To compete or to non-compete? An analysis of the government’s proposed reforms to restrictive covenants in contracts of employment
Currently, non-compete clauses are available as part of an employer’s contractual arsenal: terms in an employment contract preventing outgoing employees from undertaking activities harmful to the employer’s business, such as joining competitors, soliciting clients or poaching staff, for a period of time. However, they should only be used to protect a company’s legitimate business interest and be no wider than reasonably necessary, to protect that interest.
Following Brexit and the economic fallout resulting from the global pandemic, the Government have sought to make the UK more attractive for entrepreneurs and investors. The government believes that non-compete clauses stifle competition and innovation, as they deter individuals from leaving to set up their own business or to join competing businesses, hindering economic growth. The success of the economies of California (home to Silicon Valley) and Israel, where non-compete clauses are essentially unenforceable, have given the Government an appetite for potential reform on this area. In February of this year, the UK Government closed a consultation process surrounding restrictive covenant reform, and the outcome is awaited. The proposed changes to the restrictive covenant regime is analysed below.
Proposal 1 – Require the employer to pay compensation to the employee for the duration of the restrictive covenant
The Government believes that this would be beneficial, as:
- there would be a financial disincentive to use restrictive covenants;
- Any use of restrictive covenants would be shortened due to concerns of a prolonged compensation pay out;
- Less money would be spent enforcing restrictive covenants as employees who are paid for the duration of the restrictions are less likely to breach them; and
- There is less psychological pressure on employees who may fear the repercussions of litigating in the High Court (where the loser pays the winner’s costs).
Similar premises to this system are currently utilised throughout Europe (i.e. Germany) and ensures that employees are fairly compensated for a period where they may struggle to find work suitable for their skillset without breaching the non-compete. However, the proposal does raise a number of questions. Firstly, what is the amount of compensation that is to be paid – could it be up to 100% of pay, akin to garden leave? Furthermore, what happens when there is a redundancy of a part of a business? Will the employer be obligated to make large scale compensation payments for covenants that protect business interests that no longer exist?
These are questions which will hopefully be addressed in the outcome of the consultations. There is a risk that if the compensation requirements are too onerous on the employer, the proposed reforms may have the opposite effect of deterring businesses from setting up in the UK, as legitimate business interests may be left exposed and unprotected.
Proposal 2 – complementary measures
The Government has proposed complementary measures to ensure restrictive covenants do not stifle innovation and competition for any more than is necessary, including:
- Statutory limits on lengths of restrictive covenants; and
- Transparency obligations, such as disclosing the exact terms of the restrictive covenants prior to entering any employment relationship.
It is hard to see how introducing these statutory provisions would change the status quo. The common law developed through the courts have over time created limits on restrictive covenants (including on duration) already. With regard to transparency obligations, it is arguably the norm for employees to read through their contract before signing and to take advice if there are queries - it is questionable whether this requires legislating on.
Proposal 3 – ban restrictive covenants
The Government believes that this proposal could be beneficial, as:
- There is greater certainty for all parties – restrictive covenants are never permitted; and
- There is a positive impact for innovation and competition, as there is increased labour mobility and individuals can start new businesses without fear of enforcement action.
While the Government has attributed the success of Silicon Valley’s thriving tech industry to the fact that restrictive covenants are unenforceable there, caution should be exercised when making assumptions on why economies are thriving. For instance, non-competes have been alleged to exist de facto in Silicon Valley, whereby Google and Apple agreed not to hire one another’s employees – clearly, even a ban on restrictive covenants may not necessarily prevent the effects of them. Furthermore, the Government has assumed that employee mobility is always a good thing. Arguably, it may be more effective for the economy to have employees who perfect what they do at one firm, rather than becoming a jack of all trades, master of none, jumping from firm to firm. In addition, it is uncontroversial to say that not every employee leaving a business is an innovator capable of releasing the next iPhone, nor is it controversial to say that employers have genuine business interests which will be harmed if restrictive covenants are ceased to be used altogether.
Clearly, the Government has a lot of factors to balance, and the awaited outcome of the consultation will inform employers of the considerations they need to make before hiring new staff.
What does this mean for your and your business, and what do you need to be doing now?
It does not appear that the potential statutory reforms will retrospectively impact existing employment contracts containing restrictive covenants. However, it is likely that restrictive covenants will, as a result of the Government’s renewed spotlight on them, be scrutinised even more than before by employees.
As my colleagues have highlighted in previous articles (linked below), restrictive covenants need to be considered carefully and not copied and pasted from contract to contract. Due to their controversial nature, the judiciary have, over time, imposed restrictions on their enforceability. They need to be carefully drafted with legal advice or they run the risk of being unenforceable.
In anticipation of statutory reforms which may completely overhaul the use of restrictive covenants, it may be worth considering alternative avenues to protect your business. For example, intellectual property law will protect certain interests independently of any employment contract, while copyright law may prevent a former employee from utilising works created in their former employment, without the consent of their former employer.
If you have any concerns about restrictive covenants or their enforceability, please contact BPE’s Employment team to discuss this. Equally, our Commercial and Litigation teams can assist in ensuring that your intellectual property is safeguarded.
Recommended Reading
My colleagues, Nick Rowe and Will Carter, have both written articles on the enforceability of restrictive covenants which can be found here:
Protecting your business with restrictive covenants
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.