Non-Compete Clauses in the UK and U.S.: Recent Trends

Non-Compete Clauses in the UK and U.S.: Recent Trends

September 2024, Covington Alert

What is happening?

In the U.S. and UK, the use of post-termination non-competes has recently been under scrutiny, and how effective these will be as a tool for protecting a prior employer’s business in the future is unclear.

On 23 April 2024, the U.S. Federal Trade Commission (“FTC”) voted to issue a final rule adopting a “comprehensive ban on new [post-termination] non-competes with all workers”. The FTC’s rationale for banning post-termination non-compete clauses in employment contracts is that, in its view, they constitute “unfair methods of competition”, and that their cumulative effect is to suppress wages and stifle innovation. Others believe that non-competes often serve legitimate interests of businesses, such as protecting against misappropriation of their intellectual property and confidential business information, and that the FTC has not collected information sufficient to support the proposed ban. Thus, numerous legal challenges have been filed contesting the ban. The latest development is that, on August 20, 2024, a ruling by the United States District Court for the Northern District of Texas prohibits the FTC from enforcing the proposed non-compete rule nationwide, on the basis that the FTC does not have substantive competition-related rulemaking authority and the rule was arbitrary and capricious. The FTC will very likely appeal this decision (see our recent alert for more in this regard).

In spite of the challenges its proposed rule is facing, the FTC’s crackdown echoes the proposed reforms to post-termination non-competes made by the UK’s (former) Government last year. On 12 May 2023, the Conservative government announced its intention to introduce a statutory cap on post-termination non-compete clauses of three (3) months for employment and worker contracts. This would have a significant impact on market practices, given that 12 month non-competes for senior employees are relatively common. It is not yet clear when, or indeed if, the statutory cap will come into force, particularly now that the Labour Party is in power and little has been said in this regard. However, given the widespread appetite for curtailing non-competes, it seems unlikely that the new Government will take a more lenient approach and so the future effectiveness of non-competes in the UK is still uncertain.

In the vast majority of European jurisdictions, the enforcement of post-termination restrictions has always been challenging, particularly where the employee is not compensated in any way for complying with the obligation(s) following termination. For example, in Germany, a post-termination non-compete clause is invalid if there is no corresponding compensation for the employee having entered into it. Similar notions exist under French and Italian law. In contrast to the U.S. and the UK, there have not been any similar efforts in the EU to further restrict the use of post-termination non-competes in the employment context. That being said, in the antitrust context, the EU Commission seems to be paying particular attention to limiting the effectiveness of so-called non-solicitation agreements.

Why does it matter?

Post-termination non-compete clauses are commonly used in employment agreements for senior or business-critical employees, particularly in the U.S. and the UK. Businesses use them, for example, to prevent such individuals from misappropriating the intellectual property or confidential information of the business by prohibiting them from working for competitors for a limited period of time after their employment ends. Non-competes are particularly important for senior employees, but in practice workers of all levels of experience can be subject to them. In the U.S., approximately 30 million workers have non-compete clauses in their employment contracts.[1] In the UK, this figure stands at around 30% of employees.[2]

Given their relative ubiquity in the U.S. and UK, the undermining (or outright ban) of non-competes would force many employers to look for different ways to protect their legitimate business interests.

In addition, these developments are likely to result in a spike in litigation between employers and departing employees. Many businesses may find themselves, for example, seeking to obtain injunctions against ex-employees from divulging important know-how to competitors and may find themselves increasingly reliant on enforcing confidentiality and intellectual property provisions, among other things. It is not clear that such measures would be as effective in protecting the legitimate business interests of employers.

What should you do about it?

Employers who operate in these markets and rely on non-competes should monitor developments in this area and perhaps consider alternative ways of effectively protecting their business interests.

In the U.S. – in spite of the challenges that the FTC’s proposed rule is facing – employers should take stock of their use of non-competes, including in current employment agreements, severance agreements, consulting agreements, IP assignment agreements, confidentiality agreements, employee handbooks, and equity award agreements, as well as in any past agreements where any such non-compete provisions are still effective. Employers that have an existing practice of including non-compete clauses in arrangements with workers, or are considering doing so for the first time, should consult antitrust and employment / executive compensation counsel. If the FTC successfully appeals the recent order prohibiting its proposed rule, employers will need to determine which of their workers are subject to non-compete clauses and whether – and by when – they are required to provide notice of non-enforcement to those workers or to take other required actions.

In the UK, employers should be cautious about imposing non-competes with a long duration. Their necessity should be considered on a case-by-case basis. Whether or not the previous UK government’s proposals materialize into law any time soon, courts will likely be sensitive to the policy reasons for curtailing the power of non-competes, meaning that the enforceability of longer restrictions could become more difficult to defend.

As alternatives to non-competes, employers may wish to lean more heavily on garden leave arrangements where this is possible. However, extending employees’ periods of garden leave so that they effectively operate as non-competes will likely prove expensive (due, in part, to the adverse tax consequences of keeping inactive employees on the books for longer periods). Other means could be pursued – arguably, the former UK government’s proposals do not extend to management incentive plans for senior employees, and therefore it may be permissible to make the awards under such plans subject to non-competes which persist over a specific period. It remains to be seen, however, whether workarounds such as these will be possible.

When it comes to EU Member States, given the stringency of existing regulations and extensive case law, international employers must be cognizant of the non-unified legal landscape. Each post-termination non-compete agreement must continue to be carefully scrutinized to ensure compliance with the specific requirements and relevant case law of the applicable Member State. For instance, in Germany, despite the relevant codified law now being over 100 years old, new case law continues to contextualize and refine the way that the law in this area is applied. Therefore, it is crucial for employers to stay updated on the latest legal developments in each jurisdiction.

If you have any questions concerning the material discussed in this client alert, please contact the members of our International Employment practice.