Restrictions on restrictions? Will non-competes become a thing of the past?
The Conservative government’s recent announcement of its intention to legislate to cap the length of non-compete clauses in employment contracts to 3 months has been widely publicised and prompted reactions of concern from key business leaders. It came as a surprise to many lawyers, as the common view was that such covenants were a valuable and necessary tool to protect business interests, and that the common law governing this area had worked well.
The government’s own rationale is that removing such barriers will lead to greater labour market flexibility and, in turn, greater innovation and higher wages, in its endeavours to boost innovation and growth in the wake of the economic impact of the COVID-19 pandemic.
The government estimates that up to 5 million employees are subject to non-compete clauses within their contracts of a duration of 6 months or more. As part of its response to the consultation on the reform of non-compete clauses in employment contracts, the government decided not to proceed with either of the two proposals which were touted within the consultation. These were an outright ban on non-competes, as was implemented in California, US, and, secondly, the introduction of mandatory compensation (in other words payment of salary) for the non-compete period, similar to the position in Germany and France.
Instead, and in what will be the first legislative intervention in this area for over 300 years the government instead stated its intention to limit the length of these clauses to 3 months and that it will legislate when parliamentary time allows. This would require primary legislation and, with limited time left to run until the next election, it is questionable how much of a priority this will be.
The underlying thinking is that non-competes have a detrimental impact on competition and innovation and may consequently hamper economic growth. It is quite right in my experience that properly and reasonably drafted non-compete restrictions can and do delay and deter employees from moving forward in their careers or from setting up a competing business. It is also true that in some cases, they are included in employment contracts by default, to deter employees, with the threat of expensive injunctive relief proceedings being sufficient to dampen the entrepreneurial spirit of some. They may also be included in all contracts, rather than being reserved for those for whom they may be appropriate. Of course, I would not advise any employer to adopt a blanket, deterrent approach to the imposition of non competes, which are the most draconian of covenants, and if a court was to find that an employer had taken such an approach, this could backfire by rendering them unenforceable.
Instead, and ideally an employer should consider the particular business interests that are threatened by a particular role or employee, and tailor the restrictive covenants to suit. For example, a non-compete could be justified under the current common law for an employee engaged in innovation and exposed to highly sensitive confidential information that would be of immediate and significant benefit to a competitor.
It is worth noting that this announcement has no impact on restrictive covenants in the wider context, such as those within business sale agreements, shareholder agreements, franchise agreements or LLP agreements. Within business sale agreements it is not uncommon to see non-competes for several years, justifiable by the need to protect the goodwill being acquired, and this announcement will have no direct bearing upon covenants in those contexts. The 3-month cap will apply to employment and worker contracts only.
Whilst this is a change that is on the horizon, with no definite implementation date, it is something that is already having ramifications in practice. Businesses are already experiencing greater pushback from potential recruits based on this announcement. At the current time, it is not unlawful to include non-compete clauses for more than 3 months, and so there is nothing to prevent an employer from continuing to include these. An employer could then include within these clauses an express right to amend and reduce in scope the restrictive covenants, and could do so and seek to rely upon that in due course if and when the law is implemented. It is unclear what the effect of the legislation would be on existing non-competes -and whether these would be void if for longer than three months, or enforceable up to a limit of three months.
If the cap becomes law, businesses can look to other sources of protection in anticipation of this ban being implemented, including:
- Wider offering of long-term incentive plans, deferred compensation and equity-based incentives which can include these restrictions and which are likely to fall outside of the scope of the ban. Deferred compensation and benefits could be removed from employees who move to a competitor;
- Longer notice periods and greater use of garden leave whilst effective, these are costly, and there are limits to what can be enforced against an employee if they can demonstrate that long periods on garden leave would lead to an attrition of their skills and knowledge;
- Greater focus on other forms of restrictive covenants that are not subject to the ban, including clauses prohibiting the solicitation of customers, dealings with customers, dealings or interference with supplies from suppliers, poaching of employees or the employment or engagement of employees. It would be wrong to assume that such clauses could automatically be drafted to apply for longer periods in the absence of a non-compete; but if drafted properly, they can provide very good protection of customer and supplier relationships and the stability of the workforce, whilst not preventing an employee from moving forward with their career.
- The more difficult area will be how to protect the business against the threat posed by senior, non-shareholding employees who receive or create trade secrets. A key argument I have used to justify imposing and enforcing non-competes is that can be extremely difficult to police compliance with confidentiality provisions. It may be that more creative use of long-term incentives may provide the solution.
- Employers who are particularly concerned may even choose to apply the law of a jurisdiction other than England and Wales, which has a more favourable approach to the enforcement of non-competes, or if based internationally, choose to relocate certain key roles outside of the UK.