In three brief paragraphs of a new policy paper, the Government has proposed a potentially radical intervention into an area which has previously received little legislative attention, despite its practical importance to employers and employees alike. If implemented, the Government’s plan to reform the law of restrictive covenants will see employee non-compete clauses limited to three months’ duration, with a host of potential implications.
At their simplest, restrictive covenants – or as they are sometimes also known, post termination restrictions – are obligations which restrict an employee’s activities after their employment with a particular employer terminates. They are usually, if not exclusively, found in employees’ contracts of employment. The most far-reaching type of covenant is generally a non-compete obligation, which prevents an employee from working for a competitor for a certain period after leaving their role (often 3-12 months).
Employers are not permitted to introduce non-compete obligations purely because they wish to limit competition itself. Rather, the default position is that such clauses are unenforceable, unless they go no further than is reasonably necessary to protect the employer’s legitimate interests. Non-compete clauses are often justified on the basis that they are one of the few effective means of protecting confidential information which could easily (and even inadvertently) be used if an employee was to join a competitor. However, the law is generally sceptical of them and while they are routinely seen in contracts of employment, they must be drafted carefully to be enforceable.
Despite this, there have been concerns about the over-use of such restrictions. In many instances, employees (save for perhaps the most senior and well-remunerated) lack the bargaining power to effectively negotiate or influence the terms of restrictive covenants, if indeed they are aware of them at the outset of the working relationship. It can and sometimes does happen that an employee receives a nasty surprise upon leaving, believing that they are essentially a ‘free agent’ but finding themselves bound not to use their specialist skills in perhaps the only way they know how for an (unpaid) period of several months. Furthermore, even if a covenant looks potentially unenforceable, unless it is obviously bad it may have a chilling effect on an employee’s decision about a new role or even whether to leave their employment in the first place.
In a formal consultation launched in late 2020, the Government cited some of these issues regarding the use of non-compete clauses and identified reform as a possible driver of economic growth and recovery following the COVID-19 pandemic. In particular, it appeared drawn to the approach taken in California, where such clauses are not generally enforceable. However, it also considered other options including: (i) requiring the employee to be paid during the period of the non-compete; and (ii) limiting the duration of non-compete obligations.
Nearly two-and-a-half years later and with the consultation now over, the Government has confirmed its intention to limit non-compete obligations to three months in length. That is no small change given that, at present, there is no such limit on duration of any kind. While it is often thought that twelve months is the maximum permissible, that is no more than a rule of thumb and nothing like the hard limit which the Government currently proposes.
The proposal sounds relatively simple, as its subtitle in the paper suggests: ‘Reform non-compete clauses to boost competition and innovation’. However, there are a number of important questions about implementation which are currently unanswered. Perhaps most pressingly, will the three-month limit apply to existing contracts, or only those entered into after a certain date? How, if at all, will the limit interact with time spent on garden leave? Will it apply to members of LLPs and partners? These questions are not mere details, and the responses could have a significant impact upon how profound and how quickly a change is felt.
Once we have more detail regarding the proposals, the onus will turn to employers to decide how to react. One can imagine a variety of potential responses, such as longer notice periods or fixed-term contracts becoming common (although at a cost) or other kinds of covenant becoming more extensive and complex. However, particularly where existing employees are concerned, attempts to introduce those changes may meet considerable resistance. It will also be interesting to see if more indirect restrictive covenants are utilised in share option and other equity agreements.
At present, much remains unknown about the detail of the proposals and what their real impact will be. However, what we can say is that, after more than a century of slow and incremental evolution, employers should ensure that they are prepared for this potentially swift and significant shake-up of the law of non-competes.