The increasing importance of trade secret protections for U.S. businesses

April 2, 2024 - Over the past several years, a host of U.S. states have enacted laws that limit or ban the use of non-compete and other restrictive covenant agreements. Such agreements typically restrict an employer's ability to hire their competitors' employees and limit an employee's ability to solicit their former employer's clients and personnel.

In addition to states adopting or proposing laws that subject non-compete and other restrictive covenants to higher levels of scrutiny, if not banning them altogether, the Federal Trade Commission (FTC) is expected to issue a rule next month banning, at least to some extent, the use of non-compete agreements in the U.S.

Even in jurisdictions that no longer permit non-compete agreements, however, one important carve-out remains: An employer may still protect their trade secrets from their competitors. As the landscape facing restrictive covenants continues to shift, ensuring proper trade secret protections has become ever more important for employers.

What is a trade secret?

A trade secret can take on many forms. Trade secrets can include formulas, patterns, compilations, programs, devices, methods, techniques, or processes. In other words, a company's proverbial "secret sauce." Additional examples include patents and other forms of intellectual property. However, trade secrets can constitute all different types of information, including business and computer programs, financial information, business plans, budgets, customer and supplier lists, internal marketing data, methods of calculating costs and pricing, or research and development.

In short, virtually any type of information relating to a company's business may constitute a trade secret. The real test in determining whether information constitutes a trade secret is how the business obtains and treats the information, and whether the trade secret provides the business with economic or competitive value.

How should businesses protect trade secrets?

To be considered a trade secret, the information has to be ... well, a secret. In general, the information must not be known to the public and must be sufficiently secret to confer an actual or potential economic or business advantage or benefit to the business.

A trade secret may also comprise a combination of elements, which are in the public domain but, when combined, provide a competitive advantage to the business. Thus, although any information could be a trade secret, not all information will necessarily retain trade secret protection if the information can be easily obtained by the public or not kept sufficiently protected by the business.

In the analysis of a trade secret claim, one of the primary issues that courts consider is whether the business took "reasonable measures" to protect the information. "Reasonable measures" under trade secret laws are not clearly defined and depend on the nature of the trade secret, as some secrets can be more readily protected with minimal effort than others with extensive care. For example, readily accessible electronic information may require electronically walling off the information from certain personnel, maintaining password-protected formats, and the implementation of other electronic security measures.

Although businesses are not required to build an impenetrable fortress or keep their secrets under proverbial lock-and-key to retain trade secret protection, they are nonetheless required to demonstrate some degree of internal measures were undertaken to protect their secrets. Limiting who may access trade secret information within and outside the organization, for instance, is one measure a business may take. To that end, confidentiality agreements are typically a central focus of a reasonable efforts analysis, as employees can be the primary source of trade secret loss, especially upon their departure.

Given the recent trend in limiting or banning the use of restrictive covenants, confidentiality agreements and other safeguards become ever more important for companies to protect their business advantage with respect to competitors and departing employees.

The current restrictive covenant landscape

To protect against their competition, businesses have long relied on restrictive covenants to limit a departing employee's ability to work for a competing business, appropriate their former employer's clients, and poach co-workers. As noted above, however, restrictive covenant agreements have come under increased scrutiny in the past years, with some states even banning such agreements altogether.

In California, for example, where courts have long held that non-competition agreements place an unfair restriction on trade, the state Legislature has banned all non-compete agreements and gone so far as to place an affirmative duty on employers to notify current and former employees that any previously signed non-compete agreements are void and enforceable. In addition, Minnesota, North Dakota, and Oklahoma have banned noncompete agreements entirely.

Still other states, such as Colorado, Idaho, Illinois, Maine, Massachusetts, Nevada, New Hampshire, Oregon, Rhode Island, Virginia, and Washington, have placed limitations on the type of employees that can be subject to non-competition agreements. These limitations are typically based on the employee's exempt status, wages, or position within the business.

And this year, businesses can expect attempts by the federal government to restrict non-compete agreements. On Jan. 5, 2023, the FTC proposed a rule that would ban all U.S. employers from imposing non-compete agreements on employees.

The proposed rule came after President Biden issued an Executive Order in July 2021, encouraging the FTC to exercise its rule-making authority to "curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility." The FTC is expected to vote and issue its final rule sometime in April 2024.

The increased need for employers to implement trade secret protections

In short, in some jurisdictions and perhaps soon across the country, non-compete and other restrictive covenant agreements are starting to become a potentially unreliable method to protect businesses against misdeeds by their departing employees. Although trade secret protections may not limit an employee's ability to work for the competition, trade secret protections offer many benefits and, in some cases, may prove to be a more reliable business-protection strategy on this front.

Unlike non-compete agreements, the benefit of relying on trade secret protections is that they have significant legal safeguards, including under the federal Defend Trade Secrets Act and the U.S. Uniform Trade Secrets Act, as enacted by various states. And states that have not outright adopted the U.S. Uniform Trade Secrets Act provide similar protections.

Typically, under these laws, a business may bring a claim for trade secret misappropriation to seek injunctive relief, restitution, and monetary damages. Another benefit is that trade secret protections can typically last in perpetuity — or at least for many years — and without regard to geographical scope.

Moreover, in the last decade, there has been a significant upward trend in trade secret litigation, with largely positive results for businesses that bring such claims. Most trade secret cases result in a settlement, but according to a review conducted by Law360 and utilizing Lex Machina, from 2019 to 2023, the trade secret cases that went to trial in federal court resulted in an estimated 86% win rate for plaintiffs. Other types of cases during the time period resulted in an estimated 57% win rate for plaintiffs. Further, juries seem to be willing to award large verdicts in trade secret cases.

The rise and success of trade secret cases can be attributed, in part, to businesses preferring to bring claims under theories of trade secret misappropriation, rather than relying on patent or trademark infringement laws that, in comparison, can be more difficult and costly to litigate. Still, businesses can point to large jury verdicts to ensure departing employees abide by the terms of confidentiality agreements and perhaps secure favorable results in the event of a breach.

Given the seeming recent successes of trade secret lawsuits, employers might increase their focus on trade secret protections, rather than relying solely or primarily on non-compete and other restrictive covenant agreements, whose future remains uncertain. To that end, businesses should evaluate their current workplace agreements to ensure that they contain appropriate trade secret protection and review their procedures with respect to how potential trade secrets are treated within the organization, bolstering potential safeguards where needed.

Mark Goldstein is a regular contributing columnist on labor and employment for Reuters Legal News and Westlaw Today.