Government launches consultation on the future of non-compete clauses

The government has launched a consultation on measures to reform post-termination non-compete clauses in employment contracts. Proposals under consideration include requiring employers to pay employees during non-compete restrictions or banning them altogether. Such proposals could have a significant impact on a variety of sectors where employers rely on these protections to preserve their proprietary interests in goodwill, confidential information and the stability of their client base and workforce.

The consultation, which is due to close in February 2021, is driven by the need to "unleash innovation, create the conditions for new jobs and increase competition," particularly due to the impact of the Covid-19 pandemic on the UK's labour market, according to the consultation paper.

The government is concerned that non-compete clauses are effectively a barrier to competition, new jobs and innovation because they prevent individuals from working for competing businesses or starting new businesses for a period of time. Currently, in the UK, employees are not usually paid during the period of a non-compete covenant. In certain other jurisdictions, however - such as Germany, France and Italy - payment is a requirement.

The consultation seeks views on proposals to:

• require employers to continue paying compensation to employees for the duration of a post-termination non-compete clause.

This could be complemented by a requirement for employers to confirm in writing to employees the exact terms of a non-compete clause before their employment starts, and a limit by law on the length of non-compete clauses, or

• ban the use of post-termination non-compete clauses altogether.

What are non-compete clauses?

Non-compete clauses are used in some employment contracts to restrict an employee's ability to start up, or work for, a competing business, for a certain period of time after they leave. They are a type of post-termination restriction or "restrictive covenant". Other examples include non-solicitation and non-dealing covenants which restrict an employee's ability to contact and deal with certain clients for a period of time after their employment ends.

Up until now, the law relating to non-compete clauses has been developed by the courts on a case-by-case basis. The courts recognise the tension between a person's freedom to trade and the need to uphold contracts and protect employers' legitimate business interests.

The law assumes that non-compete clauses, and other types of post-termination restriction, are unenforceable unless they are drafted no wider than is reasonably necessary to protect a legitimate business interest of the ex-employer.

The measures being considered

There are two main options that the government is asking for views on:

Option 1 - Requiring employers to continue paying compensation to employees for the duration of a post-termination non-compete clause

The government is considering making post-termination non-compete clauses in employment contracts only enforceable if the employer provides compensation during the restriction period and asking for views on this. The government believes that this may this may:

• encourage employers to consider whether the use of a non-compete clause is necessary and reasonable for a particular role before putting it into an employment contract,
• create a financial disincentive for employers to use non-compete clauses ‘as standard’ in employment contracts and reduce misuse of them,
• disincentivise employers from applying non-compete clauses for an unreasonable length of time as this would incur additional cost for the employer,
• reduce litigation as employees may be less likely to breach a non-compete obligation where they are being compensated financially, and
• avoid employees feeling they have to abide by restrictions which are overly-wide and unlikely to be enforceable because they fear the legal repercussions of not doing so.

The government is also asking for views on what level of compensation employers should have to pay if it goes ahead with this proposal. It suggests that this should be a level of compensation that is set as a percentage of the ex-employee's average weekly earnings prior to termination for the duration of the non-compete clause, e.g. 60%, 80%, 100% or some other percentage.

It is also asking whether the requirement to pay compensation during the period when the employee is restricted should be limited to non-compete clauses or should also apply to other types of post-termination restrictions, such as non-solicitation and non-dealing clauses.

Other "complementary" measures under consideration

The government is also considering combining requiring employers to pay compensation during post-termination non-compete clauses with two "complementary" measures. These are:

• introducing a requirement on employers to disclose the exact terms of a non-compete agreement to the employee in writing before they enter into the employment relationship. Failing to do so would make the clause unenforceable.
• putting statutory limits on the length of non-compete clauses, so that a non-compete clause would only be enforceable if it did not exceed a maximum period.

The consultation paper says that courts tend to enforce non-compete restrictions of up to 12 months, depending on the seniority of the employee concerned and their access to confidential information and clients. The government asks for views on whether clauses should be limited to 3, 6, 12 or some other number of months.

Option 2 – Banning non-compete clauses

The second proposal is to make post-termination non-compete clauses in employment contracts unenforceable - so effectively banning the use of them altogether.

It is suggested in the consultation paper that this would have the benefit of providing greater certainty for all parties and would make it easier for individuals to start new businesses, find new work and use their skills to drive the economic recovery. However, it also makes clear that the government recognises that non-compete clauses play an important role in helping businesses to protect their legitimate business interests.

The government notes that this type of approach has been taken in Israel and California.

The consultation document does say that the government is not currently looking at reforms to confidentiality clauses, intellectual property law or other means of protecting legitimate business interests.

What does this mean for employers?

The possibility of a ban on non-compete clauses may well cause concern for businesses who use them to protect their legitimate business interests.

This consultation follows a Call for Evidence on the use of non-compete clauses in 2016 which found that they worked well and were a valuable and necessary tool for employers in protecting their business interests. However, the damage that Covid-19 has caused to the UK labour market and economy may mean the government decides to go ahead with some reforms in this area.

We would anticipate that reform along the lines of Option 1 is more likely than Option 2, if any changes are made. We will provide further updates as this area develops.