Regulators on both sides of the Atlantic are placing greater focus on non-compete and no-poach clauses, clamping down on restrictive covenants which are common in employment agreements and market practice in M&A deals. As regulatory scrutiny grows, deal teams will need to review the use of these clauses, navigate safe harbours, and find new ways to protect goodwill within new laws and regulations.
In January 2023, the US Federal Trade Commission (FTC) proposed a new rule to ban non-competes in most situations, challenging the clauses as an “unfair method of competition”. The proposed rule would effectively prohibit employers from limiting a worker’s right to seek or accept employment elsewhere and would apply to traditional non-compete agreements. It would not expressly prohibit other forms of restrictive covenants, such as non-solicit or non-disclosure clauses. However, if such a clause is drafted so broadly that it effectively precludes a worker from operating a business or seeking or accepting employment after separation, the clause could be considered an unlawful “de facto non-compete clause”.
The FTC’s proposal would require all US employers to rescind existing non-competes and would significantly limit the use of deal-based non-compete clauses with narrow exceptions. The FTC is expected to vote on the proposed ban in April 2024. Meanwhile, several US states already have or are seeking to put in place complete or partial non-compete bans so that careful deal analysis and detailed advice from legal counsel will be necessary when evaluating the inclusion of non-compete clauses.
Non-competes are also on the EU’s radar. In Europe, employment laws are typically more favourable for workers and the standard approach remains that in order for a non-compete to be enforceable, employees must receive appropriate compensation during their post-termination period. As regards no-poaching, the European Commission has signalled enhanced enforcement on no-poach agreements, citing their impact on wages and the movement of labour, and has imposed fines on companies in various jurisdictions and sectors.
In the UK, following a government consultation on non-compete clauses, the UK government confirmed plans to introduce a statutory limit on the length of non-compete clauses in employment contracts to three months post-termination. The proposed new law would not have an effect on non-solicitation clauses, paid garden leave, notice periods, or confidentiality clauses. However, whether it will apply retrospectively like the proposed FTC rule is unclear.
The UK’s Competition and Markets Authority (CMA) has also demonstrated an appetite for enforcement against no-poaching that violates competition law. In February 2023, the CMA issued a brief guidance document to help employers avoid unlawful poaching, wage-fixing, and information sharing; the authority’s guidance follows the July 2022 announcement of an antitrust investigation into alleged wage-fixing for freelance technical staff.
Restrictive covenants appear in both M&A and employment contexts. Inclusion is market practice in M&A, where provisions tend to be more extensive than in employment agreements on the basis that such clauses are necessary to protect the goodwill of the business for the buyer, inclusion may assist sellers on price, and parties typically have equal bargaining power.
Deal teams should pay careful attention to the drafting of restrictive covenants in sale and purchase agreements. In the UK, we expect that the enforceability test will continue to apply such that parties will still need to consider scope, duration, and geographical reach and ensure that a restrictive covenant goes only so far as necessary to protect a legitimate interest. In the US, currently in most states reasonable sale-based non-compete covenants are generally permitted, but nevertheless should be appropriately tailored to the activities and geographic scope of the sold business. However, the proposed FTC ban would only permit a sale-based non-compete in limited circumstances, in which the restricted party is a substantial owner / member / partner of / in the business entity — with “substantial” expected to be deemed as at least a 25% ownership interest. Acquirors will need to be vigilant when negotiating restrictive covenants with owner-shareholders, and mindful where a 25% ownership threshold could be met.
Deal teams should also pay attention to when restrictive covenants become active. If applicable between signing and closing, restrictions on an employee’s movement (and generally on the seller operating the business) should be reviewed to ensure they do not give rise to gun-jumping.
To mitigate the growing risks in the use and enforceability of restrictive covenants, due diligence should seek to identify problematic contract provisions (for example, in connection with wage-fixing or non-solicitation provisions that are not narrowly tailored), and gaps in HR and training policies.
Corporates should review employment or other related agreements now for provisions which violate existing state-by-state laws in the US or which could violate the FTC’s proposed rule, the UK’s proposed new law, and which could be of concern to UK and European competition regulators and US enforcers if they contain no-poaching and/or wage-fixing provisions. For example, certain provisions (or discussions that are not memorialised in writing) that seek to restrict the solicitation or hiring of employees from competitors, prevent competitors from soliciting or hiring their employees, or could limit competition over their employees’ compensation, could be pursued as criminal offences in the US. Corporates should also consider employee communications and address instances of non-compliance given the elevated enforcement risk.
In the UK, corporates can continue to use non-competes in contracts for the time being but must be aware that agreements exceeding three months may have to be revisited in the future. Gardening leave may be considered as an alternative tool for managing the departure of key staff.
Corporates should also review HR policies to ensure competition law compliance and update HR training to ensure that it addresses competition rules relevant to employees.
The increased regulatory focus in the US, Europe, and the UK on restrictive covenants signals that corporates and their advisors should increase their focus on the use of the same, especially if such focus extends to looking at other employment restrictions and arrangements such as leaver provisions in employee share plans.