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Reform of restrictive covenants: our clients' views

We asked our clients for their views on the Government's proposal to either (i) ban non-competes or (ii) require employers to pay employees for non-competes. Our survey results suggest that the Government's proposals are not well targeted in achieving their underlying objectives – namely boosting innovation and promoting flexibility within the labour market to support the UK's economic recovery from the impact of COVID-19. This consultation is highly relevant to our employer clients: 90% of the respondents to our survey use, or have used, non-competes in their contracts of employment.

As practitioners, we consider that the Government's premise for this consultation only addresses one perspective: that of the entrepreneur setting up a new business.

Encouraging innovation is important, but without restrictive covenants, how can those entrepreneurs protect what they have created when they themselves become employers? In many industries, restrictive covenants are an essential tool for the preservation of a business' commercial viability. Less than five years ago, the Government had concluded no action was necessary on restrictive covenants following a 2016 Call for Evidence. At the time the Government concluded that restrictive covenants were a "valuable and necessary tool" and "do not unfairly impact on an individual’s ability to find other work.” We have seen no evidence that the pandemic has changed this, and our clients agree.

At the end of last year, the Government launched a consultation on reforms to non-compete clauses in contracts of employment. We surveyed our employer clients across a wide range of sectors for their views on the 37 consultation questions, and were overwhelmed with the volume of considered responses we received.

Mishcon de Reya sat on the Employment Lawyers' Association's (ELA) working party responding to the consultation earlier this year, and our clients' responses formed part of ELA's comprehensive response (here). The Government has not said when it will publish its report on the consultation. In the meantime, we summarise the results of our survey here.

To coincide with the launch of the survey, we have also produced a podcast discussing recent developments on restrictive covenants as part of our Mishcon Academy: Digital Sessions series.

You can listen to the podcast here

Our clients consider that:

  • The Government's proposals will not achieve their desired objective of promoting innovation.
  • Banning non-competes would make hiring new talent easier. However, concern about the inability to protect business interests from unfair competition far outweighed any such advantages.
  • There is no appetite for significant reform.

Non-competes remain a valuable and necessary tool, which in general do not unfairly impact on an individual’s ability to find other work.

"We believe that such restrictions are better placed in a shareholders' agreement to give them added weight. We would consider - possibly – setting them to one side and not including them in an employment contract, but appreciate this is a "bold step"." [Client quote]

A reminder of the law today

In the employment context, restrictive covenants are contractual provisions designed to prevent employees from competing with their former employer for a limited period after they leave. Restrictions take different forms and include restrictions on working for a competitor, soliciting clients and poaching employees. Non-compete clauses are the most restrictive, as they seek to prevent departing employees from working with or for a competitor. Covenants in employment contracts are more difficult to enforce than those found in commercial agreements, because of the relative inequality of bargaining positions between employer and employee. In some cases it may be appropriate to impose similar restraints on other types of worker. 92% of our survey respondents said they use, or have used, non-compete clauses in contracts of employment, but only 47% said they use such clauses in contracts for the wider workforce such as contractors.

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One client advised us that "The impact of banning non-competes could be very serious … Allowing senior executives, relationship managers, and software developers working on new products to start new employment with a competitor immediately after leaving the business could be costly and disruptive." [Client quote]

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The court's starting point when assessing these covenants is that any contractual term which restricts an employee's activities after their employment is terminated is void as a restraint of trade. However, as the law stands today, employers can enforce covenants that go no further than reasonably necessary to protect a legitimate business interest. In the case of a non-competes, the courts have recognised that other forms of protection, such as confidentiality restrictions and non-solicitation restrictive covenants, are not always sufficient to safeguard an employer's legitimate interests. For example, it may be foreseeable that an employee who carries the employer's confidential business strategy or financial data in their head might use such information in any future employment. A restriction against competing until that information becomes stale is easier to police. As one respondent put it: "key commercial confidential information cannot be policed without a non-compete period. We wouldn't know or it would be too late to know when there had been a breach - which would then result in expensive and time consuming litigation to enforce the business' rights."  Similarly, an individual's influence over customers or suppliers may be so great that the only effective protection is to ensure they cannot go to a competitor for a period.

 

A negative impact on business

The resounding message from our survey is that there is no appetite for significant reform amongst our employer clients. Only 27% of our respondents believe they would be able to adequately protect their business interests if the Government introduced a ban on non-competes, and an overwhelming majority believe that a ban on non-compete clauses would have a negative impact on their business. Whilst the Government's intention is to promote innovation and flexibility, the responses echo concerns that it could have the contrary effect of inhibiting growth.

Many of our respondents recognised that it was a two way street: banning non-competes would make hiring new talent easier. As one respondent candidly put it: "It would be easier to hire people from our competition and benefit from their networks of contacts more quickly. It works both ways." However, concern about the inability to protect their business interests from unfair competition far outweighed this for most respondents: "Our competitors would be more likely to obtain access to confidential business information.""Fee earners would be free to go to competitors and damage our valuable business""It would mean that I could no longer have Associates as my business would be too vulnerable if they chose to leave and compete against me, having been introduced to all of my clients."

Around 70% of those employers surveyed would be content to rely on other restrictive covenants to protect their business interests if non-competes were banned.

We asked our clients whether a ban on non-compete clauses would have a positive or negative impact on their businesses.

"Business that has maybe taken years to nurture… could be lost due to one individual who may have a significant influence on a contract." - [Client quote]

A need for certainty?

One legitimate concern the Government highlights is certainty. Restrictive covenants are notoriously uncertain, precisely because the courts work hard to weigh up the interests of both parties - and public policy - when considering enforceability. There is certainly work to be done to provide transparency for employees and certainty of enforcement for both sides, and to ensure that employees are not deterred by the cost, or cost consequences, of challenging a restraint that appears to be unreasonable. Various suggestions were floated as part of the Government consultation, including a change to the costs regime for these cases, a requirement for employees to take independent advice on non-compete covenants, and requiring employers to remind staff regularly of the restrictions they are bound by. None of these options are perfect, and it remains to be seen whether the Government will take any of them further.

How enforceable are your covenants?

Our research shows that employers still have work to do to ensure their covenants go no further than necessary and that their restraints are reasonable and therefore enforceable. In response to one of the Government's specific questions, 98% of respondents to our survey tend to use non-compete clauses only for highly paid employees and workers, and very few of our respondents said that they would use them for low paid employees and workers. A few, however, told us that they use non-competes in all of their contracts. Higher pay is often correlated with seniority, access to confidential information and influence on clients/staff, indicating that non-competes are usually more likely to be considered reasonable for highly paid employees. However, there is no reason to give salary level any particular significance in determining the reasonableness of a non-compete. Some of our clients quite rightly objected to the Government's question: their decision to impose a non-compete covenant would not necessarily be remuneration-based, but rather focuses on whether the employee could cause significant damage if they were to compete: "The rationale for a non-compete is to avoid commercially sensitive information being used by competitors or for commercial gain against us. That can sit with higher or lower paid workers."

When drafting covenants, it is necessary to determine what level of protection is reasonably necessary in each case: two employees at the same level of management or pay grade may have differing influences over the clients and vastly different knowledge of confidential information. Consider carefully, on a case by case basis, the restrictions that may be required. What are the risks to the business if that particular individual were to leave in the future? Will that individual have relationships with clients, or influence over other staff? Will their access to confidential information make them a competitive threat if that individual joins a competitor or sets up in competition immediately after leaving? If so, for how long? By addressing these sorts of questions and drafting accordingly within the tested parameters, restrictions are more likely to be enforceable. For the time being at least, all employers are well advised to make the most of the protections that properly drafted restrictive covenants can afford.

One client told us that "if the Government introduced a ban on non-compete clauses, we would not hire anyone in the UK. It would represent an unacceptable risk for our knowledge-based business." [Client quote]

The Government also floated the idea of mandatory compensation for non-competes. Surprisingly, around 25% of our respondents said they already pay compensation to employees for all or part of the duration of a non-compete restriction. However, when we analysed the comments made by respondents, it was clear that many employers were referring to payments made for garden leave periods. Garden leave can have the effect of reducing a post-termination non-compete period, or extinguishing it altogether. Only our international employer respondents paid for non-competes, and only in jurisdictions where this is already required by law. We therefore remain of the view that this practice is very rare amongst employers in the UK.

Two thirds of our respondents thought that employees would be more likely to comply with the terms of a non-compete clause if mandatory compensation was introduced. However, instead, this may simply lead to the use of longer notice periods and garden leave restraints.

We asked our clients whether, if they were required to provide compensation for the period of the non-compete clause, they would continue to use them? Comment: the results are fairly even, but clearly demonstrate that there would be a greater reluctance to use non-competes if mandatory compensation was required.

We asked our clients what other post-termination restrictions they would use if mandatory compensation for non-competes was introduced.

A little over half of the employers surveyed considered that they would continue to use non-compete clauses if they were required to provide compensation for the period of the non-compete clause. Interestingly, one respondent highlighted that the requirement for an employer to pay compensation for non-competes could serve to focus the employer's mind on "whether the restriction imposed on the employee is really worth the expenditure." Around two thirds of employers surveyed thought that employees would be more likely to comply with the terms of a non-compete clause if mandatory compensation were introduced.

64% of respondents believed that their use of other restrictive covenants would increase if mandatory compensation were introduced. Most commonly cited were restrictions on poaching staff, restrictions on soliciting customers or clients and restrictions on dealing with customers or clients. However, only a quarter of respondents thought that they could adequately protect their business interests through restrictions on the use of IP and confidential information alone.

"Losing our non-compete clause would mean we would need to invest in much longer notice periods and thus increase the cost of staff turnover exponentially, inhibiting growth." [Client quote]

Is legislative intervention necessary?

While banning non-competes may encourage innovation for start-ups and could provide benefits when hiring talent, most respondents think their businesses would be negatively impacted. If the Government introduced mandatory compensation for non-competes, fewer employers would use them but their use of other restrictive covenants would increase. It remains our view, shared by many practitioners, that the courts do a good job of getting the balance right between the freedom of employees and the rights of employers. The courts have been doing this for centuries and the law in this area is highly refined. As ELA concluded: "it is hard to see how legislative intervention could be of any benefit in making that balance fairer.” Our survey tells us that our employer clients agree with us, and that they would not welcome Government interference in this area.

"Our business is built on relationships with our clients and the people who work in them. Our higher paid employees are entrusted with management of relationships that others in the business have worked hard to develop. We need to protect against people abusing this trust." [Client quote]

Key contact

Jennifer Millins, Partner, Employment

If you would like to understand more about the progress of the consultation, or for advice on your restrictive covenants, please contact Jennifer Millins.

Contact Jennifer
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