Non-compete reform and the impact on business protection strategies

Last year, non-compete agreements came under intense scrutiny in both the US and the UK, with government actions challenging the extent to which businesses can limit former employees from working with competitors.

In the latest development, the Federal Trade Commission (FTC) in the US has just announced a nationwide ban on non-compete clauses. This is a dramatic shift for employers and if it comes into effect will significantly change the business protection landscape in the US. 

In the UK, a Government proposal to limit non-competes to three months is still on the table.  Whether or not this goes ahead, particularly with an election on the horizon, is yet to be seen. Nevertheless, a strong message has been sent that restrictive covenants are not immune from government interference. It is therefore important for employers to put in place sufficient safeguards to ensure their approach to business protection remains strong whatever reforms might come down the line.

Anna Birtwistle and Alice Yandle from Farrer & Co’s Employee Competition Group have recently delivered a Lexology Masterclass on Transatlantic Developments in Employee Competition, in conjunction with restrictive covenant specialists from US law firm Fisher Phillips. To hear their discussion about the impact of non-compete reforms both sides of the Atlantic, along with advice on business protection strategies for employers, a recording of the webinar can be viewed here.

This article provides a summary of the main points discussed in the Lexology Masterclass.

Non-competes in the UK

A non-compete (or non-competition) clause is aimed at preventing an employee from joining a competitor for a certain period after the termination of their employment. Currently in the UK, the appropriate length of non-compete clauses will vary based on principles of reasonableness established by case law. A report earlier this year by the Competition and Markets Authority, found that roughly a quarter of surveyed workers had a non-compete clause in their contract, with an average duration of six months. For more information on the law on non-competes, see our blog A global shift away from non-competes.

Rather out of the blue in May last year, the Government announced its intention to limit the length of non-compete clauses to three months. The Government described its proposal as a “bold” step to boost labour market flexibility, reduce barriers to recruitment and ensure high productivity. 

The proposed reforms

The Government has confirmed the following details about its proposed reforms:

• The three-month limit will only apply to non-compete clauses in contracts of employment and limb (b) worker contracts.
• The limit will not interfere with employers’ ability to use paid notice periods or garden leave, nor will it change the position of confidentiality, non-solicitation, or non-dealing clauses. It also won’t affect non-competes in equity arrangements, partnership agreements or shareholder agreements.
• The Government has ruled out introducing mandatory compensation for the period of non-compete clauses.
  
  

What is not clear is how current non-competes which are longer than three months will be affected.  It is likely that any limit on non-competes will have retrospective affect and so reduce the time period of existing covenants, but that has not been confirmed, nor is it clear how it will be it done. It is also not clear how the proposals will affect current garden-leave offset clauses. 

The likelihood of change

In terms of timing, the Government has said it will legislate when “parliamentary time allows”. We note that there has been no mention of the reforms since May 2023, and they didn’t feature in the King’s Speech in November 2023 nor in any of the numerous pieces of other employment legislation the Government has introduced in the intervening period.

As we head towards the anniversary of the Government’s announcement with no further news, there is increasing uncertainty over whether the non-compete reforms will come into effect.  With a general election on the horizon (most predict in the autumn), there is a question mark over whether it will be one of the Government’s priorities to push through the primary legislation required to make the change, or indeed whether it will have the time to do so. It will be interesting to see, however, whether recent events in the United States (see below) will have an impact on this.

We of course have to wonder what the position will be if we have a change of government.  Labour Party proposals for employment reforms make no mention of non-competes, which is interesting because the Labour Party has set out significant and far-reaching proposals for employment reforms in other areas. Pushing forward with a Conservative proposal may not therefore be a priority in the early stages of a possible Labour government.

What is happening in the United States?

On 23 April 2024, the US Federal Trade Commission (FTC) voted to ban all post-employment non-compete agreements. Notably the ban targets contractual clauses that function to prevent competition, meaning that in addition to pure non-competes, other restrictions which are deemed to have the same functional effect of preventing an individual competing, may also be caught. This is significant news: while previous action on non-competes in the US  has taken place at state level, this ban is due to be implemented at federal level, meaning it will take effect across the country.

The ban is scheduled to come into effect 120 days after it is published in the Federal Register (the official journal of the Government of the United States). The FTC’s rationale behind the ban is to “promote competition by … protecting the fundamental freedom of workers to change jobs, increasing innovation, and fostering new business formation”.

The prohibition is broad, covering (amongst others) employees, workers, independent contractors, and volunteers, albeit other types of non-compete agreements, such as in connection with business sales, are excluded. In addition, a limited exemption is made for existing non-competes in the contracts of “senior executives” (workers in a policy-making position earning over $151,164 per annum including bonuses).

This news is already proving controversial. The US Chamber of Commerce described the ban as “a blatant power grab that will undermine American businesses’ ability to remain competitive” and announced its intention to file a lawsuit challenging the rule. Whether the FTC’s ban comes into effect in its current form therefore remains to be seen.

Although the FTC ban on non-competes has the been the most far-reaching action so far in the United States, at a state level there have been other initiatives aimed at restricting or prohibiting their use. For example, recent legislation in California has reinforced its longstanding ban on non-compete by making it unlawful to include a non-compete clause in an employment contract. Last year Minnesota passed a full non-compete ban, and states such as Illinois and Colorado have used income thresholds as a way of restricting the use of non-competes. Furthermore, attempts have been made in both New York State and New York City to prohibit new non-competes (though neither have yet been passed).

There is of course also a US election taking place on 5 November 2024 which may have an impact on the general approach to non-competes. It is widely believed that if the Presidency remains Democratic, efforts to restrict non-competes will accelerate. The opposite is likely to be the case if the Presidency swings back to Republican.

What strategies can employers consider?

With one of the key forms of business protection coming under threat, the issue for employers will be how to ensure the protection of their business, client contacts and confidential information while adhering to any new rules. 

We have set out some practical considerations for employers:

• Evaluate your current approach to business protection and prepare a backup plan in the event that the length of non-competes is restricted At the very least, conduct a review of templates and precedent covenants and assess whether they need updating.
• Identify which of your staff are subject to non-competes and their duration. Check these remain valid as currently drafted in case changes do not have retrospective effect.
• Consider whether non-compete clauses could be drafted in a way which includes a contingency in event there is a change in the law (albeit acknowledging the enforceability of these is not fully tested).
• Review other lessor restrictions to ensure they provide the best possible protection. For example, consider putting in place longer notice periods and placing greater reliance on garden leave to lock employees out of the market. Similarly, you may want to increase the length of non-dealing and non-solicitation clauses so that even if employees can join competitors, they will remain restricted in who they can deal with.
• Consider changes to your remuneration structures as a way of deterring unfair competition. For example, longer non-competes in bonus, LTIP and other share or incentives documents, or revised bonus schemes in which payment is contingent on departing employees returning confidential information and handing over key client relationships.
  
  

Where next for non-competes?

The modern legal framework for the enforcement of non-competes dates back to the 1700s, though has its origins as long ago as medieval times. For several hundred years employers have had relative certainty over the law and regulation of non-competes, with the odd tweak here and there.

This century however, and particularly the last few years, we have seen an unprecedented acceleration in the number of restrictions being sought to non-competes. The US is clearly leading the charge in this regard. However, it’s fair to say that recent events both sides of the Atlantic have shown that non-competes are fair game for reform, so this is unlikely to be the last we hear of it. 

Is this the end for non-competes? Probably not, but the landscape is likely to look a little different in the future and so require a different response from employers.

For more information and practical advice on transatlantic developments in employee competition, watch our Lexology Masterclass here.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, March 2023