'It's a good time to start contemplating ways to protect your business'

Both the UK and US governments have proposed to reform restrictive covenants in employment contracts post-termination with a view to empower employees by allowing them to change jobs more freely.

It is expected the changes will increase competition among businesses and boost the economy. But it is not yet clear whether they will affect employees only, or also partners and LLP members.

In a Q&A with FTAdviser In Focus, Jimoh explains what the proposed changes might mean for financial services.

Many employees have non-compete obligations without realising

FTA: What are non-compete clauses and how do the rules currently in place affect financial services in the UK?

SJ: Non-compete clauses are obligations which, at their simplest, may be used to prevent a departing employee from going to work for a competitor.  

They are very common in the financial services industry and particularly so at the highest levels, where a senior leaver may be expected not to work with a competitor for up to around 12 months.

The main argument in support of these kinds of restrictions is that, during their employment, individuals will have confidential information regarding their employer’s business that they could potentially use to their advantage following the termination of their employment. 

While there are other, more direct ways of protecting that information, often a straightforward prohibition on working for a competitor is simplest to police.

There are controls on non-compete obligations and, in short, they can go no further than reasonably necessary to protect a business’s legitimate interests. Otherwise, they will be unenforceable.  

In reality, however, provided that a non-compete is drafted carefully, the current law often permits non-competes and so limits individuals’ ability to move between roles.

FTA: The government plans to change non-compete rules for employees, what impact will that have on firms?

SJ: The headline change announced by the government is that non-compete clauses will be limited to just three months in duration. 

That may have a liberating effect, with employees finding a move easier and less long-winded, and employers therefore having a more readily available pool of talent.  

On the other hand, employers may move to compensate for the change by requiring lengthier notice periods, provided that they are willing to meet the additional costs of paying salary for a longer time. 

FTA: Will these rules cover a broader spectrum of employee status, such as partners, LLPs etc?

SJ: The interests being protected by non-compete obligations are often similar, whether one is discussing an employee, a partner or an LLP member.  

In addition, many partnerships and LLPs are increasingly corporate in feel and so there may be good reasons to have uniformity.  

At present, it is unclear how wide the changes will be in scope.

FTA: What would be the effect of widening them out to other types of restrictive covenants such as non-solicitation of or non-dealing with clients, or non-poaching of employees?

SJ: Non-compete obligations are often regarded as the most onerous kind and tend to be more of a concern for departing employees than limits on dealing with clients/contacts or poaching colleagues, for example.

If the same reforms were applied to other forms of restrictive covenants, that would potentially represent a significant reduction in the tools available to employers to protect legitimate business interests such as their confidential information and the stability of their workforce.  

It is anticipated that 5mn UK workers will have greater freedom to switch jobs.

It is difficult to predict what the specific effects would be, but one would expect detailed consultation over such a sweeping change.

FTA: What impact might the proposed changes have on the wider UK economy?

SJ: The government projects that this new legislation will allow employers to expand their businesses by broadening the selection and quality of candidates they can hire, to the benefit of the economy generally.

It is anticipated that 5mn UK workers will have greater freedom to switch jobs, apply their skills elsewhere and even earn a pay rise.

How broad the impact is on the wider economy remains to be seen.

Many employees have non-compete obligations without realising. They tend only to come to the fore when an individual leaves their job and, for most employees, should not impact their day-to-day work.  

Equally, much of the workforce is not subject to obligations of this kind.

FTA: What about the American model, where measures will be more drastic, to what extent could that work in the UK?

SJ: In theory, if the UK were to adopt a more American model (banning employers entirely from using non-compete clauses), it may offer yet more competition, with employees facing fewer, if any, barriers to switching roles more freely.  

However, there could again be lower protection for employers to shield their legitimate business interests and there may be a noticeable shift in power dynamic between employers and employees on departure.

FTA: What are the as yet unanswered questions around the government’s proposals?

SJ: There are a number of unanswered questions, including most pressingly whether the new proposals will apply to existing contracts of employment, or only new agreements.  

If the former, employers might find themselves needing to renegotiate existing arrangements to maintain appropriate levels of protection.

It is also unclear how the time limit will interact with garden leave. At the moment, time spent on garden leave often reduces the length of a non-compete obligation. It will be interesting to see how the proposed law addresses that.

Lastly, there is a question as to whom these changes will apply to: employees only, or also partners and LLP members?

FTA: What is your advice to employers following publication of the proposals?

SJ: While the changes are not yet introduced, the announcement is a good reason for employers to start contemplating new and practical ways to protect their businesses, interests and confidential information.

It will still be permissible for employers to utilise other types of restrictive covenants such as non-solicitation of or non-dealing with clients or non-poaching of employees, without the time limitations being applied to non-competes.

However, are they as well-drafted as they should be?

carmen.reichman@ft.com