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Competition and restrictive covenants – is a change on the horizon for employers?

Posted on 11 April 2023

Governments and competition authorities are increasingly focusing on employment practices which can potentially have negative impacts both on employees and the labour market generally.

This article considers the importance for employers to continue to ensure that they not only comply with employment laws but that they also remain vigilant in relation to competition law at the same time.

Recent action in the United States by the Federal Trade Commission (FTC)

At the beginning of this year, the FTC issued a proposal for a new rule banning non-compete clauses in employment contracts across the United States on the basis that they harm workers and inhibit competition. The new rule would apply both prospectively and retroactively and would: (1) prevent employers from entering into non-compete clauses in employment contracts; and (2) require employers to inform current and former employees that existing non-competes are invalid. The rule is currently in a consultation period and, if passed, is not expected to go into effect until the end of 2023, at the earliest.

The FTC suggested that the proposed rule is necessary because “non-compete clauses reduce competition in labour markets” resulting in the suppression of “earnings and opportunity even for workers who are not directly subject to a non-compete.”

The FTC's proposal has come against the backdrop of concern from federal government in the United States for many years, including in 2021 when President Biden signed an Executive Order encouraging the FTC to ban or limit non-compete agreements. Some states, such as California, North Dakota and Oklahoma, already prohibit the enforcement of non-compete clauses and agreements against their residents, irrespective of where the employer is based.

Potential UK Government intervention regarding non-competes

In the United Kingdom, post-termination restrictions, including non-compete clauses, have to date been governed by common law, meaning the principles of enforceability have been developed through case law over many years. Broadly, case law provides that a non-compete will not be an unjustifiable restraint of trade and will be enforceable so long as it goes no wider than is reasonably necessary to protect the employer’s 'legitimate business interests' (for example, trade secrets or client connections).

However, in a similar vein to the United States, there are indications that there may be some change on the horizon regarding the enforceability of non-competes over recent years. At the end of 2021, the UK Government launched a consultation on reforms to non-compete clauses in employment contracts, seeking responses to two alternative measures on reform, being: (i) banning non-competes; or (ii) requiring employers to pay employees for non-competes. In doing this, the Government explained that they were "exploring avenues to unleash innovation, create the conditions for new jobs and increase competition" following the pandemic. The consultation also asked whether similar reform should be applied to other types of post-termination restrictions, such as non-solicitation and non-dealing clauses.

While we are still waiting on the outcome of the consultation, it does at least indicate that the Government may be contemplating a broad overhaul on the law on restrictive covenants. This marks a shift from how the law on restrictive covenants has historically developed.

Renewed guidance from the Competition and Markets Authority (the "CMA")

In February this year, the CMA published guidance materials to remind employers of their legal obligation to avoid collusion and to comply with competition law. The guidance reiterates that there are three main types of anti-competitive behaviour to consider:

  • no-poaching agreements, where competitors agree not to approach or hire each other’s employees, including where the consent of the other company is required;
  • wage-fixing or benefit-fixing agreements, where competitors agree to fix employees’ pay or other employee benefits, such as agreeing the same wages or setting maximum caps on pay; and
  • sharing sensitive information about employee terms and conditions between competitors, which can reduce competition in terms of recruitment and retention.

Businesses that are found to have infringed competition law can be fined up to 10% of a group's annual worldwide turnover. Individuals participating in anti-competitive behaviour can also face disqualification as a director for up to 15 years and, in extreme cases, criminal sanctions.

In its guidance, the CMA emphasised the following key recommendations for businesses:

  • understand how competition law applies to no-poaching and wage-fixing agreements;
  • don’t agree with a competitor to fix wages;
  • don’t agree with a competitor not to approach or hire each other’s employees;
  • don’t share sensitive information about your business or employees with a competitor;
  • provide recruitment staff with training on competition law and how it applies in the recruitment context; and
  • ensure solid internal reporting processes are in place, and that staff are aware of these and how they can use them.

What does this mean for employers?

It is likely that the scrutiny of employment practices by competition authorities will continue to increase.

In the UK, if the Government decides to reform the law on restrictive covenants, we anticipate that any change will take some time, particularly as the responses of the consultation last year have not yet been announced. Given that many businesses in the UK regard reasonably drafted non-competes as useful tools in protecting them from unfair competition, and that the consultation responses are therefore likely to reflect that, we think it is unlikely that the Government will follow the FTC and take steps to ban non-compete restrictions altogether. However, at the very least, businesses should audit their employment contracts, particularly focusing on non-competes and all other restrictions, to ensure that they go no further than reasonably necessary to protect a legitimate business interest. Other protections, such as intellectual property, notice periods and confidentiality provisions should also be reviewed to ensure that they bolster protection for the company and could, in certain circumstances, be a means of adequately protecting the business, reducing the need for post-termination restrictions all together.

The three anti-competitive behaviours listed in the CMA guidance are broad and could conceivably encompass a wide range of employment practices that are relatively commonplace. We would therefore recommend that businesses should consider whether new training and updated internal guidance needs to be issued to make sure that all staff are fully aware of the CMA guidance and the types of behaviour which could be considered anti-competitive.

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