Nine Strategies for Protecting Your Business against Unfair Competition

after FTC’s Ban on Non-Competition Covenants

Overturning common law in many states, the Federal Trade Commission’s April 23, 2024  final rule  bans nearly all employee non-competition covenants as an “unfair method of competition.”  How, then, can you protect your business from unfair competition by your former trusted employees (assuming the rule survives pending judicial challenges)?  

Who is Affected? 

The FTC’s ban affects all stakeholders in any U.S. business, whether a startup, family business or publicly-traded global enterprise.  Such stakeholders include anyone with an ownership interest – founders, entrepreneurs, “friends and family,” venture capital, private equity, next-generation, strategic acquirers, financial acquirers with “rollup” strategies, family offices, and even other employees with stock options and/or incentive compensation.  Aside from general risks of human resource turnover, stakeholders risk future abuses of trade secrets and confidential information that could impair enterprise value or even enterprise viability.  Franchises and foreign-based employees are excluded. 

What is a Non-Competition covenant?

 Under a “noncompete” agreement, an employee agrees that, after leaving a job, he or she will not work for a competitor for a limited time in a limited geography.  The FTC’s rule defines a noncompete as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) 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 (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” For generations, such covenants have been enforceable in most states under common law judicial decisions that concluded that restrictions that are reasonable in time, scope and territory serve a valid purpose for the employer. 

Which Non-Competition Agreements are Still Valid?  

Under the FTC rule, all employers will be required to notify employees that the existing non-compete agreements will not be enforced with limited exceptions.    The FTC rule permits enforcement of existing non-competes in two cases.  

In the first exception, noncompetes are valid as to senior managers in a policy-making position who are under an existing non-compete and earning at least $151,164 per year.  This requires “final authority to make policy decisions that control significant aspects of a business entity or common enterprise” at the parent company level.  The threshold compensation includes “salary, commissions, nondiscretionary bonuses and other nondiscretionary compensation” and excludes benefits.  After the rule comes into force (120 days after publication in the Federal Register), an employer cannot impose a new non-compete covenant on any new incoming senior manager.  This benefits new hires over incumbents. 

A second exception validates non-competes for employees, as selling owners, who engage in “a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.”  

Design Thinking and Possible New Strategies: How to Protect Your Business without a Non-Compete. 

Your business lawyer can help you design a business protection plan to mitigate risks of abuses, focusing on trade secrets and other confidential information.   This applies to commercial companies, not just tech and software.

1.   Non-Disclosure Agreements.  The FTC rule does not prohibit agreements that the employee will not use third-party confidential information in your business and will always maintain confidentiality of defined confidential information in your business   You might add a clause that you can check with the employee’s next employer whether there is any relationship that might result in a breach of your non-disclosure agreement with your departed former employee.  If your employee leaves to start a competing business, you may certainly investigate whether this will violate your trade secrets.  Even without your employee’s consent, you can warn the new employer not to go down a path that might breach your trade secrets.  In doing so, be careful to avoid being sued for tortious interference with contract.  
2. Operations: Narrower Segmentation of Trade Secrets (Cloaking from People and AI). Everyone knows that only very few Coca-Cola employees have access to the secret formula for the soft drink.  Similarly, when Michelin began producing new radial steel tires, its factory workers were required to wear different colored clothing to prevent individuals from gaining access to secret processes in a different department.  After the FTC rule, business owners should rethink what is a trade secret (useful information that only your business and perhaps a few others know) and what is patentable (concepts that are novel, useful and non-obvious).  

Employers should take a fresh look at their internal “information sharing” procedures. You might cloak trade secrets so that only a few “senior executives” and others holding equity ownership (or voting rights) have access to the full range of the company’s “secret sauce.”   This includes:

• Product designs and new product plans
• Customer, supplier and licensor lists
• Contracts and terms of commercial and financial agreements with third parties
• Secret processes in services, production or manufacturing 
• Business continuity and disaster recovery plans
• Financial and insurance information

Cloaking can be implemented by using password-protected tech environments.  

If you fail to cloak your trade secrets, you expose yourself to the risk that they become publicly known through no breach of your rights.  The same situation might even invalidate your ability to file for patent protection.

Beyond HR risks, unfair competition risks arise when using artificial intelligence tools.  You face risks that your proprietary data or trade secrets will train an AI “bot” that your competitors might use with the same AI “bot.”  

3. Worker Retention Strategy: Garden Leave (Extended On-the-Job Employment).  Non-competition agreements are valid during the term of employment, since the employee is being paid for some kind of service.  If the employee’s new task is to “go tend your garden and don’t contact us or our clients or suppliers or competitors,” that is a service that can include a binding non-competition covenant.  “Garden leave” clauses can be included in the employee’s employment agreement.  This may be costly, but it should not be illegal even under the FTC rule.
4. Worker Retention Strategy: Policies and Improved Conditions. If a key employee’s trade secret knowledge is highly valuable, the employer should use incentive compensation, employee benefits and other non-wage worker retention inducements to encourage the employee to stay forever.  This includes qualified stock option plans, stock appreciation rights and phantom stock.  The FTC pushes this high-wage, high-benefit, high-incentive strategy.
5.   Operations: Strategic Sourcing. Third-party service providers have may specialized knowledge outside the scope of your employee pool.  Your business might benefit from re-distribution of certain highly complex and time-consuming tasks to a third party (not an individual who is an independent contractor or sole proprietor) as a work for hire under an outsourcing “master services agreement.” This would require special contractual provisions governing intellectual property.
6. Operations: Foreign Employees. You might establish a foreign subsidiary to manage certain confidential tasks.
7. Equity-Based Compensation: Planning for a Smarter Business Exit™. Controlling owners should review their shareholders’ agreements, operating agreements and subscription agreements.  These could include “smarter business exit™” strategies including buy-sell terms with insurance funding and deferred payouts, drag-along and tag-along co-sale rights, and post-sale non-competes.
8. Post-Employment: Ongoing Fiduciary Relationship.   If the former employee ceases to be a “worker” but continues with your business as a director or otherwise has a fiduciary relationship with your business, under common law principles, you might insist on respect of fiduciary duties to avoid conflicts of interest.   
9. Post-Employment: Non-Solicitation. The FTC rule does not expressly prohibit covenants not to solicit other employees to leave your business, unless your non-solicitation covenant prevents your former employee from “working” or “operating a business” in the U.S.  

Legal Advice for Design Thinking. 

Every business needs to consider the impact of this FTC rule and similar laws.  (You may not rely on this article or website as legal advice.)  For tailored advice, you may wish to consult an attorney to consider strategies to protect against abuses that might impact human resources, technology and AI, intellectual property, risk management, concerns of investors and lender, valuation and smarter business exit™ planning.  

P.S.  Over 26,000 people filed comments in 2023 to argue for or against the FTC’s initial proposal.  William Bierce’s comments advocated moderation, using a mediator’s strategy.  “A strategic negotiator (or a neutral mediator) can help parties focus on a party’s real interests, thereby by assisting each party choose and negotiate outcomes that fit its interests and equitably accommodate the interests of its ‘adversary.’”