NEW REPORT: The State of CLM and AI-Powered Contract Intelligence

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Non-Compete Agreements Banned by the FTC. What Businesses Can Do Now

The Federal Trade Commission's new rule bans non-compete agreements for most workers. Learn about who was covered, what this means for your business, past challenges enforcing non-competes, and alternative methods for protecting trade secrets. Learn how Contract Lifecycle Management (CLM) software can help companies stay on top of the changing legal landscape. 

The Federal Trade Commission voted on Tuesday, April 23, 2024, to ban the use of non-compete agreements on most U.S. workers. The new rule will make it illegal for employers to include non-compete agreements in new employment contracts or enforce clauses that restrict workers from switching employers within their industry. It will also require companies with existing non-compete agreements to inform their workers that they are null and void.

The ban carves out an exception for existing non-competes for senior executives because these agreements are more likely to have been negotiated. Senior executives are defined as workers earning more than $151,164 annually who are also in a “policy-making position.”

Controversies Remain

The FTC estimates that 30 million people – one in five US workers – are bound by a non-compete agreement in their current jobs. For most of them, the FTC asserts, such an agreement restricts them from freely switching jobs, lowers wages, stifles innovation, blocks entrepreneurs from starting new businesses, and undermines fair competition.

The U.S. Chamber of Commerce has previously called this rule “blatantly unlawful.” Some news outlets speculate that it will be challenged in court.

The rule will take effect after 120 days.

What is a Non-Compete Agreement?

A non-compete agreement (NCA) is a legal contract between an employer and an employee that restricts the employee's ability to work for a competitor, start a competing business, or disclose confidential information after employment ends. NCAs typically limited the employee in three ways:

Time:

After leaving the company, the employee could not work for a competitor for a defined period of time. This period can range from a few months to a year or more, depending on state laws and the specific agreement. 

Geography:

The NCA restricted the employee's ability to work for a competitor within a particular geographic area, such as a specific state or region. 

Industry:

In some cases, the NCA even prevented the employee from working in a particular industry altogether!

Who Was Covered Under a Non-Compete Agreement?

Traditionally, non-compete agreements (NCAs) were most commonly used for high-level employees with access to valuable trade secrets or confidential information. This could include:

Executives:

CEOs, CFOs, COOs, and other high-ranking executives privy to strategic business plans, marketing strategies, and other sensitive information.

Salespeople:

Particularly those selling in specialized industries or with a large established client base, to prevent them from taking those relationships to a competitor.

Scientists and Engineers:

In fields with cutting-edge research and development, NCAs were used to protect intellectual property or prevent employees from working on similar projects for a competitor.

However, in recent years, the use of NCAs has expanded significantly. Now, we see them applied to a broader range of workers, including:

Mid-Level Managers:

Those managing teams or projects with access to confidential processes or customer information.

Tech Employees:

Programmers, software developers, and other tech workers who may have knowledge of proprietary software or code.

Low-Wage Workers:

Surprisingly, non-compete agreements were increasingly used for blue-collar jobs or service industry positions. This could include hairstylists with a loyal clientele, fast-food workers to prevent them from revealing operational secrets, or even cashiers to limit competition from opening similar stores nearby.

The growing prevalence of non-compete agreements for lower-wage workers has sparked controversy. Critics argue that these agreements stifle worker mobility and limit their ability to earn a better living elsewhere. They also point out that these workers often lack the bargaining power to negotiate fairer terms in the NCA or even fully understand its implications.

Challenges Enforcing Non-Compete Agreements

Up until the FTC announcement on April 23, 2024, the enforceability of NCAs varied depending on state laws and the specific terms of the agreement. Non-compete agreements have been prohibited in three states — California, North Dakota, and Oklahoma — for more than a century. In recent years, 11 states and Washington, D.C., have passed laws that prohibit the agreement for hourly wage workers or those who fall below a salary threshold.

However, the patchwork nature of the legal landscape has made it difficult for companies to manage their employment agreements efficiently. The enforceability of non-compete agreements varied greatly from state to state. The risks of noncompliance loomed ever larger as state laws changed and complexities grew. This made it difficult for businesses operating in multiple locations to comply with the law. Many companies have forgone non-compete clauses from their employment contracts to ensure compliance with every state and federal regulation. Here's a breakdown of some significant hurdles businesses faced under the old paradigm:

Keeping Up with Changing Laws:

The enforceability of non-competes varied greatly by state. With states constantly revising their regulations, it could be difficult for businesses operating in multiple locations to stay compliant.  This required constant monitoring of legal updates and having different NCA versions for various regions.

Ensuring Wording is Legally Sound:

Non-compete agreements needed to be drafted carefully to be enforceable. Overly broad restrictions on time, geography, or industry could render the agreement null and void. Businesses needed legal expertise to ensure their NCAs comply with specific state and federal regulations.

Information Protection at Odds with Employee Mobility:

Finding the right balance between protecting confidential information and not unreasonably restricting employee mobility was problematic under this type of agreement.  Furthermore, agreements that were too restrictive discouraged top talent from joining the company or made it harder to retain valuable employees.

Potential for Litigation:

Even seemingly well-drafted NCAs can be challenged in court, leading to costly legal battles even if the company ultimately prevails.

Administrative Burden:

Managing the lifecycle of NCAs, from initial drafting and signing to monitoring expiration dates and potential enforcement, can be a time-consuming and tedious process. The time that legal professionals could spend on more strategic deals.

Employee Relations:

NCAs can strain the relationship and morale between employers and employees. Employees may feel undervalued or resentful when they perceive the NCA as an unnecessary restriction on their career opportunities.

Difficulty in Proving Damages:

If a company sought to enforce a non-compete agreement, it needed to demonstrate that the former employee's new role definitively harmed its business interests. Proving these damages can be dauntingly complex and expensive.

Fortunately, there are strong alternatives to protecting a company’s confidential information without unduly restricting employee freedom and the legal challenges that may come with it.  We will explore these alternatives now.

Alternatives to Non-Compete Agreements for Protecting Trade Secrets

While non-compete agreements (NCAs) have traditionally been a tool for protecting confidential information, their enforceability is now null and void except for a very narrow slice of carve-outs. However, the competition for top talent goes on, and businesses can’t put their contracting on hold.

Nondisclosure Agreements (NDAs):

The nondisclosure agreement binds employees, contractors, and other third parties to keep confidential information secret. NDAs can be broader than NCAs, restricting disclosure even after employment ends, without impinging on an employee’s freedom to seek other jobs.

Consult with your in-house legal team to ensure that the NDA is legally sound. Overly broad restrictions can risk the agreement being challenged in court.

Invention Assignment Agreements:

If an employee develops an invention while working for you, these agreements ensure ownership rights are assigned to the company.

Legal agreements, while essential, aren’t the only measures companies can take to protect their proprietary information. The technologies a company uses to safeguard sensitive information and the company culture it builds can play a role just as important.

Technical Measures to Protect Information

Technical tools such as data encryption, access controls and Data Loss Prevention software can work together to make sure only designated individuals have access to confidential information, while reducing the chance that unauthorized persons can gain access to them.

Building a Culture of Data Privacy and Confidentiality

Cultural practices such as regular employee training, limited access, and ongoing monitoring for security breaches can go a long way to ensure all employees understand the importance of protecting confidential information and have only the amount necessary to perform their job duties.

How CLM Software Helps Businesses Stay Compliant in a Changing Regulatory Landscape

Having a contract lifecycle management (CLM) software is an essential ingredient to success for businesses navigating the ever-shifting regulatory landscape of legal agreements.

With the right CLM system, organizations can respond to regulatory changes in two critical ways:

1. Review all live agreements impacted by a new regulation

First, it can review all active contracts currently in its portfolio to better understand how a new regulation impacts its live agreements. For example, in this case a company could pull a report on how many NCAs are active across its workforce. This is data that can support better decision-making as response strategies take shape.

2. Ensure new contracts are created with compliant language

Second, a CLM system can ensure that all net-new contracts created in the business reflect the latest approved contract language — again, to use the NCA example, it eliminates the risk of an old contract template being sent to a prospective employee that still contains a non-compete clause despite it being ruled unenforceable.

Here are some more specific areas where a CLM system can help in a business:

3. Risk Management and Mitigation

Risk Identification: 

CLM software can scan contracts for clauses that might indicate potential compliance risks. This allows businesses to proactively address these risks before they become legal challenges.

The best CLM platforms come equipped with AI capabilities that intelligently surface risky clauses, enable contracting professionals to perform chat queries to dig further, and generate a risk score in one easy-to-use dashboard.

Version Control: 

Using a CLM software ensures that all parties, internal and external, are working on the latest contract version, eliminating the risk of accidentally using outdated or non-compliant language.

Automated Reporting: 

CLM platform can generate reports that identify areas where contracts might be non-compliant or highlight upcoming deadlines for regulatory filings. This allows businesses to take corrective action and avoid potential penalties.

4. Automated Compliance Checks

Clause Libraries and Templates: 

You can build libraries of pre-approved clauses that adhere to relevant regulations in a CLM platform. The software can automatically suggest relevant clauses during contract creation, reducing the risk of missing crucial compliance elements.

Regulation-specific Workflows:

An advanced CLM platform can be configured with workflows that trigger specific actions based on the type of contract or the regulations involved. For example, the software might automatically route employment contracts to the legal team for review, ensuring compliance with state and federal regulations. 

Alerts and Notifications:

The CLM software can be configured to trigger alerts when relevant regulatory changes occur. This allows businesses to proactively review existing contracts and stay on top of compliance mandates with updated legal language.

5. Improved Visibility

Centralized Repository: 

By storing all contracts in a single, centralized location, a CLM software provides a clear view of all contractual obligations. This makes it easier to identify potential compliance issues and track contract changes over time.

Audit Trails: 

The CLM software keeps a detailed record of all actions taken on a contract, including who made changes, when they were made, and the previous versions of the document. This audit trail is invaluable during compliance audits or potential legal disputes.

Integration with Systems of Record:

An advanced CLM platform easily integrates with an ERP and other systems of record to ensure the HR team is equipped with the most up-to-date, compliant employment contract.

The Icertis Platform

Equipped with all of the advanced CLM capabilities listed above, the Icertis platform can help your organization manage risks and stay compliant in a changing landscape while you compete for top talent. At any business that must consistently get contract compliance right, a contract lifecycle management platform is no longer just a want, but a must-have.

Learn more about what the Icertis Contract Intelligence platform can do for your organization, and receive a free demo today.

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