Legal

What would restrictive covenant reform mean for businesses?

18 Jan 2021 By Stefan Martin

Stefan Martin explores the government's proposals on amending the non-compete and exclusivity clauses in employee contracts 

In early December, the government published two consultation papers outlining how it may reform the labour market in 2021 in response to Covid-19. Their focus is on promoting innovation and competition as a way of kick-starting the economic recovery and preventing unnecessary barriers to people finding work. However, the proposals in relation to restrictive covenants may have the opposite effect to that intended by the government and actually make the UK a less attractive home for new businesses.

The first consultation revisits the question of whether the government should regulate the use of non-compete clauses. Although a 2016 review by the Department for Business, Innovation and Skills (as it was known then) concluded that the law surrounding non-competes provides appropriate protection for employers and employees, there is clearly a perception that restrictions inhibit employees’ ability to set up new businesses, damaging the economy.

The consultation paper proposes two options for reform. Either would be a major change to the current position in the UK. The more radical suggestion is to make non-compete clauses unenforceable, with employers falling back on intellectual property rights and existing common law rules on confidential information to protect their business interests. Under the second option, non-competes would continue to be enforceable, but employers would have to compensate employees for the period of the restriction, as is already common in many European countries. Compensation would be set as a percentage of an employee’s average weekly earnings and the paper suggests that a figure of 60 per cent or higher might be appropriate. The government is also considering whether to introduce a maximum period for non-competes and the paper seeks views on what would be a suitable period, ranging from three to 12 months. 

In the government’s view, the proposals would discourage businesses from using non-compete clauses on a blanket basis without justification, or imposing restrictions for longer than necessary. However, as the consultation paper recognises, they could result in longer employee notice periods, more extensive use of garden leave provisions or deferred remuneration mechanisms that give employees an incentive not to leave employment. Those outcomes would run counter to the desire to promote competition.

It is also possible that the mooted reforms will make prospective entrepreneurs think twice about establishing their start-ups in the UK. At best, the proposals will make it more expensive for an employer to protect its confidential information or customer connections. At worst, a blanket ban on non-competes in employment contracts would make it more difficult to protect confidential information, either because separating confidential information from an employee’s skill and knowledge is notoriously tricky, or because confidentiality clauses cannot be policed effectively. Abolishing non-competes would also make it easier for key employees to walk out and set up a rival business, so establishing or funding a start-up could actually become riskier.

The change the government is proposing to exclusivity clauses is pragmatic but less far-reaching. Exclusivity clauses that prevent a worker from accepting work from another employer are already unenforceable in zero-hours contracts. Employees cannot be dismissed fairly for breaching such a clause and workers must not be subjected to a detriment for doing so. 

The government’s second consultation paper suggests extending the ban on exclusivity clauses to the contracts of all workers with guaranteed earnings of less than the lower earnings limit, subject to an exception for those working a small number of hours on a high hourly rate. This is designed to allow low-paid workers whose hours have been reduced as a result of the pandemic to seek additional work from other employers without facing or being threatened with adverse consequences for doing so. 

Stefan Martin is a partner at Hogan Lovells

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