Most of us will have heard about post-termination restrictive covenants in some shape or form, or have perhaps even been subject to one.
These clauses are inserted into an employment contract to prevent an employee from acting in competition with the business for a defined period of time (typically three – 12 months) after the termination of their employment.
There are different types of restrictions available, the most common being:
- obligations not to be involved in any capacity (whether as employee, consultant, shareholder, etc.) with any business in competition with the employer (referred to as “non-competes”); and
- obligations not to solicit, or have any dealings with, clients, customers, suppliers, or other employees (referred to as “non-solicitations” and “non-dealings”).
They are used by businesses globally but different parameters apply depending on the relevant jurisdiction. In this article, we highlight recent significant changes in the US and consider the position in the UK.
Federal Trade Commission bans non-competes across the US
The Federal Trade Commission (FTC) defines a non-compete clause as:
“a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person … or (2) operating a business in the United States…”
Under a new rule adopted by the FTC, the use of non-compete clauses by employers across the US will in almost all cases be prohibited with effect from 4 September 2024, with the aim of increasing innovation and protecting workers’ freedom to change jobs.
In theory, this means that employers will no longer be able to prevent employees from working for a competitor or starting up their own business in competition after the end of their employment, with the FTC finding that such restrictions are unfair. The rule is not a complete ban and there are exceptions but, for the most part, employers cannot enforce non-competes from 4 September 2024 and they will be required to notify workers subject to existing non-competes that these will not be enforced against them.
As for who falls outside of the ban – the FTC introduced an exception for “senior executives” so that non-competes applicable to senior executives entered into before 4 September 2024 will remain enforceable. “Senior executives” are defined as workers earning more than $151,164 annually and who are in “policy-making positions”.
In addition, the ban does not apply to non-competes entered into with sellers in certain sale-of-business agreements, provided that such arrangements are made in good faith, with the FTC recognising that the interests of parties in such commercial transactions are different to those in an employment relationship.
The rule applies widely to “workers” in the US, which the FTC says includes unpaid workers and independent contractors.
While the prohibition will not specifically apply to other types of restrictions under an employment contract, such as confidentiality obligations, non-solicitation, or non-dealing covenants, the FTC clarified that such restrictions may be caught under their definition of a non-compete if the clause is drafted so that it effectively functions as a non-compete. The FTC provided an example of a confidentiality obligation that restricts a worker from disclosing in a future job any information that is “usable in” or “relates to” the industry in which they work, which effectively prevents someone working for another employer in the same field.
Further, employee incentive arrangements linked to obligations on an employee not to compete could fall within the scope of the prohibition where the individual is financially penalised for doing so.
The ruling is currently being challenged in the US and there may be further developments. If it comes into force, businesses will need to look to alternative workarounds to protect their business interests, such as garden leave periods, non-solicitations, non-dealings, and confidentiality obligations.
Reform in the UK
In May 2023, following a consultation, the government announced its intention to introduce a statutory cap restricting the length of non-compete clauses to a maximum of three months from the last day of employment.
Currently in the UK, non-compete clauses and other post-termination restrictive covenants are permitted so long as they go no further than is reasonably necessary to protect the legitimate business interests of the employer, including its confidential information, trade connections, and the stability of its workforce. There is no defined limit on the length of the restrictive period but if the provision is held to be too wide or unnecessary in the circumstances, then it will be unenforceable.
As part of the consultation, other options were considered, including a requirement for employers to provide compensation to the employee for the period that the clause prohibits them from working for a competitor or starting their own business, and a proposal to ban non-compete clauses all together. However, the government confirmed its plan to go ahead with the three-month statutory cap on non-compete clauses in a drive to boost the labour market and innovation. The change applies only to employment and worker contracts, and not other contracts such as contractor, partnership, or shareholder agreements.
It is not yet clear when (or if) the statutory cap will come into force. The government had confirmed that it would bring forward legislation to introduce the statutory limit “when parliamentary time allows”. However, some time has since passed and with a general election looming, it remains unclear whether the plans will go ahead.
If it does, then we expect to see employers in the UK relying more heavily on alternative ways to protect their business interests, as we are likely to see in the US.