The Government is reviewing whether non-compete clauses remain appropriate in the new post Brexit and post COVID-19 era. In our previous article, "Protecting your business – how restrictive covenants can help ", Charlotte Farrell looked at the ways in which restrictive covenants can be used to protect businesses and the issues to consider when drafting and enforcing them. The Government has also been looking at restrictive covenants, but from a very different perspective. They launched a consultation in 2020 and finally in May 2023 they published their formal response to it. The full paper can be found here.
Is there reform ahead for restrictive covenants and in particular non-compete clauses?
In early December 2020, the Financial Times printed an article titled "UK aims to nurture starts ups by curbing non-compete clauses" and on 4 December 2020 the Government launched a consultation with the catchy title "Measures to reform post termination non-compete clauses in contracts of employment". The consultation closed on 26 February 2021 and puts restrictive covenants firmly in the spot light.
This article looks at the reasons for this consultation and review, the controversy surrounding restrictive covenants and how Brexit and COVID-19 may be partly responsible for changes to restrictive covenants in 2023 and beyond following the outcome of the consultation.
We will then comment on the government's formal response to the consultation and their decision that non compete clauses should be limited to a maximum length of three months.
WHAT IS A RESTRICTIVE COVENANT?
A restrictive covenant essentially restricts the action an employee can take when they leave their employment. They can cover any type of activity but the most common are non-solicit, non-deal, non-poach and non-compete clauses. These can apply to clients, customers, suppliers, employees or any other category of person that does business with a company.
When drafting a restrictive covenant, a company should look at who it does business with, what confidential information or trade secrets it has and how that business could be harmed if a key employee left and used that confidential information or trade secret. Any restrictions should then be specifically tailored to that risk and should go no further than is necessary to protect it.
WHY ARE NON-COMPETE CLAUSES SO CONTROVERSIAL?
Non-compete clauses have been controversial for several years. They can stop a person from working and earning a living. Depending on their industry, they could also prevent them from using skills which need to be regularly exercised to stay up to date and relevant.
Normally when the legal profession refer to "non-compete" clauses we are referring to specific clauses that stop people working for a competitor or setting up a separate business in competition, for a specific period of time and normally within a certain geographical area. These are the clauses that can potentially completely stop people from working in their chosen industry.
Other restrictions, i.e. non-poach, non-deal and non-solicit are normally considered separately and seen as much more reasonable restrictions, especially when they are tailored to the people, businesses and information the employee themselves had contact with or knowledge of. The tighter the drafting the better.
The reason non-complete clauses are seen as so controversial is that it is generally accepted that non-poach, non-deal and non-solicit clauses will often offer enough protection to a business when someone leaves. Unless there are particular circumstances to justify a tighter restriction, non-compete clauses may go further than is necessary to protect legitimate business interests and can start to look like a punishment or deterrent to someone leaving a company.
Non-compete clauses are often included in a contract of employment along with the other restrictions as a standard clause. However, commercially employers often accept that if pushed they may not be enforceable. They are often included as a deterrent with employers not actually intending on enforcing them if breached, but instead hoping employees will abide by them due to the fear of any repercussions if they did breach them.
The Government's consultation
In early December 2020, just before the Brexit transition period ended, the Government launched its consultation into non-compete clauses in contracts of employment. The consultation web page sets out two very specific issues the Government was seeing views on:
- "Proposals to make non-compete clauses enforceable only when the employer provides compensation during the term of the clause, and whether this could be complemented by additional transparency measures and statutory limits on the length of non-compete clauses".
- "An alternative proposal to make post-termination, non-compete clauses in contracts of employment unenforceable".
WHY DID THE GOVERNMENT'S FOCUS TURN TO RESTRICTIVE COVENANTS?
Back in 2020, the Government's consultation stated "to support economic recovery from the impacts of COVID-19, the Government is exploring avenues to boost innovation, create the conditions for new jobs and increase competition"; i.e. COVID-19 had caused a lot of redundancies and job losses and the Government would like people to set up their own businesses or move to companies that are currently in a position to recruit, without the barrier of post termination restrictions.
The Government had previously looked at the issue of restrictive covenants in 2016 but did not take it any further at that time. COVID-19 had brought this issue back to the focus once more.
The Government also appeared to be taking note of the recent surge in start up companies and the technology sector in the US, in particular Silicon Valley in California, where non-compete restrictions are illegal and the entrepreneurial culture has exploded. They appear to hope that taking similar action in the UK may have a similar effect.
The discussions weren't just fuelled by COVID-19 though. An article in the Financial Times around the same time as the consultation was launched, also looked at Brexit and the role it had played in this review. It can be no coincidence that many of the existing start-ups in London were set up by entrepreneurs who had moved from the EU to the UK. As of 1 January 2021, this was no longer such an easy option for those entrepreneurs not already here in the UK and the Government therefore needed to look more closely at how to encourage and develop the entrepreneurial culture amongst those already in the UK.
THE DETAILS OF THE CONSULTATION
Consultation point 1 – keep the non-compete clause but limit its scope and compensate employees for them
The first of these points looked at keeping a non-compete clause but putting restrictions on it. It focused on whether companies should have to pay employees for the period of a non-compete clause. For example – a company could choose to include a 6 month non-compete clause in the contract but must then pay the ex-employee a certain amount, or put them on garden leave, for that period. Under this arrangement, the company would gain time to protect its clients and business and the employee should not be left unable to pay their living expenses.
It would not prevent companies from using non-compete clauses but it would make them think twice about whether they were truly necessary as there would be a cost involved. If this proposal was adopted, employers were only likely to use such covenants for employees that really need them and employees were more likely to abide by their restrictions as they would be compensated financially for the period they applied for.
This part of the consultation also looked at whether there should be a fixed time limit for non-compete clauses. Currently the courts are only likely to enforce restrictions up to 12 months long, and even then, only for senior employees who could cause serious damage. Restrictions of 3-6 months are seen as much more reasonable for most employees. More formal guidance on the length of a reasonable restriction would certainly make it easier for businesses and avoid the frequent uncertainty over whether a particular length of restriction may be enforceable or not.
Consultation point 2 – ban non-compete clauses
The second of the consultation points went further and looked at whether no compete clauses should be prohibited altogether and deemed unenforceable.
There is no doubt that this would be good news for employees and could certainly increase innovation with people moving between competing companies or setting up in business on their own without the threat of legal action from ex-employers. We have seen a lot more of this in recent months in any event, with ex-employees relying on non-compete clauses not being enforceable and risking breaching them to start their own business journey. If the Government did ban non-compete clauses this would be a much easier thing to do for those entrepreneurs.
However, it would be bad news for those businesses which rely heavily on non-compete restrictions to give them time to protect their business and deals for a short period of time before key employees are back in the market place.
It may not be such bad news for all businesses though. As long as other restrictions remain possible, these along with intellectual property clauses and general confidentiality clauses should continue to give most businesses a great deal of protection and it would at least remove the uncertainty over whether or not to include a non-compete clause and, if included, how long to make it for.
THE OUTCOME OF THE CONSULTATION PUBLISHED IN MAY 2023
The background information in the report confirms that the Government wants to "make it easier for individuals to start new businesses, find new work and apply their skills to drive economic growth".
The response to the consultation does seem somewhat low to base such a fundamental change to employment law on. The report confirms they received only 104 formal responses from a range of stakeholders and individuals.
However, the Government clearly felt this was sufficient to make a final decision and the report confirms the Government will "proceed by introducing a statutory limit on the length of no compete clauses of three months".
Essentially they had chosen neither option 1 nor option 2 but had taken the additional question included in option 1 and made it into option 3.
In justifying its decision the Government said "by limiting the length of non compete clauses to 3 months, the Government is taking bold action to boost flexibility and dynamism in the labour market and to unleash greater competition and innovation".
They felt that option 1, introducing mandatory compensation, would involve too many direct costs to businesses and that option 2, an outright ban on the clauses, would go too far and prevent employers and workers negotiate their own working arrangements. They were concerned about the unintended consequences of an outright ban.
Reading the report, it seems clear that the decision was heavily influenced by the impact that non compete clauses can have on individuals who are unable to work in their chosen field for a period of time. The consultation also refers several times to economic growth, the wider economy and driving down the cost of living through these changes. The Government seems to hope that by limiting non compete clauses the economy in general will see the benefit.
It down plays the effects on businesses of limiting these clauses and the fact that all individuals, no matter their seniority and knowledge of the business, will be subject to the same maximum limit. The previous flexibility offered by the regime which allowed longer restrictions to be used for more senior employees will go.
WHEN WILL IT COME INTO FORCE?
The Government will need to put forward legislation to introduce the three month statutory limit and there is currently no date set for this. It will be considered when parliamentary time allows and so will be interesting to see how high a priority this is given. Seeing as it took the Government almost three years to release the results of the consultation it is possible we could be talking about significant further delays.
It will apply to England, Wales and Scotland but as employment law is devolved to Northern Ireland it won't currently apply there.
WILL IT APPLY RETROSPECTIVELY TO EXISTING NON COMPLETE CLAUSES?
We will need to wait for the legislation to be published to know whether the limit will be applied retrospectively. It seems likely it will be and that the legislation will include wording that will be read into any restrictions entered into before the legislation is enacted but we will have to wait and see. It could cause an administrative headache for employers if they were required to renegotiate any historic restrictive covenants which lasted for longer than 3 months so they could still be relied upon. So it seems likely the Government will address this in the legislation.
Whilst it is possible at the moment to still include longer non complete clauses in new contracts, it is worth bearing in mind that these changes are on the horizon and are a factor to consider when setting the length of them.
CAN A THREE MONTH NON COMPETE CLAUSE BE USED AS STANDARD IN ALL CONTRACTS NOW?
Unfortunately the answer to this question is no. The three month limit is a maximum limit and should not be used in all contracts without first considering the individual's circumstances.
The existing rules on the enforceability of restrictive covenants remain and so restrictions must still be considered carefully and must go no further than is necessary to protect a legitimate business interest. Please see the blog referred to at the top of this article for more information.
However, at the moment many businesses use a three month limit as their lowest restriction and so it is likely that three month restrictions will become the norm in the future.
WILL THE RESTRICTIONS APPLY TO NON COMPLETE CLAUSES NEGOTIATED AS PART OF A SETTLEMENT AGREEMENT OR IN CORPORATE TRANSACTIONS, SHAREHOLDER AGREEMENTS AND OTHER DOCUMENTS?
The consultation confirms that the new arrangements will apply to non compete clauses in contracts of employment and worker contracts.
At the moment there are no plans to extend this to the covenants found in documents used during corporate transactions, shareholder agreements, consultancy agreements, partnership agreements, franchise agreements and employee share options or other investment documents. It is already common for individuals entering into shareholder documents and employment contracts to have different lengths of covenants which apply to their respective roles and it seems likely this will continue. It may be a way for businesses to increase their protection where a key individual is also entering into another form of arrangement with them.
The situation with settlement agreements is a little less clear as this is normally a commercial arrangement between an employer and an exiting employee to increase the protection given to the company in return for a sum of money. As a settlement agreement is not "a contract of employment" or "worker contract" it seems likely that it will still be possible to negotiate higher periods in a settlement agreement but an employer is going to have to compensate an individual financially for this before a legal adviser will advise signing up to such restrictions. The legislation is likely to weaken the negotiating power held by the employer.
WILL IT AFFECT NON DEALING, NON APPROACH AND NON SOLICTATION CLAUSES?
The simple answer is no. At least not yet.
One point we were keeping a close eye on before the consultation was concluded was what the government were defining as a "non compete" clause. As mentioned above, lawyers traditionally view this as narrowly as covering working for competitors or setting up in competition. It generally excludes non-poach, non-deal and non-solicit clauses as they look at very different things and don't prevent someone from working.
Whilst the main text of the consultation focused on these narrow non-compete restrictions, the Government had included a question in its consultation asking whether or not these changes should be limited to the narrow non-compete clauses or be extended to apply to all restrictions, including the non-poach, non-deal and non-solicit clauses.
Placing any significant restrictions on these wider restrictions, and particularly banning them all together, could have disastrous consequences for businesses which rely on personal relationships with clients and customers. Arguably businesses rely on these clauses much more than a non-compete clause when someone leaves as they protect the key confidential information much better and are easier to enforce. Placing significant restrictions on these types of clauses could have a much bigger impact on existing businesses than the purpose of the consultation suggested.
It was with a sigh of relief that the consultation response confirmed that no changes were being made to the other forms of restrictive covenant commonly used in employment contracts and these can continue to be used as before.
WHAT OTHER MEASURES CAN BUSINESSES TAKE TO REPLACE THE PROTECTION OFFERED BY THE PREVIOUS NON COMPETE CLAUSES?
It is inevitable that businesses will want to consider what other measures they can take to protect confidential information and to prevent disgruntled employees from setting up in business and taking key clients or knowledge with them.
As mentioned above, non poaching, non solicitation and non dealing clauses can still be used to limit what employees can do when they go to work elsewhere. In practice, we often find these clauses are relied on more frequently than non compete clauses anyway given the controversy that has surrounded them for many years.
We anticipate we may see a rise in the use of garden leave for senior employees and employers may think twice about allowing employees to offset periods of garden leave against their restrictive covenants. So an employee may be asked to spend their three month notice period on garden leave, followed by a three month non compete clause to remove them from the workplace for up to 6 months. It will be interesting to see whether this is covered in the legislation once it's released.
Businesses may also consider using longer notice periods for all employees, not just those in senior positions.
For individuals entering into other commercial arrangements or share options at the same time, the length of restrictions in those documents are likely to remain longer to offer some added protection.
It is also fairly unusual for restrictive covenants to be negotiated in settlement agreements now. Usually because employees already have them or because the cost of paying an employee to sign up to them is too high. This may change if businesses feel the protection from a non compete clause is worth the financial cost of a few extra weeks' pay.
THE FUTURE OF NON COMPLETE CLAUSES IN GREAT BRITAIN....
Whilst there are still several unanswered questions and the outcome to the consultation will seem frustrating for many on both sides of the debate, it is positive that the Government has now reported on the consultation and clarified the way forward.
We will await the legislation eagerly but would recommend that all businesses start considering their options to protect their business and review template documents and commercial documents to check they remain fit for purpose.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
