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Noncompetes under fire: Alternatives that protect your organization

CWS 3.0 - Contingent Workforce Strategies

Noncompetes under fire: Alternatives that protect your organization

Fiona Coombe
| October 15, 2024
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Legal document Non-Compete Agreement on paper close up

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When the US Federal Trade Commission in January 2023 proposed a rule that would make it illegal for an employer to enter into or attempt to enter into a noncompete agreement with a worker, it seemed to be part of a global trend. Despite uncertainty around their enforceability, governments are targeting noncompete clauses, saying they deter employees from switching jobs, which in turn inhibits wage growth.

Global Effort

In 2023, the UK government announced legislation that would limit the duration of noncompetes to a period of three months after termination of employment. The Australian government’s consultation on the use of noncompete clauses earlier this year is part of its review of competition, productivity and wage growth. The New Zealand Parliament is also currently looking to enact the new Employment Relations (Restraint of Trade) Amendment Bill, which would prohibit the use of restraints of trade in employment agreements for employees who earn less than three times the minimum wage. And with a recently published bill on modernization of the noncompetition clause, the Dutch cabinet proposed tightening existing regulations to reduce the number of nonessential clauses used, promoting free choice of employment and labor mobility.

The proposals for reform focus on traditional post-termination noncompete restrictions, which typically prevent an employee from setting up their own similar business or joining a competitor after the termination of employment. These should be distinguished from nonsolicitation and nonpoaching provisions that seek to prevent employees from soliciting or dealing with former clients or enticing away former colleagues. These restrictions are usually far less onerous and more likely to be enforceable.

US State-Level Bans

In the US, in addition to the Federal Trade Commission’s attempt to ban noncompete clauses, state-level noncompete reform has gained momentum in recent years. At least 16 states have introduced some form of ban in the past two years constituting either a complete ban; a ban that prohibits the use of clauses with workers earning below an income threshold; a prohibition on the use of noncompetes in certain industries including healthcare; or introducing steps an employer must take to enforce a noncompete against a worker. Several other states have passed or considered proposed laws in the past two years.

In a setback for attempts to impose a federal ban, the US District Court for the Northern District of Texas on Aug. 20 held that the FTC’s noncompete rule is unlawful and ordered that the rule should not take effect, preventing the FTC from enforcing the rule against any company nationwide. This decision in Ryan LLC v. FTC was taken on procedural rather than substantive grounds and was based on the finding that the FTC lacks rulemaking authority with respect to unfair methods of competition.

The rule defined a prohibited noncompete clause to include any contract term, workplace policy or term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from seeking work, accepting work or operating a business after the conclusion of the employment that included the term or condition. This would include clauses giving employers the right to recover the cost of training if employees leave within a certain period after completing the training.

Effects on workers

While there is doubt over the effect that noncompete clauses have on labor mobility, it is clear that such clauses are often used as standard in contracts of employment with workers at all skill levels, often with little justification. A report by the Centre for Economic Performance, which conducted the first representative survey of noncompete agreements in the UK, found that about 26% of workers appear to be bound to such clauses, a higher fraction than in comparable surveys in the US (18%) and Italy (16%). Although such agreements are more prevalent for skilled workers, many low-skilled workers are also subject to restrictions (e.g., over a fifth of plant operators).

There can be little justification for using noncompete clauses with low-skilled workers, where leaving to work for a competitor is unlikely to cause harm to the employer and where the outlay in training is unlikely to be significant. But as one of the key forms of business protection comes under threat, the issue for employers will be how to protect their business, client contacts and confidential information while adhering to any new rules.

Alternatives

As a start, employers should review which staff are subject to restrictions and ensure their contracts provide the best possible protection. As alternative measures, employers could consider putting in place longer notice periods and placing greater reliance on garden leave clauses to lock employees out of the market during the period of notice. Similarly, using nondealing and nonsolicitation clauses will restrict employees in whom they can deal with even if they join competitors.

Often noncompete clauses are used by businesses to protect intellectual property and trade secrets because they restrict employees from gaining valuable business insight only to leave and share those insights with a competitor. But a more effective tool for that goal is a nondisclosure agreement containing a clear definition of “confidential Information” and identifying the purpose for which the receiving party may use such confidential information. These clauses can be included in employment agreements, severance agreements, contracts or independent contractor agreements to maintain the confidentiality of the company’s information, even beyond the termination of their relationship with the company.

The agreement should specify the duration of the confidentiality obligations and exclusions from the obligation to keep information confidential. Such exclusions might include information that is publicly available, or independently learned or developed by the employee without any use of information that is confidential.

Employers have relied on the noncompete clause for centuries, but it is not the only tool at an employer’s disposal to protect its business and is long overdue for reform.