Lawmakers in New York passed a bill in June of 2023 to ban noncompetes statewide. Although Gov. Kathy Hochul vetoed the bill in December 2023 due to overbreadth, citing concerns regarding its impact on the economy, the governor noted she favored a ban on noncompetes for middle-class and low-wage workers. Lawmakers plan to reintroduce a revised bill in 2024.
Noncompetes are increasingly being banned by states, and a proposal to ban them nationwide is being considered by the Federal Trade Commission. Proponents of noncompetes have long cited their importance for the protection of trade secrets. As businesses can no longer rely on the enforceability of noncompetes to help protect their trade secrets, now is the time to reevaluate and reinvigorate your business’s approach to trade secret protection. It’s essential to take a more proactive approach to trade secret management to ensure that your business's valuable trade secrets are well-protected in the event of misappropriation.
This article will provide guidance regarding: the evolving legal landscape of noncompetes and the FTC proposal to ban them; how to re-evaluate and reinvigorate your company’s approach to handling confidential information and trade secrets; and an active approach to managing trade secrets to best position your company in the event of misappropriation by former employees and business partners.
Changing Landscape
Noncompetes have long been governed by state law. The enforceability, allowable duration and geographic extent of noncompetes varies from state to state, with the vast majority of states permitting enforcement of noncompetes, and a number of states putting time limits or geographical limits on their enforceability.
A shift away from the enforceability of noncompetes has been occurring over the last several years. Opponents of noncompetes have cited examples of abuse or overuse.
They have pointed to cases where workers such as hair stylists and cooks are required to sign noncompetes as a condition of their employment, which limits their mobility and potentially their ability to make a living. In July 2021, President Joe Biden signed an executive order directing the FTC to review the situation and make a recommendation. In January 2023, the FTC published a proposed rule banning noncompete provisions nationwide.
If enacted in its current form, the FTC’s proposed rule is likely to face legal challenges by pro-business groups. Meanwhile, several states, including Minnesota, California and New York, have passed legislation to ban or limit noncompetes.
Taking Action
Although the fate of the FTC’s proposed rule is not yet known, the current trend is clear: businesses cannot rely on noncompetes to protect their trade secrets and need to reevaluate and reinvigorate efforts to protect their intellectual property, and their trade secrets in particular.
As part of this reevaluation, businesses should examine the steps taken to protect their intellectual property, including trade secrets, patents, trademarks and copyrights. The optimal mix of intellectual property protections will vary depending on the nature of the business.
Businesses at the forefront of science and technology often have developments that can be patented or protected as trade secrets. Choices between patent and trade secret protection will depend on whether the information can be kept secret, whether use by a third party can be detected, whether the information is patent-eligible subject matter, and other considerations. Robust intellectual property protection depends on making the right choice for each innovation.
For example, new developments implemented in physical products — e.g., machines and hardware, among others — can often be reverse-engineered, which may favor patent protection, as it is difficult to keep such developments secret, and the ability to reverse-engineer such innovations allows detection and proof of patent infringement.
By contrast, new developments not implemented in a physical product — e.g., manufacturing processes, or algorithms running in the cloud — may be difficult or impossible to reverse-engineer, and use by third parties is often undetectable.
Rather than applying for patent protection, which entails publishing the particulars of the invention to the public, including to competitors, developments that can be kept secret — such as manufacturing processes or algorithms — may be better protected as trade secrets.
Additionally, following the U.S. Supreme Court's 2014 Alice Corp. v. CLS Bank International
decision,¹ the patent eligibility of certain types of software is often questionable. Publishing the specifics of such software in a patent application, and then failing to receive patent protection, may be more harmful to the business than taking no action at all.
Businesses often underinvest in trade secret protection. While pursuing patent protection necessitates filing an application with the government, and following rigid rules and procedures, potentially resulting in a granted patent, trade secret protection does not require such formalities, nor does it result in recognition of the trade secret by the government.
When a decision is made not to patent an invention, experience has shown that often businesses simply decide to keep it confidential, and do not take further steps to protect the invention as a trade secret.
While businesses may know they have trade secrets, they may be unable to easily identify them, where they are stored, who has access, or what agreements exist with vendors who have access to the information. Protecting trade secrets requires addressing these knowledge gaps.
Under federal law, trade secrets are information that have value in businesses because they are secret, and are subject to reasonable measures by the owner to keep the information secret.²
Courts have found reasonable measures need not be perfect measures, but need to be reasonable under the circumstances. Some examples of what courts consider in assessing whether the measures taken to protect trade secrets were reasonable include using nondisclosure agreements, limiting access, requiring passwords to computer systems, documenting access and marking information “confidential.”
If your business does not have a list, also referred to as an inventory or catalog, of your trade secrets, how do you know that reasonable measures are being taken to protect those trade secrets? Simply requiring login credentials to access your computer network may not be enough.
If your business is not making a list of trade secrets and verifying where the information is stored, who it is shared with, and how, you may be letting your trade secrets out the door. For example, do you know what online platforms your employees are using to share sensitive information, and whether they allow information to be accessible to the public?
Do you know what information your employees are providing to vendors, and whether robust
confidentiality agreements have been put in place before information is shared?
Have you documented that your company is the owner of the trade secrets you have identified? Unless your business is making a list of, at the very least, its most important trade secrets, and making sure they are handled appropriately, your valuable trade secrets are at risk.
Since trade secret protection does not require formalities, as required for patent protection, you may not know that your trade secrets are at risk until you have already lost them due to failure to take reasonable measures to keep them secret.
You may not know what you have lost until the time comes to litigate against a competitor, or a departing employee or business partner, who misappropriated the trade secret.
Some who litigate trade secrets have argued that companies should not keep lists of their trade secrets because they do not wish to have their arguments constrained in litigation by a document created prior to the start of litigation.
For example, if confidential information is misappropriated, and it is not on your list of trade secrets, an opposing party may argue that it should not be considered a trade secret because it was not on your list.
Others have argued the risk may be mitigated by including disclaimers noting that the list only includes some of the valuable trade secrets that could be identified at the time, is not an exhaustive list, and may change over time.
While flexibility in litigation may be useful, businesses need a sound way to operate to ensure their valuable assets are protected. Although a company’s physical assets may not be protected by “Mission Impossible”-style laser beams and vaults, it would be unusual for a company not to know what its most valuable physical assets are and where they are kept.
An even greater level of diligence and care should be devoted to protecting your company’s valuable trade secrets. As mentioned above, without knowing what your trade secrets are and how they are being handled, you have no assurances that your business is taking even the minimum measures commonly needed to meet the “reasonable measures” standard.
Such an approach also begs the question of what the value of your trade secrets is. If your trade secrets are misappropriated, and the time comes to demonstrate that a competitor should pay a significant sum in damages as compensation, the competitor may point to a lack of processes and procedures to protect the trade secret.
They may argue: if your trade secrets are so valuable, why didn’t you even make a list of what they are, as you did with your tangible assets such as buildings, equipment, etc.? This not only undermines meeting the legal requirement that the trade secret has value in business, but also undermines your argument for a sufficient damages award in the event of misappropriation.
Further, if you do not take a proactive approach to identifying trade secrets and assessing how your trade secrets are handled, what will you do in the event your trade secrets are stolen by a departing employee or business partner?
Proceeding with litigation will require you to identify what the trade secrets are at a fairly early stage. Attempting to identify the trade secret only after you suspect they have been misappropriated is a race against time. Compiling the list of trade secrets ahead of time will allow your business to be better prepared.
Finally, proactively managing trade secrets should include not just keeping a list of your trade secrets and assessing how they are handled, but also taking precautions that will alert you in the event of possible misappropriation.
Although espionage attracts headlines, you are far more likely to have trade secrets stolen by a departing employee or business partner. Quite commonly, this involves the mass downloading or e-mailing of files, often outside of business hours, shortly before or after leaving the company.
If you do not put measures in place to alert you to such activity, then the trade secrets — and your business — are at heightened risk.
Conclusion
Your business can no longer rely on noncompetes to help protect your trade secrets, which makes this an excellent opportunity to reassess and reinvigorate your business's approach to protecting your trade secrets and other intellectual property.
Now is the time to adopt a more proactive approach to identifying your trade secrets, and to make sure you are well-prepared in the event of misappropriation.
¹Alice Corp. v. CLS Bank Int’l, 573 U.S. 208 (2014).
²18 U.S.C. § 1839.
This article was originally published in Law360 on February 22, 2024.