The New Challenge to Employee Confidentiality Agreements

August 28, 2023

IP Watchdog

“Three may keep a secret, if two of them are dead.”

           — Benjamin Franklin

It used to be so simple. For centuries, China was able to maintain its monopoly on silk production just by killing anyone who tried to leave the country with knowledge of its secrets. Thirteenth century Venice showered benefits on the Murano glassmakers but also prohibited them from leaving the island. Augustus the Strong preserved the secrets of Meissen porcelain by setting up a workshop in one of his remote castles and basically imprisoning the artisans there. A similar containment strategy was employed by England to protect its preeminent position in textile manufacturing. With the Exportation of Machinery Act of 1774, Parliament decreed that neither “Implements used in the Manufacture of Cloth” nor “Descriptions” thereof could be exported. Although this was presumed to apply to skilled workers with such knowledge in their heads, the law did not stop one ambitious young apprentice, Samuel Slater, from slipping out to find his fortune in the colonies by applying what he knew, seeding the U.S. industrial revolution.

The Apprenticeship Contract

It helps to remember that Slater’s behavior challenged not only the law against exportation of technology, but also the system of apprenticeships that had developed in England since the sixteenth century. The 1563 Statute of Apprentices (also called the “Statute of Artificers,” referring to skilled workers who produce goods by hand) made an apprenticeship compulsory for anyone who wanted to enter a trade. This was no summer internship, but typically required a seven-year commitment to learning at the foot of a master in the trade, who in addition to training would also provide room and board. Although the apprenticeship “indenture” was similar in many ways to the general contract of indenture by which workers pledged themselves for a set period in return for some benefit such as a piece of land, its focus was instead on training. Indeed, many middle-class families would pay a hefty fee for their 14-year-old son (there were relatively few female apprentices) to learn from a well-regarded master.

Apprenticeship indenture contracts tended to constrain the young worker in ways that their modern counterparts would likely find unacceptable. The apprentice had to “gladly obey” the master’s commands, forego “Cards, Dice or any other unlawful Game” and avoid “Ale-Houses, Taverns and Play-Houses” (that is, theaters). But we also see in them some of the same restrictive covenants that are common in modern employment agreements. The apprentice had to “keep the said Master’s Secrets,” and in many cases agree not to compete with the master for seven more years after expiration of the apprenticeship (the English Statute of Monopolies of 1623 set the term of a patent at 14 years; coincidence?)

When Slater traveled to New England, he was responding to an advertised market need for skilled artisans. In the same year that Britain barred the export of textile technology, its colonies had begun to offer bounties for textile workers willing to emigrate. Pennsylvania’s was first, at £100, and following independence most states offered amounts up to £500. In effect, these were the signing bonuses of the nascent industrial revolution. Fast forward to today, when very skilled artificial intelligence professionals can command salaries of as much as $900,000. In an economy fueled by the expanding horizons of innovation, money talks and talent walks.

Noncompete vs. Nondisclosure

The recruiting side of this process comes with its own challenges and risks around contamination with information belonging to others, a subject we have examined before. But for the moment, let’s focus on how business gets employees to respect and protect the integrity of the company’s own data assets. Here, we need to distinguish between two types of restrictive agreements: (1) prohibiting competition for a period after the employment ends (a “noncompete”) and (2) prohibiting use or disclosure of the employer’s trade secrets (a “confidentiality” or “nondisclosure” contract).

Noncompete agreements have always been controversial to some extent. Employers like them because they avoid messy litigation over whether the employee has breached confidentiality; a noncompete eliminates the risk as a practical matter. But it is a blunt instrument, preventing fair as well as unfair competition. At a macro level, a few states, notably including California, long ago decided that noncompetes are anathema in an open economy. Some people point to the extraordinary story of Silicon Valley to argue the wisdom of this policy. Indeed, Minnesota has just jumped on board, and a growing number of other states have limited noncompetes to high-earning executives.

In contrast, employee confidentiality agreements have almost universally been embraced by courts, even though they usually operate in perpetuity to restrain use or disclosure of information. This is mainly because even without a contract, the common law recognized a duty of confidentiality by all employees to respect the trust implied by having access to secrets. In that context, the contract is not necessary to create the obligation, although it certainly is helpful, because it provides evidence of the confidential relationship and notice to the employee. As a result, employee confidentiality agreements are ubiquitous in most industries.

Protecting Labor Mobility

But establishing a relationship of confidence isn’t the same as enforcing one, and in a society that values the free movement of labor there can be some real tension between the employer’s interest in ensuring exclusive control over its trade secrets and the employee’s interest in moving to another job, even one that is directly competitive. We resolve that tension in part through rules that guarantee all employees the right to use their accumulated skills and general knowledge as they move on. In effect, they have a growing “tool kit” to take with them. But increasingly, legislatures and government agencies have expressed policies that more clearly support labor mobility.

In the negotiations that led to the federal Defend Trade Secrets Act of 2016 (DTSA), a provision was inserted that restricted the ability of judges to issue injunctions against departing employees. Courts may not prevent someone from accepting a job, and any restrictions they impose on what an employee can do must be based on evidence that misappropriation is likely, but “not merely on the information the person knows.” Technically, the statute does not limit the applicability of confidentiality agreements, but it can make more challenging the company’s attempt to enforce them in ways that are effective to protect secrets.

More recently, the Federal Trade Commission has proposed a rule that would ban noncompetes nationally but would also apply to any employee confidentiality agreement “written so broadly that it effectively precludes the worker from working in the same field.” We examined that proposal when it emerged some months ago, and while it may not ever issue as an enforceable regulation, it rhymes with much of the effort at the state level to rein in noncompetes.

When a Confidentiality Contract Looks Like a Noncompete

Whatever position you might take on noncompetes as such, a troubling dimension of this debate is the use of the same broad brush to paint confidentiality agreements as threatening to employee mobility. And it’s not just government that is pressing this position; the courts have also joined. In a 2020 case from the First Circuit Court of Appeals, TLS Management v. Rodriguez-Toledo, the lower court had ruled for the employer, a tax advisor, against a former employee who it claimed had been using its proprietary techniques in violation of his confidentiality agreement. The appellate court reversed, explaining that “overly broad nondisclosure agreements, while not specifically prohibiting an employee from entering into competition with the former employer, raise the same policy concerns about restraining competition as noncompete clauses where, as here, they have the effect of preventing the defendant from competing with the plaintiff.”

This willingness to analyze nondisclosure agreements as if they were noncompete contracts presents a serious conundrum for businesses. Imposing nondisclosure agreements on employees is a key feature of most companies’ information security programs; indeed, the law’s requirement that the employer engage in “reasonable efforts” to protect its trade secrets often starts with looking at where such agreements are in place. If you don’t have them, you risk losing your rights. And when you create them, you can’t know exactly what information the employee will be exposed to over the years of employment. As a result, the definition of “confidential information” in the contract necessarily will be very broad, with the details to be filled in by on-the-job training and experience.

How to Avoid the Problem

So, what is the employer supposed to do? First, avoid trying to claim that everything the employee learns on the job belongs to the company. The language of the contract in TLS Management was so expansive that it arguably swept up information that was generally known, making the employee radioactive in terms of litigation risk. As a test, make sure to read the agreement in a way that ensures there is a path forward for the honest worker who just wants to get another job. Second, accept that there is no way in the modern world to make yourself whole for having released into the market someone whom you have endowed with the skillset to compete with you. Get over that annoyance. And third, focus on the risks to your specific secrets by engaging in a meaningful exit process. More on that here.

We’re not in the 18th century anymore. Ultimately, talent will break free to pursue new opportunities, and that, together with hackers and heavy-handed regulators, represents the modern business environment. But take heart: litigation (a modern form of capital punishment) is not the only answer. Almost all concerns about protecting trade secrets can be solved with better management.

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