What does the future hold for businesses looking to retain lawfully their market positions and prevent unfair competition from ex-employees, shareholders and other stakeholders? Recent developments in the US, as well as potential changes mooted in the UK, may fundamentally alter the way that organisations can impose contractual restrictions on those who hold valuable confidential information and influence. In this article we look at some of the upcoming potential changes and discuss other ways that businesses may need to shore up their business protection practices in the coming years.
What’s happening in the US?
Certain US states have for some time limited the use of non-compete restrictions on workers on the basis that they stifle innovation (for example, California and Oklahoma). However, the US Federal Trade Commission (FTC) has recently announced a proposed rule to ban non-compete clauses between employers and workers at a federal level. The proposed rule follows President Biden’s Executive Order, issued in July 2021, on promoting competition in the US economy in which the FTC was ordered to restrict the unfair use of non-compete clauses that may unfairly restrict worker mobility.
The proposed rule would make it illegal across the US for an employer to:
- enter into or attempt to enter into a non-compete clause with a worker;
- maintain an existing non-compete clause with a worker; or
- represent to a worker, under certain circumstances, that the worker is subject to a non-compete clause.
There are some limited exceptions – non-compete clauses between a buyer and seller of a business, where the restricted person holds a minimum 25% shareholding in the business, would not be prohibited. The FTC recognises in this context the importance of a non-compete to protecting the value of the business being acquired and that the parties are on a more equal footing than in a traditional employment relationship.
In justifying the policy change, the FTC commented that less onerous alternatives to non-compete clauses, in particular non-disclosure agreements (NDAs) that protect confidential information and legislation on trade secrets provide adequate protection to businesses. It is certainly the case that, in locations such as California, proceedings against individuals for breach of NDAs and trade secrets protections are more common. We understand it is expected that the proposed rule will be subject to judicial challenge not only in terms of the FTC’s legal standing to introduce such a rule but also, so commentators suggest, because of the uncertainty it brings. However, for now, we understand that organisations are needing to take these proposed changes seriously.
It is notable that the position in the US is being driven by the FTC as its anti-trust regulator, indicating that this matter is seen as a broader unfair trading issue, rather than just a matter of what is fair or reasonable to impose on an individual. Similar commentary is now being seen from the UK’s Competition and Markets’ Authority (CMA), as well as the CMA’s European counterparts, on unfair competition practices when recruiting and retaining talent (you can read more about the potential overlap in employees’ rights and competition law in our Law-Now UK regulator joins the global enforcement trend (cms-lawnow.com)). Employers should keep a close eye on these regulatory developments, as well as ensure that internal processes (particularly on HR information sharing and existing employee contractual clauses) are up to date.
Are there other changes afoot in the UK?
In the past few years, there has been some talk of change to the current UK legal regime on non-compete restrictions imposed on individuals. The government launched a consultation in December 2020 on measures to reform post-termination non-compete clauses in employment contracts (following a ‘call for evidence’ on the same topic back in 2016). The 2020 consultation set out similar public policy aims to those in the US – increasing competition, and reinvigorating the economy following the Covid-19 pandemic by “unleashing innovation” and creating new jobs.
The consultation, which closed in February 2021, sought views on two main options for reform:
- making post-termination non-compete clauses enforceable only when an employer provides compensation (calculated as a percentage of an employee’s average weekly earnings prior to the termination of their employment) during the term of the clause (which is similar to the approach taken in various European nations); and
- introducing an outright ban on non-compete clauses (akin to the FTC’s approach).
For further information, see our Law-Now – Non-compete clauses: change afoot prompted by Covid-19. A number of interested parties, including the Employment Lawyers Association and highly regarded barristers’ chambers, responded to the consultation, flagging (amongst other things) the lack of clear evidence that such changes would achieve the stated policy aims and also that legislative reform in this area would cause enormous upheaval to the current common law legal regime which has been built up flexibly and dynamically over years of case law.
The outcome of the consultation is awaited, although a minister confirmed on behalf of BEIS that the government was in the process of analysing responses to the consultation and that a response would be published “in due course”. More recently, the government has emphasised, following its Spring 2023 budget and the handling of the Silicon Valley Bank restructure, its support of the tech sector and the importance of innovation to the UK economy.
So what is the current position?
For now, UK employers can continue to include post-termination non-compete covenants in their employment contracts. These remain a useful and legitimate business protection measure. The proposed approach in the US may, however, help galvanise the UK government’s proposals for reform and make it increasingly likely that they will proceed with change.
We consider that the most likely route for reform is that an employer must compensate the employee during the restricted period. This would align with the approach in other European jurisdictions where the payment of compensation is a prerequisite for enforceability. For example, in Germany non-compete covenants are enforceable provided that they are reasonable and necessary to protect an employer’s legitimate interests, are limited in time and geographical scope, and an employee is compensated at a rate of at least 50% of their pre-termination contractual remuneration (which includes fixed and variable pay components) throughout the restricted period. The legal position is similar in France and Italy.
There is, however, little point in UK employers taking formal steps to adopt such an approach within their businesses at this stage because any changes will be a long way off (amending legislation would have to be introduced to parliament and go through the parliamentary review process before being enacted). In addition, the payment of compensation is not a factor that the UK courts currently take into account in determining the enforceability of restrictive covenants under the existing common law regime and so would be of no practical effect from an enforcement perspective. Payment mechanisms are being used in some sectors in the UK, but can be unwieldly and add another arena for dispute. Garden leave is a more straightforward alternative, and can be used effectively alongside restrictive covenants.
What should businesses be considering at this point?
Despite the above and based on our experience and extensive discussions with clients, it remains the case under the current legal regime in the UK that many businesses either: (1) do not consider that the contractual restrictions often imposed on key stakeholders are effective (or necessarily enforceable); or (2) find that it can often be disproportionately time-consuming and costly to seek to enforce them. But the risks for businesses have perhaps never been greater, especially in today’s hybrid working world. For a more detailed analysis of those risks and ways to mitigate them, see our Law-Now – How can businesses protect their trade secrets in a hybrid working world?
Where enforcement via litigation is not the preferred (or perhaps realistic) route, there are other measures that businesses can rely on to protect their legitimate interests, particularly as effective prevention is nearly always better than cure. For example:
- implementing enhanced information security arrangements such as employee monitoring (subject to compliance with data privacy obligations), access restrictions, prohibiting the use of personal email addresses for company business, and system alerts in respect of unusual copying, printing or downloading activities;
- extending notice periods and making use of garden leave clauses instead of payments in lieu of notice;
- considering whether retention mechanisms and/or restrictions on competition can be built into bonus schemes and longer term incentive plans;
- refreshing restrictions and other retention mechanisms as a matter of course on promotion or role change or location change, both to ensure that they are up to date and enforceable and also as part of considering whether other, less onerous restrictions (such as non-solicitation and non-dealing covenants and express confidentiality provisions) can be used instead; and/or
- using exit interview processes to:
- ensure that any company confidential information and/or property (including company devices) has been returned;
- remind employees of their ongoing obligations; and
- identify whether an employee is leaving to join a competitor and gauging the level of risk to the business.
There are of course situations where it becomes commercially imperative to seek to enforce contractual restrictions. In those cases, and where businesses anticipate they may find themselves in those situations, it is essential to ensure that as many of the above preventative steps have been taken as possible.
There may also be other causes of action available where a former employee sets up, or prepares to set up, in competition. For example, during the course of their employment employees are subject to a duty of fidelity which includes an obligation not to compete with their employer. Some employees, especially senior executives, will owe additional duties (which may include a duty to act in the best interests of their employer) and statutory company director duties. Where there is a breach of fiduciary duty, the courts have a discretion to award additional remedies including an account of profits, which can be an effective tool. Organisations may also be able to obtain “springboard relief” to prevent a competitor gaining an unfair advantage arising from a breach of confidentiality or other obligation, which can be useful where there are no other post-termination restrictions in play.
Businesses also shouldn’t forget the statutory protection afforded to their trade secrets under the Trade Secrets (Enforcement, etc) Regulations 2018 (which operate in parallel with the common law of confidentiality) where an employer has taken “reasonable steps” to protect the information and can establish that that information is secret and has commercial value. While there is no government guidance or case law yet on what constitutes reasonable steps under these regulations, they are likely to include a business identifying its trade secrets, restricting access to trade secrets and using passwords or encryption. Employers might also be expected to have taken steps to make relevant employees aware of the existence of trade secrets and include appropriate confidentiality obligations in employment contracts and/or NDAs.
There is therefore plenty more that many organisations can do in this area, before the horse has bolted out of the stable.
Where to go from here?
Business protection via litigation against (ex)employees and other stakeholders is sometimes unavoidable. However, with the legal landscape changing in the US and potentially also the UK, the direction of travel in this area is becoming less favourable to employers. Businesses should consider what they can do to both mitigate the impact of these legal developments and also shore up their internal business protection practices to prevent issues from arising in the first place.
Please do get in touch with your usual CMS contact if you would like to discuss the potential implications for your business.