Just as fashions reflect wider societal change, such as hemlines reflecting economic crises, the global shortage of skilled labor has led to global trends in legislation. One of the latest involves proposals in the US and UK to ban or limit noncompete clauses used in employment contracts aimed at preventing an employee from joining a competitor for a certain period after the termination of their employment.
The idea is that such bans would boost the wider economy by providing workers with greater flexibility to switch jobs and increase productivity by widening the talent pool.
In January, the Federal Trade Commission announced it was proposing a rule that would make it illegal for an employer to:
- enter into or attempt to enter into a noncompete with a worker;
- maintain a noncompete with a worker; or
- represent to a worker, under certain circumstances, that the worker is subject to a noncompete.
Characterizing noncompete agreements as an “unfair method of competition” that violates the Federal Trade Commission Act, the FTC’s proposed rule is broad in application and scope. The proposed rule would apply to independent contractors and anyone who works for an employer, whether paid or unpaid. It would also require employers to rescind existing noncompetes and actively inform workers that they are no longer in effect. The single exception to the proposed rule would be limited to noncompete provisions in the context of the sale of a business for sellers who have a substantial ownership in the sold business.
Separately, the general counsel of the US National Labor Relations Board at the end of May said most noncompete agreements violate the National Labor Relations Act.
Meanwhile, the UK government on May 10 announced its intention to legislate to limit the length of noncompete clauses to a maximum of three months. The ban would apply to clauses that seek to prevent an employee from joining a competitor or setting up a rival business for a period of time after termination (commonly somewhere between six and 12 months).
In the US, noncompete agreements are governed by state law and thus may be enforceable in one state but not in another. In most states, a noncompete agreement cannot be enforced unless the employee receives a payment or benefit in exchange for signing it. Some states only enforce trade secret protection but invalidate work restrictions. About 33% of states restrict noncompete agreements because they prevent individuals from being able to work for a living and support themselves. The employer has the burden of proof to show that the restrictions it has placed on the employee are reasonable.
Unlike many jurisdictions, the UK permits noncompetes without the need for any payment of compensation to be made to the employee during the period for which they are restrained from working. However, they are often difficult to enforce. Such clauses have been described as “the most powerful weapon in an employer’s armory” and are considered to be void and unenforceable unless the employer can show that their legitimate interests, particularly protection of confidential information, cannot be adequately enforced by other, lesser forms of restrictions (such as nonsolicitation or nondealing clauses).
Impact of Restrictions
As reported by NBC News, roughly 30% of private sector employers currently use noncompete agreements for all their workers, said Evan Starr, an economics researcher at the University of Maryland.
In the UK, the proportion is likely to be higher, but there are no statistics because there is no legal definition of such clauses. However, the use of noncompete clauses is controversial, and employment lawyers have avoided using such clauses in employment contracts for many years. A clause preventing an employee from working for a competitor or setting up a separate business in competition can stop a person from working in their chosen profession or using skills and knowledge which need to be regularly exercised to stay up to date and relevant. As such, courts are unwilling to enforce them unless they are tightly drafted to cover a specific period of time and a certain geographical area.
How will businesses protect themselves in the future?
A noncompete clause is one of several different types of “restrictive covenant” provisions used in employment contracts. While a “noncompete” clause purports to prevent an employee from working for a competitor after their employment with a current employer, by contrast, a “nonsolicitation,” “nondealing” or “nonpoaching” clause purports to prevent an employee from either enticing away or responding to a client or poaching a colleague but does not prevent the employee from working for a competitor.
These latter types of provisions will generally offer enough protection to a business when one of their employees leaves, even if they join a competitor.
Such provisions are often included in employment contracts as “boilerplate” or standard clauses as a deterrent. Employers hope that employees will abide by them due to the fear of any repercussions for the employee, and any future employer (inducing a breach of contract), if they did breach them. An injunction preventing the employee from committing the breach — i.e., working or networking with former clients — followed by damages reflecting the losses suffered by the employer can have substantial consequences.
But with the scrutiny on restrictive covenants like never before, employers should review their employment contracts to ensure they will be enforceable. Ideally tailored to their individual employees, a restriction against competing post-termination or solicitation of former clients should reflect the people, businesses and information the employee had contact with or knowledge of.