later with the benefit of further time to review.
I see three immediate major problems. First, the FTC provides absolutely no guidance on what an overly “broad” NDA is. In the accompanying 16 CFR Part 910, the FTC notes that employers can use “appropriately tailored NDAs” that will fall outside the scope of the proposed rule, but the FTC simply refers them to the “functional test” provided under Section 910.1(2) for guidance on how NDAs that might qualify as de facto noncompetes. But that functional test seems circular to me: it provides that a de facto noncompete has the “effect of prohibiting the worker from seeking or accepting employment with a person or operating a business after the conclusion of the worker’s employment with the employer.” There is still no guidance on what an appropriately tailored NDA would look like, and the test emphasizing the “effect” of the NDA is so potentially broad as to be meaningless. Put differently, every NDA has a limiting effect potentially on future employment because it necessarily restricts the use of important information.
Second, the rescission requirement is especially problematic because NDAs do not provide the clarity that accompanies a restrictive covenant, which generally provides specific limitations (i.e., temporal and geographic parameters). An employer doesn’t know what information an employee may potentially use or disclose after he or she departs, so an employer’s tendency is frequently to over-include categories of information so that the employer is protected in a later trade secret dispute. But if an employer doesn’t rescind its potentially broad NDA, has it engaged in the forbidden unfair competition? Arguably.
Third, there are certainly situations where an important employee may be substantially impacted by his or her ability to compete based on the trade secrets disclosed to them under the protection of an NDA. Take Anthony Levandowski for example (the notorious engineer who took more than 14,000 files containing highly confidential information about his former employer Waymo’s self-driving technology with him to his new position at Uber). Would his NDA be deemed to be a de facto noncompete if it prohibited him from using the information that had been the focus of virtually all of his work while at Waymo? Under the proposed rule, one could persuasively argue that would be its “effect” and that it would be a de facto noncompete.
There will almost certainly be multiple challenges to the proposed rule, as I expect Russell Beck, Erik Weibust and others who have closely covered the FTC’s expanding jurisdiction will explain in detail later. Perhaps most notably, as the dissenting FTC Commissioner Wilson emphasizes, the proposed rule likely runs afoul of the U.S. Supreme Court’s recent decision in West Virginia v. EPA that scaled back federal regulatory efforts that are not clearly granted under a statute and that have been delegated to Congress (for a preview of those arguments, check out Erik Weibust and Stuart Gerson’s post on the obstacles a noncompete ban issued by the FTC will face in light of that decision).
So What Can Employers Do? The public is invited to submit comments on the proposed rule, which are due within 60 days after the Federal Register publishes the proposed rule. Employers can certainly make their views known during this process, as well as other stakeholders, industry groups and lawyers.
In the meantime, there are three things every employer can control to minimize a claim that their NDAs are overly broad and operating as a de facto noncompete. And frankly, these are good practices that employers should implement anyway.
The first is definitional. Many employer NDAs frequently define “confidential information” to include every conceivable category of information that is shared with that employee–i.e., marketing strategies, financial information, customer information. To the extent possible, an employer should tailor the NDA to the general job description of the employee.
Second, NDAs should expressly exclude information that is not to be treated as confidential or that is not owned by the employer. Information that is publicly available or known within the industry should be explicitly carved out. Information that the employee has brought with him or her (their general skill and knowledge) should be explicitly carved out.
Third, the manner in which an employer enforces its NDA likely will prove critical. Since the functional test for a de facto noncompete is determined by its “effect,” employers will have to be careful in how they enforce these agreements, whether by cease-and-desist letter or through litigation. And exit interviews will prove even more important than ever in terms of defining that effect, since these are the last and best opportunities for an employer to communicate its expectations over any limits on confidential information.
At the end of the day, the FTC’s proposed rule presents more uncertainty in an ever-evolving landscape. More to follow soon.