Protecting Your Business from President Biden's "New Deal" for FTC to Curtail "Non-Compete Clauses"

 

                 On July 9, 2021, President Biden issued an Executive Order to coordinate all federal agencies around a national policy to promote competition, prevent and curtail abusive monopolies and monopolistic practices.  

 The Executive Order calls upon the Federal Trade Commission (FTC) to “address agreements that may unduly limit workers' ability to change jobs.”  Under Section 5(a) of the FTC Act, the FTC can regulate “unfair or deceptive trade practices in or affecting interstate commerce.”  Existing 2015 FTC policy targets “the promotion of consumer welfare.”   President Biden seeks to expand that policy to include worker mobility: “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”  But “unfairness” is not defined by statute.  If a non-compete agreement is too restrictive, a worker might not find a new job with higher wages or better employment opportunities.

                For business owners and tech investors, it is time to anticipate and manage potential challenges to non-competition covenants. 

                For employees, consultants, business service providers and strategic alliance partners, new federal regulations probably cannot replace the need for smart negotiations to prevent possible abusive enforcement of a valid restrictive covenant.  

                What is a Non-Compete Clause?  A non-competition clause or “covenant” is a contractual obligation by an employee not to compete with the employer’s business during employment and for some limited period after employment.  This restricts the employee from joining a competitor until after a reasonable “cooling off” period.  But the restriction is limited in scope, duration and, if appropriate, geography.  Every situation is different, so courts analyze the benefits, burdens and reasonableness.  The non-compete clause typically includes protections for trade secrets, which can exist forever (e.g., Coca Cola’s secret formula for its soft drink).

Why Businesses Require Non-Compete Clauses.  Non-compete clauses serve valid competitive purposes.  They protect a business against:

·         Poaching of the business’s clients and employees (but not forever);

·         Unauthorized disclosure of trade secrets (both of the employer and third parties doing business with the employer) and other employer confidential information; and

·         An employee’s abuse of his or her duty of loyalty while an employee.

 What are the Public Policy Limitations on Enforcement of Non-Compete Covenants.  In New York, such clauses are permitted as a matter of long-standing public policy (“common law,” not statute) to protect an employer.  (An exception exists for the broadcast industry.)  New York common law (“public policy”) already limits non-compete covenants.  The covenant must be reasonable in scope of work (relating to the first employer’s business activities), duration and geography.  As summarized by a former New York attorney general in 2017:

A non-compete [agreement] is only allowed and enforceable to the extent it (1) is necessary to protect the employer’s legitimate interests, (2) does not impose an undue hardship on the employee, (3) does not harm the public, and (4) is reasonable in time period and geographic scope. An employer’s legitimate interest may include protecting an employer’s trade secrets and confidential information and preventing employees from taking specialized skills they gained on the job to a competitor. A non-compete’s restrictions must be no greater than necessary to protect the legitimate interests of the employer. To determine if a non-compete is enforceable, courts consider an employee’s job duties, the employer’s business interest, and the language of the agreement.

In contrast, a California statute bans non-competition covenants as a “restraint of trade” unless negotiated as part of the sale of shares or the employer’s business.  Exceptions apply to situations involving business exit transactions including the sale of the goodwill of a business, the seller’s entire ownership interest in the business entity, or all or substantially all of a business’ operating assets together with the goodwill.  Calif. Bus. & Prof. Code §§ 16600 and 16601.

 Negotiated Contractual Limitations on Non-Compete Clauses. To limit an overly broad limitation on mobility of workers and business service providers, employees, business service providers, licensors, strategic partners and others can negotiate limitations on non-compete clauses.  For example, one might negotiate an exclusion for information and know-how that is “general skill and knowledge” in an industry.  Or an employee might negotiate a separation bonus can seek some compensation, particularly where the employee to cover the post-termination period, especially where the termination was “without cause.”   For new senior executives coming on board with broad substantive and strategic knowledge, a blacklist of “competitors” and a whitelist of “non-competitors” might be identified to give comfort to both employer and executive.

 Planning How to Improve your Chances of Enforcing a non-Competition Clause.  Anticipating new FTC regulations on interstate businesses, you can improve your odds of judicial enforcement of your non-competition covenants.  In addition to carefully crafting your non-compete clauses, you can:

 ·         Pay some money that is earned only during the post-termination period.  This provides special “consideration” beyond one’s normal salary. 

-        In England, they send such employees to “garden leave” to do nothing but grow a garden. 

-      In Japan, the “corner office work” serves the same function, where job duties are restricted with full pay.

·          Limit the scope to what is needed for saving your customers, your employees and your trade secrets from poaching.  

·         Protect trade secrets through internal management practices, manuals, trainings and segregation of functions, as well as clauses in employment agreements, licensing agreements, business services agreements (outsourcing), non-disclosure agreements, financings, strategic transactions, and any transaction for a change of control.

·         Protect existing and prospective client relationships and employees from being poached by delivering good customer experiences and employee satisfaction.

·         Link non-compete clauses to stock options, restricted stock units and/or deferred compensation.

·         Negotiate with your new employees (and their attorneys) to have them agree the restrictions are reasonable.

·         Require disclosure to new employers so that they can evaluate whether there is a risk of conflict and breach.

·         Consult an attorney who understands your business model and can help you build, protect and securely exit your business.

Protecting Company Intellectual Property: Simple Moves against In-house Theft of Trade Secrets and IP

Intellectual property (“IP”) is the elephant in the valuation of a company at sale or financing, but can be undervalued on the balance sheet.  Major enterprises have compliance officers, legal departments and major law firms and tech consultants to help secure their intellectual property?  What about small to mid-sized enterprises or small multinationals?  

Leadership.   First, appoint a person responsible for managing intellectual property.  This usually requires someone with a broad overview of the company’s business strategies, methodologies and competitive positioning.   In a smaller company, this could be the CEO or a deputy. 

Training and Managing Your Employees and Value Chain.   Every person in the company’s “value chain” should be trained in the basics of intellectual property.   These include (1) the differences between a trade secret and a patent, (2) the limited but potentially valuable scope of protection of copyrights, (3) the value of trademarks and related goodwill and how such value can be protected or lost, and (4) the rules defining who owns intellectual property in the absence of a contract.  The “value chain” includes the company’s employees and contractors, and employees of corporate contractors.  

Adopting and Highlighting Policies to Your Employees and Value Chain.    Written policies and procedures on IP protection can serve as references for education, swords against wrongdoers and shields against competitors and other adversaries.   Such policies can be included in employment contracts, employee handbooks, sales manuals (to guide sales personnel), template contracts, joint venture agreements, licenses, IP assignment agreements, website “Terms of Use” and other handy everyday documents.    Without good policies and procedures, the company’s shareholder value risks dilution.

Data Security.   The Healthcare industry lives under federal regulations governing logical, administrative, legal and technological barriers to unauthorized data access.   Your business should apply the wisdom of such practical protections.

Transition Management.    Change management refers to adaptive behaviors.   Transition management relates to a company’s procedures for transitioning relationships (onboarding or termination) with individual employees, contractors, suppliers and others in the value chain.   Checklists, coordination among IT and HR departments and Sales can help avoid or mitigate litigation costs.  Make sure your trade secrets and other IP do not leave the company when the individuals “in the know” leave the company.

IP Risk Prioritization.   Sure, every person in a business has some knowledge of trade secrets that could help a competitor.  But, as in George Orwell’s Animal Farm, certain people are more equal than others, by reason of having broader scope and deeper knowledge of trade secrets.  The Board needs to ensure surveillance and even forensic analysis in relation to high-risk positions such as heads of R&D, scientists, product developers and new business developers. 

Business Modeling in Outsourcing, Licensing and Joint Ventures.  In the early days of outsourcing, companies gladly gave up their employees to the external service provider without charging a headhunter fee or a training fee, and without getting the right to re-hire them, or to get some knowledge management tool to capture the company’s implicit knowledge so it can be restored upon termination of the outsourcing.   The same applied to joint ventures.   This was pretty astounding.   Over time, business models have evolved to incorporate knowledge management.   When outsourcing a process, think about how to keep some residual knowledge for effective management of service providers and integration of the supply chain.   See www.outsourcing-law.com for more.

Spoliation of Evidence.   If business owners and managers have learned anything in the last 10 years, it’s “e-discovery” and “spoliation of evidence.”   Policies and procedures should be adopted to ensure against insider theft of trade secrets and spoliation of evidence of theft.   There are software tools and IT procedures for network administration that can help manage this increasingly costly risk to IP owned by or licensed to the company.  When a high-profile IP person leaves, the company should conduct a quick forensic review.  Evidence lost when hard drives are overwritten can be irreplaceable.

Legal Audit.   When you suspect a loss of IP, call the lawyers.  An internal investigation supervised by lawyers is entitled to confidentiality protections in court under the attorney-client privilege and the attorney work-product doctrine.  Put the lawyer in charge as Maestro, and let the IT, HR, security, forensic analysts and other joint the orchestra.   Even if you don’t suspect any problems, attorneys with Maestro batons can elicit better-protected music for your IP.   And consider legal audits on a regular basis, not just before the time you sign up for an intellectual property rights insurance policy.

Are we feeling innovative yet?