Are Restrictive Covenants a Thing of the Past?

The short answer is no, not yet, but their future looks uncertain. In this update we have a look at developments affecting restrictive covenants across various jurisdictions around the globe and what multinational employers should know.

Non-competition clauses (otherwise known as “non-competes” or restraints of trade) are clauses aimed at preventing an employee from joining a competitor for a certain period after the termination of their employment. Non-competes have been around since the Middle Ages, with the first known English case involving a restraint of trade emerging in 1414, when a Mr. Dyer promised to not exercise his trade in the same town he had been trained in for six months.[1] Nowadays, non-compete clauses are common practice in the employment relationship and are often accompanied by other post-employment obligations including restrictions on soliciting or doing business with the former employer’s clients and other employees.

However, in the last few years we have seen an increased regulatory interest in limiting post-employment obligations and specifically, non-compete clauses.

On the one hand, non-compete clauses are essential to prevent employees from using their specialised knowledge gained during their employment to benefit a direct competitor of their employer. Non-compete clauses can also incentivise employers to invest in their people’s training and development, with greater confidence that their investment will be protected. On the other hand, some argue that non-compete restraints hamper innovation and labour mobility and can lead to lower wage growth.

USA’s influence

The US kick-started the trend at the start of 2023, with the Federal Trade Commission (FTC) proposing a rule to ban most non-compete clauses in the US. Under the FTC’s proposal, employers will no longer be able to enter into, attempt to enter into or maintain any agreements which contain non-compete clauses and, if the ban were successful, they must rescind all existing non-competes. Other types of post-employment restrictions such as non-solicitation, garden leave, and non-disparagement obligations would not be affected by the ban (as long as they do not operate as non-competes). 

The FTC claims their proposal is intended to increase the mobility of labour and that the “freedom to change jobs is core to economic liberty and to a competitive, thriving economy” and that non-competes suppress wages and hamper innovation. The FTC suggests one in five American workers is bound by a non-compete clause.

Whilst it may seem drastic, the FTC’s proposal is not without precedent in the US, as several states have already taken steps to limit the use of non-compete restraints. Some states, such as California, North Dakota, Oklahoma, and Minnesota, have already largely banned non-competes altogether. Other states, including Washington, Oregon, Nevada, Colorado, Illinois, Maine, Massachusetts, Rhode Island, Maryland, Virginia, and the District of Columbia, have enacted laws over the past few years that impose compensation threshold or notice requirements on employee non-compete covenants.

The UK following suit

Shortly after the FTC’s announcement, the UK government announced a proposal in May 2023. The Department for Business and Trade issued a policy paper announcing that the Government will introduce a statutory limit on the length of non-compete clauses of three months. Similar to the FTC’s reasoning, the paper states that “by limiting the length of non-compete clauses to three months, the Government is taking bold steps to boost flexibility and dynamism in the labour market, and to unleash greater competition and innovation.”

It is unclear from the policy paper how this will affect non-compete clauses that are effective at the time the proposed change is introduced. The changes will be introduced “when parliamentary time allows”, but it is not clear when this will be.

What are other countries doing?
In Australia, the Government seems to be heading down a similar regulatory path to the US and the UK. In March 2023, citing the US proposal, the Assistant Minister for Competition, Charities and Treasury (Andrew Leigh MP) formally sought advice from the Australian Competition and Consumer Commission (ACCC) on the competitive impacts of non-compete clauses and what (if any) action should be taken by the Australian Government in response. Mr Leigh has argued that the use of non-compete and non-solicitation clauses in employment contracts is hampering job mobility and wage growth by preventing employees from accepting employment with higher paying competitors.

The ACCC is yet to undertake a consultation or review of the effects of non-compete and non-solicitation clauses or provide any advice to the Assistant Minister. Depending on the eventual advice from the ACCC, the Government may decide to ban the use of non-compete clauses (likely in a similar manner to the recent ban on pay secrecy clauses that came through with the industrial reforms under the Secure Jobs, Better Pay Act earlier this year).

Looking to Europe, no major jurisdictions have banned non-competes completely, and they remain enforceable. It is common practice to include non-compete clauses in employment agreements for managers and essential employees. However, many jurisdictions have a limit of 12 months on non-compete periods and/or require non-compete periods to be paid at full or part-pay as is the case in France, Spain, Italy, Belgium, Denmark, Poland, Norway, Portugal, and Germany (with German law going one step further and entitling employees to insist on payment even when the employer waives the non-compete period).

However, the recent movement by the US and UK may shift the European position. In late 2021, the EU’s competition chief, Margrethe Vestager announced that anti-competitive restraints were coming into the spotlight of the Commission’s investigative agenda. Ms. Vestager focused namely on non-solicitation clauses, but she said that whilst non-competes are not commonly used in Europe, she would “definitely” look into restrictions on their usage if this were to change.[2]

In some other countries around the globe, including India, Mexico, and Singapore, non-compete clauses are normally void and only enforceable in very particular circumstances.

What should employers know?

Any proposed ban or restriction on the use of non-compete clauses will probably not affect an employer’s ability to use other post-employment restrictions including garden leave, non-solicitation clauses, and confidentiality agreements.

However, given the increased scrutiny around non-compete clauses, now would be a good time for employers to review their template employment contracts to ensure any non-compete clauses are compliant with local legal restrictions and case law.

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Laurence and Georgina are part of Seyfarth’s leading International Employment Law practice. To find out more about non-compete clauses, please reach out to them or anyone else on our specialist team.

 

[1] Dyers Case (1414) 2 Hen. V, fol. 5, pl. 26.

[2] Speech by Margrethe Vestager at the Italian Antitrust Association Annual Conference, "A new era of cartel enforcement", on 22 October 2021.