13 May 2016

The Government has recently announced that it is seeking views on whether “non-compete” clauses are stifling innovation, by preventing entrepreneurially-minded individuals from leaving employment to set up their own business.

The Government has recently announced that it is seeking views on whether “non-compete” clauses are stifling innovation, by preventing entrepreneurially-minded individuals from leaving employment to set up their own business.

As an employment lawyer who spends a lot of time helping businesses put in place (and, if necessary, enforce) effective restrictions for key staff, the idea of banning or curtailing restrictive covenants certainly grabbed my attention. However, having given it some thought, I believe any proposal to relax non-compete clauses would be flawed and, in fact, act as a barrier to enterprise.

I am a big fan of innovation and entrepreneurship. I practise in a law firm, Taylor Vinters, which prides itself on its reputation for helping innovators, start-ups and fast-growth businesses turn their ideas into reality, driving the economy and improving lives through clever thinking. Taylor Vinters is also entrepreneurial in its own right – by investing in start-up businesses such as Pekama and Thoughtriver, we have a direct stake in two forward-thinking commercial enterprises that seek to challenge how legal services are provided. It makes sense for me to embrace anything that will help our clients (and our investments) to prosper.

The Government has said that it wants to see “more enterprising start-ups and greater productivity in a free and fair marketplace”. It is hard to disagree with that aspiration. But I am not persuaded that this is the way to achieve it. Let me explain why.

A free and fair marketplace requires a balance to be maintained. I endorse the principle that an individual who wants to strike out on their own should not be prevented from earning a living, or using the skills they have learned in employment for their own gain. Equally, an employer is entitled to a degree of comfort that their trade secrets, their best ideas and processes, their clients and senior staff – in short, the very things that give them a competitive edge – will not be jeopardised by an employee’s departure.

In this context, a UK commercial landscape that did not recognise appropriate non-compete protections would be shark-infested waters for entrepreneurs seeking to swim, rather than sink, as they are starting out. It is worth remembering that today’s employee seeking to cut loose and start their own business is tomorrow’s employer seeking to protect what he or she has built up.

When it comes to being the master rather than the servant, the dynamic for a free-spirited innovator changes somewhat. In most cases, they cannot do everything themselves. They will need to bring other expertise on board to develop the USP of their product or service, make it marketable and financially viable, sell it and create processes to turn it into a commercial reality. Outside help, often in the guise of skilled employees, will be needed to grow the business.

At this early stage, start-ups are amongst the most vulnerable to attack. If their core business concept or key talent is gobbled up by a competitor (perhaps one which is more established, with deeper pockets and a clear interest in discouraging disruption in the market), their business can soon disappear without trace before it has had a chance to gain a foothold in that market.

Valid restrictive covenants mean that, not only is an employee contractually limited in what they can do, a competitor seeking to poach them can also be liable if it encourages the employee to ignore those restrictions. Get rid of covenants and the threats to entrepreneurs increase significantly.

My concern is that it would create an environment in which innovators are fearful of bringing people on board. This would have the undesired effect of great ideas developing much more slowly (or not at all) and investment that is harder to come by.

Can we learn from other jurisdictions? In some countries the employer is required to pay financial compensation to an individual in order to hold them to non-compete restrictions. But I would question whether that would achieve the Government’s objectives here. A large employer might well be willing to pay in return for the certainty of wide-ranging restrictions that may stifle innovation. Conversely, this type of protection may be unaffordable for smaller, start-up operations. Arguably, it goes too far the other way.

So how do we achieve the desired balance? The answer, in my view, is that we have it already.

The scope for an employer to place contractual restrictions on an employee’s activities once they leave will depend on the circumstances. The law says that non-compete clauses (and other restrictive covenants) will only be enforceable to the extent they are reasonably necessary to protect the employer’s “legitimate business interests”.

This requires employers to consider:

  • the specific risk of a particular employee leaving the business – a tailored approach (rather than seeking to impose generic restrictions across the workforce) is more likely to work; and
  • what “legitimate business interests” are they looking to safeguard – are they worried about the risks to confidential information, customer connections or workforce stability?

My job as an employment lawyer is to get employers to ask themselves the right questions.

To give a few examples, an employer might ask whether it really needs to stop an employee from joining a competitor altogether. Would lesser restrictions (such as prohibiting solicitation of customers or key staff) do the job just as well? Does it really need more than six months to nurture client relationships, so that they don’t follow a departing employee to their new place of work? Six months is actually quite a long time (and, in any event, it is normally good practice to ensure that key client relationships are not the sole responsibility of one employee).

I am always interested to hear the views of business on these issues. In particular, I am grateful to Stuart Rose, Managing Director at Merz Pharma UK, for sharing his thoughts:

“As a company actively looking at the issue of non-compete and restrictive covenants for employees I view the prospect of relaxing non-competes as a cause for some concern. Dom Holmes captures some very relevant points in his article and his view that, by relaxing the legislation entrepreneurs may in fact be endangered as their own businesses seek to become established. Early cash flow and productivity are the early predictors of success or failure in small businesses and without the former they will (almost) always fail, but without the latter they will almost always fail to grow profitably.

There is much research to support the observation that the most successful businesses, and thereby ones which have a degree of business innovation, have low staff turnover and develop employee engagement (or “stickiness”). The presence of non-compete clauses may support this stickiness by causing more thought and reflection amongst potential entrepreneurs who may stay longer in a business before embarking on their own to both develop their skills and experience and, in doing so, add more value to the company that has invested in their development. Non-competes alone are not sufficient for employee engagement, but I believe they are an important element in an HR strategy, to confer stability on a business. There will always be cases where moving on is the right thing to do (where an idea may be time sensitive and needs rapid commercialisation) but removing non-competes is likely to create an employment environment where, through fear of losing key staff and customer relationships, business operate in a more controlling, less open and trusting way and in doing so stifle the very creativity from which entrepreneurism is born.”

In summary, I accept that the current approach will always bring with it a degree of uncertainty. There are rarely any cast-iron guarantees that a covenant will be upheld if tested by a court. After all, what is “reasonably necessary” is a very fact-specific concept.

However, it does allow employers to create well-defined boundaries within which an employee can leave to become a future entrepreneur without being unduly inhibited. In doing so, they are asked to consider very carefully, at the outset of the relationship, the minimum protection genuinely needed to protect their business. If those boundaries are imprecise or too wide, they will disappear altogether. It is often much easier to spot restrictions which will definitely not be upheld than those that will!

The current approach has been carefully built up by the courts over a long period, moulded to reflect changing perceptions of what is appropriate but guided always by the overriding public policy against unreasonable restraints of trade. Within this environment, innovation in the UK has flourished, as the strength of ground-breaking businesses in the Cambridge Technology Cluster and London’s Tech City demonstrate so well. There is no reason why it cannot continue to do so.

For more information please contact Dominic Holmes on dominic.holmes@taylorvinters.com or call +44 (0)20 7382 8046.