Reform of non-compete laws could 'disincentive investment'

A consultation on measures to reform post-termination non-compete clauses in employment contracts has closed, but critics are concerned it could “disincentivise investment” in some businesses.

The government sought views from early December from business owners, employees and legal and HR professionals on the enforceability of non-compete clauses following the termination of employment.

The consultation was prompted by the economic impact of covid-19. Despite intervention measures, UK GDP remains at 9.2 per cent below February 2020 levels, with unemployment rising. 

Non-compete clauses restrict an ex-employee’s ability to work for a competitor or to establish a competing business for a set period after termination. The government is exploring reform of non-compete restrictions in a bid to “unleash innovation, create the conditions for new jobs and increase competition”. 

The UK’s non-compete regime is currently governed by common law, with all non-compete clauses presumed to be unenforceable unless they are “reasonable”. 

A non-compete clause will only be reasonable if it protects a legitimate business interest and if it is no wider than reasonably necessary to protect it. 

Such restrictions are outlawed in certain parts of the world, including California, which is renowned as an innovative tech hub. 

The government has previously consulted on non-competes but took no action, concluding in 2018 that “… restrictive covenants are a valuable and necessary tool for employers to use to protect their business interests and do not unfairly impact on an individual’s ability to find other work. Common law in this area… is generally acknowledged to work well.”

However, the impact of the pandemic has brought the issue to the fore again and two options were outlined in the consultation: 

•    Mandatory compensation - non-compete clauses will only be enforceable if the employer provides compensation for the duration of the restriction.
•    A ban on all post-termination non-compete clauses. 

The first option would be bolstered by complementary measures to promote transparency and limit the length of the non-compete period. Employers would be required to disclose the terms of the non-compete to the employee, prior to their engagement. 

The government suggests a policy of mandatory compensation would offer financial support for individuals restricted from pursuing a role and “discourage” blanket use of non-compete clauses; allowing individuals to undertake new roles or start new businesses - boosting the ailing economy. 

It is also said a statutory length of non-compete periods would prevent businesses including unreasonably long clauses. 

Currently, the courts tend to enforce restrictions of up to 12 months, so it seems likely a statutory maximum could be set at 12 months. The consultation acknowledged the risk that the maximum permitted period may be used as a default, potentially leaving employees with a period of restriction longer than what may have previously been deemed reasonable. 

However, it believes the requirement of mandatory compensation would counter this. 

Government’s view is that a ban on non-competes would offer “greater certainty” for all parties, though its scope would need to be clearly defined and appropriate exemptions included.  

Not everyone shares the government’s view. Many businesses believe non-compete restrictions help protect legitimate business interests, though the government argues that confidentiality and intellectual property law will guard against the misuse of trade secrets and confidential information.

Catriona Watt, partner at Fox & Partners, said the consultation “came as a bit of surprise to practitioners given the very broad consensus that non-competes are well calibrated in the UK and provide a good balance of the rights of employees and of businesses”.

Watt acknowledged: “Given the current economic climate as a result of the covid-19 pandemic the government is understandably concerned about barriers which may hamper or stifle innovation and entrepreneurship at a time when the country needs it most.”

However, she expressed concerned that the government may have placed too much weight on the success of US states such as California, and cautioned: “There’s no evidence to suggest banning non-competes will encourage innovation or that there is a causal link between the absence of non-competes and the growth of the tech sector in the US.”

“Litigation in connection with executive exits, particularly relating to misuse of confidential information, is still prevalent in those places,” she added.

Watt was also concerned that removing non-competes would “disincentivise investment into businesses which have no powers to reasonably restrict key employees leaving and starting rival companies”.

It is likely the consultation will lead to change in the law and it will be interesting to see which approach the government takes, if any. Depending on the outcome, government says a further consultation could follow.
 

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