The Government is proposing to limit non-compete clauses – what are the implications?
31 July 2023
In May 2023, the Government issued a response to its 2020 consultation on post termination restrictions, confirming that it intends to introduce legislation to restrict the duration of non-compete covenants to three months.
The Government’s response makes it clear that employers will still be able to utilise mechanisms such as (paid) garden leave and notice periods as a means of restricting activities. Employers can also continue to use non-solicitation clauses (provided the employer can show such restriction goes no further than necessary to protect the employer’s legitimate business interest), confidentiality and intellectual property clauses.
There is still no indication of the timetable for these reforms – the Government has simply said “when parliamentary time allows”, which might mean it could never happen!
What are the implications of limiting non-compete clauses to three months?
The idea behind the reforms is that they will provide employees with more flexibility to join competitors or to start up a competing business, and that as a result the whole economy will benefit from more competition and a wider talent pool.
Under the reforms, there will be no changes to other types of restrictive covenants such as non-solicitation clauses (which limit the ability of an ex-employee to solicit staff or customers) and non-dealing clauses (which prevent an ex-employee from working with clients that have followed that employee of their own volition to their new employer). There will also be no change to garden leave provisions or paid notice periods.
Employers, particularly those in knowledge-driven and research-based sectors and who heavily rely on non-competes to protect their confidential information, are likely to shift their reliance to greater use of longer notice periods and garden leave clauses to prevent post-employment competition. These of course prevent an employer from working for anyone else, not just competitors.
The reforms raise a number of questions – particularly as the Government has said they will only apply to employment and worker contracts and not to non-competes that apply in other types of contracts such as sale and purchase agreements, partnership agreements and incentive plans. It is not uncommon for employees in certain industries to enter into separate employment, incentive and share agreements – which may all have different restriction periods.
It is not clear what the Government reforms mean for non-competes contained in settlement agreements. Often, departing employees and employers seek to negotiate additional post-employment restrictions in return for an additional sum of money. There is no mention of this in the consultation response – it simply says the reforms apply to employment and worker contracts, so it is possible settlement agreements will fall outside this. This is perhaps unsurprising, since an individual often has the benefit of independent legal advice when negotiating the contents of a settlement agreement and as a result, the courts often take a more lenient approach to the extent and duration of covenants contained in them. Taking the Government at its word, there does not seem to be any proposed restriction on including longer non-compete clauses in share option plans, commercial agreements and other long-term bonus or incentive plans.
It is also unclear what the approach will be to existing non-compete clauses where these are longer than three months. Will they be void completely or effectively re-written to the extent they are only enforceable up to three months? Probably the latter, given the huge amount of work that would need to be done by employers to renegotiate existing covenants/contracts otherwise.
It is not yet apparent to what extent an employer wishing to enforce a three month non-compete in court will still need to go through the legal tests to demonstrate (i) that it has a legitimate business interest to protect and (ii) that it has gone no further than necessary to achieve that. The appropriate time period for a non-compete clause will vary considerably and depend on a number of factors. This will include the “shelf-life” of the confidential information, the seniority of the ex-employee, the length of time it has taken a replacement employee to settle in and build relationships, the frequency of client contact and level of influence over customers that the ex-employee had and how long it will take for that to diminish, and the “industry standard” to the length of covenants in particular sectors. Employers should not assume that three months will be found to be automatically enforceable without the need to satisfy these tests first.
The question of whether these reforms will achieve the Government’s stated aims of increasing competition remains. Many sectors that rely heavily on their ability to protect their research, knowledge and strategies, such as tech, life sciences, R&D and financial services may well think twice before setting up or hiring for these roles in the UK if an employee can walk out of the door and go to a competitor after only a three-month restriction.
A global shift away from reliance on non-compete clauses?
As well as reforms in the UK, many other countries are now reviewing the use of non-competes. In January 2023, the US Federal Trade Commission (FTC) announced a proposed ban on non-competes across the United States. In June 2023, the New York State Assembly passed a bill that, if signed into law by the state Governor, will effectively ban future non-compete agreements. If enacted, New York would join California, North Dakota, Oklahoma and Minnesota in implementing a complete ban on non-competes.
Looking across to Europe, France, Italy, Spain, Belgium, Denmark, Poland, Norway and Portugal all have laws in place which require non-compete clauses to be paid – either at full or a proportion of normal pay. In Germany, the individual can insist on payment, even if the employer is willing to waive the non-compete. The Netherlands has also now launched a review of post-termination restrictions, the outcome of which is expected by the end of 2023. So, it is clear that we are seeing a global trend towards either severely restricting or outright banning the use of such restrictions. Whether this will improve competition is yet to be seen.
What should employers do now?
These reforms will require primary legislation before they become law, so we are some way off them being implemented. In the meantime, our view is that employers should continue to include non-compete clauses in their employment and other contractual documentation as they would have done before, but also start considering what other business protection mechanisms can be put in place. This could include making sure you have clear garden leave provisions in place and longer notice periods for those in senior or sensitive roles, as well as maximising non-solicitation clauses and looking at better use of restrictions in other types of documentation, including share or incentive plans.
If you would like to discuss any of the issues raised in this article, including maximising non-solicitation clauses or looking at other restrictions, please contact Olivia Toulson.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at July 2023.