The government recently announced in its Smarter Regulation to Grow the Economy paper that, amongst other measures intended to “reduce unnecessary regulation for businesses”, it will be limiting the length of non-compete clauses in employment contracts to three months.

Non-compete clauses are a type of restrictive covenant that prevent employees from working for a competitor business for a specified period of time upon termination of the employment relationship. Common law dictates that they are only enforceable if they are no wider than is necessary to protect the employer’s legitimate business interests, and as such, they do not typically exceed a period of 9-12 months, with their length typically determined with reference to the seniority of the employee and the risk posed to interests such as confidential information, business relationships, IP and know-how.

According to the Smarter Regulation paper, the reform will give up to five million UK workers greater freedom to switch jobs and apply their skills elsewhere and will also boost the UK economy by widening the talent pool, thereby increasing productivity.

Reform on the horizon

The government has been considering reform to non-competes for some time and the announcement is therefore not entirely unexpected. In 2020 it launched a consultation on measures to reform non-compete clauses in employment contracts, which focused on two principal options:

1. mandatory compensation during the restricted period (there is currently no obligation for the employee to be paid while restricted by a non-compete); and
2. a complete ban on non-competes.

The government published its long-awaited response to the consultation on 12 May 2023, two days after announcing the reform in the Smarter Regulation paper. Although Option 2 (a complete ban on non-competes) was opposed by 53% of respondents, who expressed concerns including a potential loss in investor confidence, a shift in jobs/functions to jurisdictions where non-competes could be enforced and increased litigation in areas such as IP and trade secrets, 60% of respondents were in favour of Option 1 (mandatory compensation), considering this to be a happy medium between allowing employers to protect their business interests and disincentivising the unnecessary or inappropriate use of non-competes.

In its response, the government rejected both options.

Despite a majority consensus in favour of a mandatory compensation scheme, the government expressed concerns that mandatory compensation during potentially long non-compete periods would be an inappropriate financial burden on businesses at a “critical juncture in our economic recovery”, noting also that small businesses would be disproportionately burdened by this and that such a system would therefore distort competition. It also warned of the “chilling effect” that a mandatory compensation system could have on labour market mobility and entrepreneurship if the comfort of remuneration were to have the effect of disincentivising employees from challenging non-competes which are likely unenforceable.

What next?

It is unclear when the measure will come into effect, as the government announced that it intends to introduce primary legislation on the matter “when parliamentary time allows”. It is also unclear whether this new rule would have retroactive effect and whether non-compliant clauses would be capped at three months or would be void. But, the government’s intention is that common law principles will continue to apply where the statutory cap is not exceeded, i.e., the starting point will be that the clause will be unenforceable unless no wider than necessary to protect legitimate business interests. How this will be assessed, particularly in industries where 9-12 month non-competes are commonplace, is yet to be seen.

However, we do know that the three month cap will only apply to employment contracts and limb (b) worker contracts, and as such will not affect other arrangements such as partnership agreements, LLP agreements or shareholder agreements. The three month cap will also not apply to commercial agreements such as M&As and Management Buy Outs. The government’s consultation response does not explicitly address the use of non-competes in equity and incentive plans, but it appears that the three month cap would not apply to such agreements and employers may therefore also continue to disincentivise post-termination competition by drafting longer non-competes into LTIPs and other equity and incentive arrangements.

The reform will also not affect the use of paid notice periods, garden leave or confidentiality clauses, nor will it impose limitations on other forms of restrictive covenants such as non-solicitation and non-poaching clauses, which are considered to be less onerous than non-competes.

If the reform is implemented as proposed, employers may enhance other methods of business protection, which may include:

• a greater shift towards retention mechanisms. These could include the introduction or tightening of golden handcuffs, e.g., by deferring payment of bonuses or equity-based remuneration (where not already covered for regulated firms), or introducing loyalty bonuses subject to clawback provisions;
• indirect workarounds such as including longer non-competes via local law in third party jurisdictions (where these are permitted) for employees with cross-border roles or for those going on long-term assignments overseas; and / or
• direct measures e.g., the use of NDAs (though, note that Justice Minister Edward Argar has recently agreed to meet with MPs to discuss extending the ban on NDAs in educational settings to other workplaces), longer notice periods (NB see note below) or longer garden leave clauses, which in practice have a similar effect to a fully compensated non-compete.

Interestingly, in rejecting the introduction of a mandatory compensation system or a complete ban on non-competes, the government said that a shift from non-competes to longer garden leave clauses would not be conducive to the aims of the reform, as this could result in even more burdensome restrictions on individuals and labour mobility than non-competes. It is difficult to see how the three month cap on non-competes would not inspire the same outcome, with lots of employers likely to consider the three month restriction insufficient.

International perspective 

The reform announced by the UK government is further evidence of how non-competes continue to be a hot topic around the globe. There is no international consensus on how best to approach non-competes, with regimes varying significantly from country to country.

The US regime hit the headlines earlier in the year when in January the Federal Trade Commission (FTC) proposed a very broad ban on non-competes and ‘de facto’ non-competes (which could include clawback mechanisms and other forms of contractual clauses) in employment relationships (also capturing independent contractors) in the United States, arguing that they hamper competition and innovation and contribute to wage suppression amounting to nearly $300 billion per year. Under the proposals, the rules would have retroactive effect and would require employers regulated by the FTC across the US to actively rescind existing non-compete clauses within 180 days after the publication of the final rule and would require them to notify both current and former employees that their non-compete clauses are void within 45 days after the rescission. The only exception would be a narrow one for sale of business arrangements where the individual subject to the restriction holds at least a 25% shareholding in the business at the time the non-compete was put in place. The proposals have come under fire from some areas of the business community.

On Tuesday 30 May, Jennifer Abruzzo, General Counsel of the National Labor Relations Board (NLRB) also issued a memo stating that non-compete agreements violate the National Labour Relations Act (NLRA) ‘except in limited circumstances’, such as when only restricting managerial or ownership interests in a competing business or when used in independent-contractor relationships. Abruzzo states that such agreements prevent employees from engaging in five specific types of activity protected under the NLRA:

• Concertedly threatening to resign to demand better working conditions
• Carrying out concerted threats to resign or otherwise concertedly resigning to secure improved working conditions
• Concertedly seeking or accepting employment with a local competitor to obtain better working conditions
• Soliciting their co-workers to go and work for a local competitor as part of a concerted activity
• Seeking employment to engage in protected activity, e.g., union organising, with other workers

This memorandum does not set any legally binding precedent (as the NLRB would have to rule that non-competes are unlawful for a precedent to be set), but requests that cases involving arguably unlawful non-compete provisions are sent to her office. This development demonstrates further momentum in favour of limiting the use of non-competes in the US.

The use of non-competes is commonplace in the APAC region. In Singapore, for example, uncompensated non-competes are generally enforceable if reasonable in length and geographical scope. Uncompensated non-competes are also common practice in Hong Kong, though enforceability rules around term are more restrictive than under the current UK regime, with such clauses typically ranging from 3-6 months.

The UK government’s strong reservations about the implementation of a mandatory compensation scheme do not appear to be mirrored elsewhere in Europe, where such systems are common. In France, non-competes are only valid if, as well as satisfying various other conditions, employees receive a minimum of around 30% of their gross salary in compensation during the restricted period. In Germany, this figure rises to 50%. A mandatory compensation system also applies in Italy.

Keen to know more?

If you would like to discuss this development in more detail please get in touch with your usual contact in the Employment Law team or Julia Gorham.

To find out more about other employment law reforms announced in the government’s Smarter Regulation paper, read our blog post: Post-Brexit employment law changes to TUPE, non-compete clauses and holiday.

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