Government confirms plans to limit non-competes in employment contracts

Non-compete clauses are one type of post-termination restriction (PTR) - also known as “restrictive covenants” - that an employer may seek to include in a contract of employment. Non-compete clauses - and PTRs more generally - are governed by case law which has developed over time and provides that PTRs will only be enforceable if they are no wider than is reasonably necessary to protect the employer’s “legitimate business interests” such as confidential information and customer connections. If a court deems a PTR to be either too wide, or unnecessary in the circumstances, it will be unenforceable.

In 2020, the government published a consultation paper exploring multiple options for reforming the law in this area. This largely focused on two main alternatives:

• Option 1 – making post-termination non-compete clauses in employment contracts permissible only where the employer provides compensation (most likely a percentage of basic salary) for the period of restraint.

• Option 2 – making all post-termination non-compete clauses in contracts of employment void and unenforceable.

The plan to limit non-competes to three months

Some two and half years after it invited comments, the government has, finally, published its formal response to the consultation paper on non-compete clauses. We now know that the government has concluded that requiring businesses to pay for a non-compete period “would apply a substantial direct cost to businesses…at a critical junction in our economic recovery”. This is despite the majority of respondents to the consultation being in favour of this Option 1. The government also decided that, in its view, banning non-competes altogether may lead to “unintended consequences” such as a “loss of investor confidence” and a “lower appetite for training employees”.

The government has therefore decided to scrap Options 1 and 2 and, instead, to go with “Option 3” – capping the period of a non-compete to three months through legislation.

This plan was first announced in the policy paper Smarter Regulation to Grow the Economy alongside various other reforms related to EU-derived working time and TUPE law, as explained in our previous article. Option 3 was not actually a main option in the consultation paper – it was simply suggested as a “complementary measure” alongside Option 1. Although some 60% of respondents were in favour of a maximum limit on non-compete clauses, a reduction to three months was the least popular option. The government recognises in the response that it has chosen a short maximum limit as a “bold” step to boost labour market flexibility, reduce barriers to recruitment and ensure high productivity.

Implications of this reform

There will be no change to wider non-solicitation clauses (which limit an ex-employee’s ability to poach clients or staff), non-dealing clauses (which limit an ex-employee’s ability to deal with previous clients), paid notice periods or garden leave clauses. There will also be no change to confidentiality clauses - these are notoriously difficult to police, which is why employers have traditionally sought the protection of a non-compete.

The government hopes that this will provide more flexibility for employees to join competitors or start up a rival business and that the wider economy will benefit from the widened talent pool. Employers, however, will undoubtedly look at other options to prevent post-employment competition, such as use of garden leave. A shift towards the greater use of garden leave clauses by employers in response to any new laws could actually have the opposite effect, because garden leave clauses stop employees from working for any party (even non-competitors) whereas a non-compete wouldn’t extend that far. This may also lead to the removal of offset clauses (where the duration of restrictions is reduced by time spent on garden leave), so that employers can benefit from a full garden leave period followed by a further three month non-compete.

A focus on non-competes alone also raises potential quirks. For example, an ex-employee in a sales or business development function will be able to join a competitor after three months but could remain effectively incapacitated by ongoing non-solicit and non-deal clauses.

The government has now made it clear that the proposals will apply only to employment and worker contracts and not to non-competes in other types of contracts, such as LLP and partnership agreements or sale and purchase agreements. Therefore, where an employee enters into, say, parallel LLP and employment contracts with the business they work for – something which is not altogether uncommon for senior individuals working in certain industries - it is likely to continue to be possible to include non-competes lasting for longer than three months in the LLP documents.

It remains unclear what these proposals mean for settlement agreements. Employers may agree additional non-compete restrictions as part of an agreed settlement with an employee, often in return for an additional payment. There is no explicit mention of this in the response. The response does say, however, that the limit will apply to employment contracts and worker contracts only, so it is possible that settlement agreements will fall outside this. Similarly, it may be possible to include longer non-competes in bonus, LTIP and other shares or incentives documents.

It also remains unclear how the legislation will impact current non-competes that are longer than three months - will they be void or only enforceable up to a maximum of three months? We think it likely that they will simply be non-enforceable for any longer period, as otherwise employers would need to renegotiate existing clauses in order to avoid losing all protection.

We do now know that where an employer wishes to rely on a non-compete, as is currently the case, they will be required first to demonstrate that it is both proportionate and necessary to impose the restriction on the employee in question. An employer will not be able to assume that any non-compete applied for three months or less will now automatically become enforceable without an underlying business need.

More broadly, some employers may start asking wider questions about hiring people in the UK, especially key people in research and development or other top technical roles, if their know-how could end up in the hands of a competitor (or a start-up founded by their now ex-employee) in as little as three months.

In order to become law, this change will require primary legislation so is some way off being implemented. The response refers to “when parliamentary time allows”. In the meantime, employers can continue to include non-competes in their employment contracts and other contractual documents, but it is worth starting to consider alternative ways of protecting the business, particularly for new starters in senior or sensitive roles. This could include ensuring there are clear garden leave provisions, and possibly implementing longer notice periods. Employers can also ensure they maximise the protection afforded by other restrictions (such as non-solicitation and non-dealing). Once details of the legislation have been published, pay increases or share awards could be used to negotiate contractual changes with key existing employees as well.

For more information, do join us for our webinar on 23 May covering these and other proposed employment law reforms.