State of the Nations - June 2023 - non-compete clauses

In recent months, governments in both the United States and the United Kingdom have announced their intention to propose sweeping changes to non-compete clauses in employment contracts. This appears to have arisen out of an interest to address allegedly anti-competitive behaviours in the labour market.

A non-compete (or non-competition or restraint of trade) clause is aimed at preventing an employee from joining a competitor for a certain period after the termination of their employment. These are usually complemented by a restriction on soliciting or doing business with the former employer's clients.

In the US and the UK the subject is particularly in the spotlight and under review. It is important to remember however that in those countries the use of longer notice periods is possible, maximum notice periods after leaving are much shorter in Europe hence the need in Europe to have recourse to post-termination non-competition restrictions.

We summarise below the current "state of the nations" on this subject…

United States

In January 2023, the Federal Trade Commission (FTC) proposed a rule to ban most non-compete clauses in the United States. The period for comments on the FTC's proposed ban expired on 19 April 2023. Approximately 25 000 comments were received. The FTC continue to consider these comments and it is not yet known at this stage when and if the proposal will be finalised.

The proposal, if finalised, will not take effect for 180 days. Those companies which intend to challenge the finalised proposal may do so from the date on which the final proposal is communicated.

At this stage, therefore, the ban is merely a proposal and we are of the view that it is improbable that the proposal, in its current form, will be implemented. The reason for this is because the Unites Stated Supreme Court has previously indicated that it is not willing to uphold decisions that go beyond an agency's explicit authority, which the proposed ban appears to do.

Has the US however kicked off a trend…and is this the beginning of the end of non-competes ?

United Kingdom

In the United Kingdom, non-competes are currently permitted. There is also no requirement for compensation to be paid to the employee during the term of the non-compete (albeit consideration is required in return the employee's agreement to abide by the clause). Employers are required to prove that their legitimate interests (particularly protection of confidential information) cannot be adequately enforced by other, lesser forms of restrictions, such as non-solicitation or non-dealing clauses. The appropriate time period for a non-compete clause will vary depending on factors such as:

• the “shelf life” of the confidential information to which the departing employee had access;
• the seniority of the employee;
• the length of time it is likely to take for the departing employee’s replacement to settle in and build new relationships with customers;
• whether the employee is in frequent contact with clients and has meaningful relationships with them and how long those relationships will take to neutralise;
• the “industry standard” for a particular sector.

It is usual in the United Kingdom for senior employees to be subject to a non-complete of between 6 and 12 months.

On 10 May 2023, the Department for Business and Trade issued a policy paper in which it proposed limiting the length of non-complete clauses to a maximum of 3 months. The effect of this is that non-competes would remain lawful but their duration will be limited. It is not known how the proposed change will affect non-compete clauses that are in place at the time that the proposed change is introduced.

This proposed change will not of course have an impact on the ability of employers to use paid notice periods (often longer than those which can be applied in Europe), fixed term contracts, garden leave, non-solicitation or confidentiality clauses as measures to protect their businesses, but the future of non-compete clauses could be shaky.

It is not yet clear if and when this proposal to limit non-competes to 3 months may come into effect as the policy paper provides that it will legislate "when parliamentary time allows"… watch this space!

Spain

In Spain, non-competition clauses remain stable at present, and continue being an important and widely used instrument in the contracts of key personnel, whether they are employment contracts (ordinary or senior management) or services agreements.

The law in its current form provides that the non-compete restrictive covenant must comply with the following requirements:

1. be limited to a maximum duration of 2 years;
2. the employee must be "adequately remunerated". In practice, this ranges from between 20% and 70% of the employee's basic salary, depending on whether this is remunerated during the contract or during the restrictive period;
3. the employer must have a real and effective " industrial or commercial interest" in order to justify imposing such restrictions;
4. once signed, non-compete clauses cannot be waived unless by mutual consent of the parties. The courts have held that permitting the employer to unilaterally waive the clause is abusive.

In the last year there have however been some interesting developments in the case law, which are set out below.

High Court of Justice of Madrid (25 April 2022)

The High Court found that a post-contractual non-competition clause which permitted unilateral waiver by the employer was valid and not abusive. The reasons for this were because the employee resigned, the duration was a period of 6 months (which was considered short given the maximum period of two years) and the employee was compensated at a rate of 100% of the monthly salary.

High Court of Justice of Madrid (30 March 2023)

The High Court ordered that financial compensation for the post-contractual non-competition agreement of an amount equivalent to 12% of the employee's gross salary was valid. Whilst financial compensation for non-competition clauses is generally between 20% and 70%, the court considered this amount to be reasonable in circumstances where the employee was compensated during employment and the restrictive period was 9 months (which is considered short).

In order for the above two decisions to be consolidated in Spanish jurisprudence and take full effect, they must be ratified by the Supreme Court…

Again therefore, watch this space but the US and UK trends to limit these clauses does not appear yet to be impacting Spain.

Germany

In Germany, there is similarly currently no real movement on post-contractual non-compete agreements, which remain stable.

The drafting of post-contractual non-compete clauses in employment contracts always requires particular care. Agreements restricting competition which contravene the requirements pursuant to statutory provisions or case law are either non-binding or null and void.

In the case of non-binding agreements, the employee has the right to choose:

(1) whether to allege the non-compete clause is invalid; or

(2) to refrain from competing as agreed and claim the contractually agreed compensation in return.

A void non-compete is ineffective from the outset and therefore cannot produce the legal effects intended by the parties.

Employers are required to pay compensation of at least 50% of the "contractual benefits last received". The costs and benefits of non-compete agreements are therefore often only commensurate if they are agreed with employees who have special knowledge, skills, experience or know-how and whose competition can cause significant damage to the employer.

In a recent decision, the German Federal Labour Court (25 August 2022, 8 AZR 453/21) found that the value of the stock options of the parent company is not relevant for the calculation of this compensation. The court was of the view that stock options were not promised by the employer itself, but by the legally independent parent company. The term "contractual benefits" only includes those paid under the employment contract and which the employer owes to the employee as remuneration for work performed.

France

Non-compete clauses remain valid and case law on enforceability is currently stable. It is common to include a non-compete clause in the employment contract of managers and key-employees.

To be enforceable against employees, a non-compete clause must:

(1) be justified by the legitimate interests of the employer;

(2) be limited to a specific geographical area for a limited period (up to 24 months). Whilst theoretically the non-compete clauses of 24-months are valid, market practice tends to limit the non-compete to a maximum of 12 months and a shorter period has a better chance of enforceability in some cases;

(3) give rise to the payment of a financial compensation (generally at least 33% of the average monthly fixed-salary).

The employer may reserve the right to waive the non-compete at its discretion upon notification of the termination, and no financial compensation will therefore be due to the employee.

The national collective bargaining agreement applicable to the employer may provide further specific rules on this matter.

Recent case law of the Supreme Court on non-compete clauses sheds additional light on technical points.

Supreme Court 1 September 2022, n° 20-18.511

If the non-compete clause provides that the period of application is renewable once, the decision to renew must be express. Therefore, in the absence of decision of the employer to renew the non-compete period, the employee cannot claim financial compensation for this renewed period.

Supreme Court 15 December 2021, n°20-17.406

As a matter of principal, financial compensation is a remuneration subject to payment of a paid leave allowance (i.e., 10% of the indemnity). The Supreme Court has held that the paid leave allowance can be included in the financial compensation (instead of being paid on top), if the clause provides for it in a transparent manner.

Singapore and Hong Kong

The law relating to restraint of trade provisions in Singapore and Hong Kong has not changed and will probably not be subject to change in future given the investment and business friendly approach of governments in those countries and the requirement to protect businesses with appropriate restraint provisions.

Importantly, both Singapore and Hong Kong have a fairly restrictive approach to restraints of trade provisions but will enforce them where the twin test of (a) protecting a legitimate proprietary interest; and (b) reasonableness can be satisfied.

South Africa

In South Africa, restraint of trade clauses in employment contracts remain valid and enforceable unless they are contrary to public policy. An unreasonable restraint would be unenforceable. SA courts are required to balance the principle that contracts entered into should be enforced, against the principle that it is in the best interests of society as a whole that persons freely engage in commercial activity of their choice.

Other factors that also play a role in determining the reasonableness of a restraint of trade include whether the employer had a legitimate interest that deserved protection and whether that interest was being prejudiced.

There is no limit on the period of a restraint, though it is common for senior executives to be restrained for a period of 24 months. However, in the recent case of Warwick Wealth (Pty) Ltd v Anderson and Others (C178/2023) [2023] ZALCCT (18 May 2023), the court had to consider the issue of a breach of a restraint of trade clause where the employee was restrained for a period of 36 months. The court held that the restraint period of 36 months was not unduly long, and employers may hold employees accountable for their conduct (and protect their proprietary rights) for extended periods of time.

There is also no limit on the geographical area to which the restraint may be applied.

There is no indication from the South African government that there is any intention, at this stage, to change the approach to restraint of trade clauses.

United Arab Emirates

Onshore UAE

In 'onshore' UAE (i.e. outside the two financial freezones), non-compete provisions remain enforceable, provided they are reasonable and restrain conduct only to the extent necessary to protect the employer's legitimate business and legal interests. The law makes specific reference to 'work secrets' (confidential information) in the context of allowing non-compete provisions in the employment contract. The clause should therefore be limited in:

• duration;
• geographical scope; and
• business sought to be restricted.

Whilst in principle the law provides that non-compete provisions may apply for a maximum duration of up to two years, historically the UAE labour courts have generally only accepted that a duration of up to six months, and with a geographical scope limited to the Emirate within which the employee has been working, is reasonable and will be enforceable. Compensation is the only remedy available in the onshore courts and for the employer to successfully claim this, it would have to prove to the court that both :

• the limitation is reasonable (see above); and
• the employer sustained a direct financial loss as a result of the breach.

Non-compete provisions are not enforceable where employment is terminated in breach of the law.

Generally, if the restriction is considered unreasonable, the UAE courts will strike out the entire clause.

DIFC

The Dubai International Financial Centre is a common-law jurisdiction (as opposed to the UAE which is a general civil law jurisdiction). The DIFC Employment Law contains no express provisions governing non-compete clauses (although there is a general obligation on employees not to disclose their employer's confidential information).

However, the DIFC courts recognise an employer’s ability to include such clauses in employment contracts, subject to complying with certain conditions which originate from English law principles, i.e. it the clause must be reasonable in terms of scope, territory and duration and go no further than reasonably necessary to protect the employer’s legitimate business interests, failing which it will be void for restraint of trade.

A DIFC court can award injunctive relief against the employee, but, in practice, this may be enforceable only within the DIFC freezone; if an employee chooses to work outside the DIFC in onshore UAE, the injunction is unlikely to be effective.

ADGM

Similar to the DIFC, the Abu Dhabi Global Market is also a common-law jurisdiction. The ADGM Employment Regulations contain no express provisions governing non-compete clauses (although there is a general obligation on employees not to disclose their employer's confidential information indefinitely following termination, or compete with their employer).

As such, the ADGM courts also recognise an employer’s ability to include non-compete clauses in employment contracts, again subject to complying with certain English-law principles, i.e. reasonable in terms of scope, territory and duration and go no further than reasonably necessary to protect the employer’s legitimate business interests, failing which it will be void for restraint of trade.

As in the DIFC, the ADGM court can award injunctive relief against the employee, but again, in practice, this may be enforceable only within the ADGM freezone; if an employee chooses to work in onshore UAE, the injunction is unlikely to be effective.

Conclusion

Whilst there appears to be little movement at this stage in most jurisdictions in relation to non-competes, we will continue to watch the developments in both the United States and United Kingdom which may influence the approach in other jurisdictions in due course as this area of law continues to evolve.