To restrain or not to restrain… why bother? This is always the question posed by employers when drafting an employment agreement for a significant new hire.
Non-compete post-termination restrictions in employees’ contracts are considered by many to be the nuclear weapon in an employers’ arsenal to protect their company’s competitive information. Consequently, changes to these restrictions announced by the Government in May this year, provoked significant concern notwithstanding the Government’s conviction that they will promote greater competition and help boost the economy.
A chief concern is a dent in investor confidence if companies are no longer able to protect commercially sensitive information and their business in this way. However, not everyone agrees and there is a contrary and commonly held view that restrictive covenants are never upheld by the Courts (which it is not always the case).
Government Proposals on Post-Termination Restrictions
Generally, employers use restrictions drafted into employment agreements to protect three key areas. These cover: non-solicitation clauses (which prevent employees from contacting previous customers or clients in an attempt to win their business) or non-dealing clauses (which prevent employees from dealing with previous customers); non-engagement/hiring clauses (which prevent employees from engaging former employees) and solicitation of employees (which prevent employees from actively looking to recruit former colleagues); and finally, there is the restriction around non-competition following termination of employment. It is this latter restriction which has been the subject of the recent attention.
These government proposals, which are just that – proposals, will limit the length of non-compete restrictions to three months duration following termination of employment in duration. The limit will only apply in contracts of employment and what are classed as “worker” contracts. The Government is not proposing that the reforms extend to equity arrangements, partnership agreements or shareholder agreements. The reason for this decision is that there are fundamental differences between these “equity type” contracts and employment contracts, primarily due to the balance of bargaining power. The Courts have generally taken a more lenient approach to non-competes in these “equity type” documents, with the result they are often longer in duration and more enforceable than those in contracts of employment.
The proposed limitation will not interfere with employers’ ability to use paid notice periods or garden leave, nor will it change the position of confidentiality clauses. However, employers will need to exercise caution when using lengthy notice and/or garden leave provisions, as these types of clauses may be open to challenge by employees on the basis that they are in reality, restraints on trade. In addition, the Government has ruled out introducing mandatory compensation for the period of non-compete clauses – a concept that is more commonplace in mainland Europe in countries like Germany, Italy and France.
Neither will the Government proposals usurp long held common law (Court derived) principles about relying on restrictions. The first reported case in this area was in England in the fifteenth century where an apprentice was prevented from working in competition with his former master on leaving his apprenticeship. So, the case law in this area is incredibly detailed and well established.
A Balancing Act
The crux of non-compete restrictions for a Court is to weigh-up the competing interests of the employer’s right to protect its business and those of the employee to work and practice their trade. The general rule when it comes to all post-termination restrictions is that they will be in restraint of trade (and so void and unenforceable) unless they are no wider than reasonably necessary to protect a “legitimate business interest” of the employer. This will remain the case, even if non-compete clauses are limited to three months in accordance with the Government proposals.
Legitimate business interests will be those things an employer can show it has spent time and resource cultivating and nurturing and which are akin to the core or lifeblood of the business, for example confidential information, client contacts, pricing information, or secret formulas! The reasonableness of a restriction is normally assessed according to the activity being restricted, its length and (where relevant, but less common nowadays) its geographical reach. Employers need to be able to show that their legitimate business interests cannot be adequately enforced by other, lesser forms of restrictions such as through non-solicitation, non-poaching, or non-dealing clauses.
Currently, the appropriate time period for a non-compete clause will vary depending on a variety of factors such as:
- The “shelf life” of the confidential information to which the departing employee had access;
- The seniority of the employee;
- The length of time it is likely to take for the departing employee’s replacement to build up and take over relationships with customers and clients;
- The extent of the former employee’s influence over customers and clients and how long it will take for that to fall away; and
- The “industry standard” for a particular sector.
The Government claims in proposing these reforms that it is “leading the world in cracking down on the use of non-competes”. So what is the global “mood music” around enforcement of non-compete restriction clauses?
Global Trends in Non-Compete Restrictions
Interestingly, the Government’s announcement comes hot on the heels of a similar, albeit more extensive, proposal in the United States. In January 2023, the US Federal Trade Commission (FTC) proposed a complete ban on non-compete restrictions. The FTC’s reasoning is very similar to that put forward by the UK Government and signals a move in the same direction. The bottom line is that such restrictions are seen as “anti-competition” and greater competition is good for business and the economy.
The FTC argues the freedom to change jobs is core to a competitive, thriving economy and that non-compete restrictions suppress wages and hamper innovation. It also suggested eliminating non-compete restrictions would generate jobs for as many as one in five workers currently subject to non-competes, raising wages by $250-$296 billion dollars. In the EU, Margrethe Vestager, the European Commissioner for Competition, has indicated that although non-compete restrictions are less common in the EU, she would “definitely” look into restrictions on their use should that change.
For now, the current status quo remains in the UK. A lack of Parliamentary time, a forthcoming General Election, or changing priorities may mean that the proposals will not be enacted and nothing will change. As such, employers should continue to include restrictions in the short-term and think about practical ways of achieving the same aim through alternative means in the long-term, by pulling levers such as paying an extended period of garden leave, as they do in France or Germany.
Non-compete restrictions can be enforced by the Court if they are reasonable and, even if the employer decides not to pursue Court action, it is far better to have them in place than not, as it provides a potential weapon to use with any new employer to encourage negotiation and compromise over something core to the business. Invariably a deal of some sort can be hashed-out as it is always in the interests of the parties to avoid litigation and get on with their lives. If restrictions are not included at the outset, this opportunity to resolve matters will not be present leaving the business open to attack.
Jonathan Maude is a Labor & Employment Partner at Vedder Price and Chair of the UK/EU Employment Law Committee. He also serves as Managing Partner of the firm’s London office.
Jonathan is an experienced and well-respected practitioner working in labor and employment law. He regularly advises across the full spectrum of employment law-related issues in the contentious and noncontentious spheres with a particular emphasis on advising corporate clients on complex strategic human resource-related matters.
In addition, he is experienced in dealing with the employment law aspects associated with regulatory compliance, investigation, and breach involving anti-bribery, anti-corruption and privacy laws, including the General Data Protection Regulation (GDPR). Jonathan also advises on and provides training for clients and their employees on the full range of employment law matters, including disciplinary and capability issues, together with equal opportunities and diversity in the workplace.