Banning non-competition clauses – how will you be affected?

17 December, 2020

You could be forgiven for missing the radical steps by the government to overhaul the protection businesses have long relied on. The UK government is currently consulting on the need for clauses that restrict the activities employees can be involved in after their employment ends (post–termination restrictive covenants). Though it has been little publicised, the intention is clear – to kick-start the UK’s economic recovery following the Covid-19 pandemic. One of the lengths being considered to promote businesses and increase economic activity is shaking up the protections that have formed part of employment contracts for many years. This was first discussed in the “Call for Evidence” in 2016 and is now seen as ripe for reform.

What are the changes are being proposed?

Changing the validity of the clauses which prevent an employee from working for a competitor or set up a competitive business for a specified period after their employment terminates. At present, such non-competition clauses are enforceable provided they are necessary to protect an employer’s legitimate business interest and are no wider in scope than is reasonable. There are two changes being contemplated:-

1: The compulsory payment for the non-compete period

The first option is the introduction of a rule making it mandatory for a business to pay compensation to the employee they are seeking to restrict. This would mean that a non-compete clause which applies after their employment has ended, would only be enforceable if the former employer pays the ex-employee for the duration of the restriction.

The intention is to reduce the likelihood of litigation as employees will be less likely to breach their restrictions if they are receiving compensation, rather than being restricted without any pay (as they are now).

Employers who want to hold an employee to the restrictions will have to pay them a percentage of their average earnings throughout the restriction period. The sums being contemplated are either 60%, 80% or 100%. The typical duration is up to 12 months, so this would increase the costs for businesses – substantially for those habitually using restrictions to prevent employees decamping to a competitor.

Making a payment will not be new to businesses that operate across Europe, where payment is already required to keep an employee out of the market. The government’s objective is to ensure businesses limit the use of these and to discouraging employers from applying a non-complete clause to employees where it is not appropriate or for unnecessarily long periods.

2: Making non-competition clauses unenforceable

The second, more radical, proposal is to render restrictive covenant clauses unenforceable in contracts of employment, effectively banning their use. The basis for this approach is the perception that removing the restrictions would increase innovation and competition by enabling individuals to start new businesses and by allowing mobility of skills and ideas between companies and regions, therefore positively impacting economic growth.

What is the realistic impact?

There has been limited appetite amongst businesses to change the status quo, for good reason. They rely on, and benefit from, the protection of these restrictions, without any cost at present. They can trust employees with confidential information and relationships with customers and staff because if the employee leaves, there is a “buffer” period in which the employee cannot compete. The possibility of the restrictions becoming unenforceable is of understandable concern. Many businesses will weigh up the ability to readily attract talent from the competitors, with the risk their competitors will be poaching those in whom they themselves have invested. The fear is that businesses will be damaged if they cannot protect their business interests by keeping staff out of the market for a limited period. If the restrictions are removed, employers will still be able to prevent staff from using the company’s confidential information. However the risk is that the business will then, as now, find it more difficult to prove that information has been used (whereas establishing the employee is working for a competitor is clear-cut).

An employee planning to start their own business will be liberated to compete with their own venture or an established business. That’s certainly good news for all those who entered in to a raft of restrictions without really considering the period they would be out of the market and unpaid, when the relationship ended. Removing restrictions may foster greater entrepreneurialism as individuals are released to compete. However, it may not foster the sought after growth – a new business will also face the prospect that its relationships and ideas could be compromised should its staff depart. That may deter new businesses or even stifle innovation, which is the opposite of the government’s plans.

Total bans on non-competition clauses exist in successful economies such as California and India. It seems unlikely that the UK will prohibit their use entirely. The overwhelming majority of business that responded on the point in 2016 favoured restrictive covenants as a valuable way of protecting business interests. In the current uncertain environment for businesses, this is not the priority where they would expect change.

The more likely outcome is the introduction of mandatory payments of financial compensation for the duration of the non-compete restrictions. This is the typical position in most European countries where the payment varies from 1/3 to 100% of the employee’s total remuneration, depending on the number of restrictions and their scope. Adopting this model would remove the tendency for businesses to impose a blanket approach of including restrictions in the contracts of all staff. The sums involved would necessitate a genuine assessment of which employees need to be restrained and the minimum period the employer will genuinely need to re-establish the business relationships. These assessments could be reviewed periodically and on each promotion, to ensure the length of the business protection is appropriate. Up-front payments should deter the unnecessary imposition of covenants and reduce the disputes (and litigation costs for all involved) that follow. Businesses may still need to litigate to hold an employee to a restriction for which they have been paid. An adequate payment would likely diminish the number of employees asserting they have been constructively dismissed to free themselves from restrictions, which limit their earnings but provide no income.

If the appetite for change is present, then limiting restrictions would prove as radical a reform as the transition to remote working, which has become the norm this past year. The overarching challenge then would be finding the parliamentary time for such legislation to be passed.

If you wish to have your say, then do respond to the consultation. The full consultation paper can be found here.

For further information about the consultation’s scope or related questions, please get in touch with Melanie Stancliffe, Partner, in the Employment Team.