by Joshua H. Lerner, Laura E. Schneider, and Andrew Stauber
From left to right: Joshua H. Lerner, Laura E. Schneider, and Andrew Stauber (Photos courtesy of WilmerHale)
As we previously reported, the Federal Trade Commission (FTC) announced on April 23, 2024, its Non-Compete Clause Rule (Final Rule), which aims to ban all new post-employment non-competition restrictions and invalidate most existing ones. The Final Rule already has sparked multiple lawsuits seeking to prevent it from taking effect as scheduled on September 4, 2024. The United States District Court for the Northern District of Texas is expected to make a decision in one such lawsuit by July 3, 2024.
As September 4 approaches, many questions remain regarding the potential impact and scope of the Final Rule. This alert focuses on how the Final Rule might affect confidentiality and non-disclosure agreements (NDAs) that employers use to protect their trade secrets and other confidential information.
The Broad Scope of the Final Rule
When the FTC initially proposed the rule in January 2023, it included prohibitions not only on traditional non-competition clauses (i.e., those expressly preventing individuals from working for a competitor) but also on any contractual terms that could function as de facto non-competes. Although explicit references to de facto non-competes are absent from the Final Rule, its definition of a non-compete clause remains broad enough that it could significantly limit the scope of NDAs and other restrictive covenants.
According to the Final Rule, a “non-compete clause” is any “term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (i) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (ii) operating a business in the United States after the conclusion of the employment that includes the term or condition.” § 910.1 (emphasis added).
When Does an NDA Function as a Non-Compete?
The FTC shares its view of the Final Rule’s application to NDAs – and other restrictive covenants – in the 500+ pages of Supplementary Information accompanying the Final Rule. While expressly stating that the Final Rule does not categorically prohibit NDAs or other restrictive covenants (including non-solicits), the FTC nonetheless cites and draws upon two decisions to support its position that such covenants, if overbroad, may be anticompetitive. We summarize these decisions below and note that employers would be wise to stay up to date on new cases in this area.
Brown v. TGS Management Company, LLC[1]
Given the state’s common law and statutory history, California’s courts traditionally have been at the forefront in considering, and sometimes invalidating, clauses that run afoul of the state’s prohibition on non-competition agreements. In 2020, the California Court of Appeal found that TGS Management’s confidentiality agreement, which defined “confidential information” to include all information related to the securities industry, was excessively broad, effectively functioning as a non-compete in violation of California law. The court ruled that – despite a carve-out for generally known information – the NDA’s broad definition of confidential information would prevent the employee from working in his chosen field of statistical arbitrage, in which he would need to use his industry knowledge to be successful. Since then, a number of state and federal courts in California have relied on this decision in invalidating NDAs.
TLS Management & Marketing Services v. Rodriguez-Toledo[2]
Also in 2020, the United States Court of Appeals for the First Circuit ruled that an NDA between a tax planning firm and its employee functioned as a non-compete. Here, the contractual restrictions extended to matters of public knowledge as well as general knowledge gained by an employee but not specific to the employer’s business, and the court included both types of knowledge in identifying three types of overly broad NDA restrictions:
- Those prohibiting – expressly or implicitly – the use of general skills and knowledge acquired during employment.
- Those seeking to protect information that is public knowledge.
- Those preventing disclosure of information properly obtained from independent sources.
Looking Ahead
Given that the FTC has signaled that the reach of the Final Rule extends far beyond traditional non-compete agreements, employers must be prepared for potential challenges to their NDAs (and other agreements) if the Final Rule takes effect in its current form. As September 4 approaches, it is advisable for employers to review such agreements and consider whether any revisions may be warranted.
WilmerHale continues to closely monitor developments relating to the Final Rule and will provide further updates and insights. WilmerHale’s labor and employment and trade secrets experts are also available to address specific questions about the potential impact of the Final Rule on employers’ efforts to protect their trade secrets and other confidential information.
Footnotes
[1] 57 Cal. App. 5th 303 (Cal. Ct. App. 2020).
[2] 966 F.3d 46 (1st Cir. 2020).
Joshua H. Lerner and Laura E. Schneider are Partners and Andrew Stauber is Special Counsel at Wilmer Cutler Pickering Hale and Dorr LLP. This post was originally published on the WilmerHale Insights blog.
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