Are non-compete clauses for employees anti-competitive?

Articles Written by Sar Katdare (Partner), Ruveni Kelleher (Partner), Morgan Blaschke-Broad (Senior Associate), Mei Gong (Senior Associate), Megan Prouatt (Senior Associate)
Business people in office

‘No-poach’ or ‘non-compete’ clauses are used widely by Australian companies to prevent the leakage and misuse of employer’s information and loss of key client and supplier relationships. Companies use such clauses to protect their commercial interests by ensuring employees cannot work for a competing business for a specified period of time and/or within a specified area after their employment contract terminates.

But could they breach competition laws in labour markets?

What is a non-compete clause?

‘No-poach’ or ‘non-compete’ clauses are clauses contained in employment contracts, contractor agreements, equity schemes and business sale agreements which aim to prevent a former employee from using commercially sensitive and confidential information, intellectual property and general know-how to compete against its former employer.

Such clauses are very common but can be difficult to enforce as Courts have generally only upheld non-compete clauses where the clause can be shown to reasonably protect legitimate business interests which usually means the restrictions relate to senior executives.

Why is this becoming an issue now?

The US experience

A few months ago, the US Federal Trade Commission (FTC) proposed that non-compete clauses should be banned in the US on the basis they were an ‘unfair method of competition’.

Under the proposal, employers:

  • will no longer be able to enter into, attempt to enter into or maintain agreements containing non-compete clauses; and
  • must rescind all pre-existing non-competes (informing employees that they are no longer in effect.

Other types of employment restrictions, such as non-disclosure agreements, non-solicitation obligations and gardening leave clauses will be exempt from the ban as long as they do not function as non-competes.  However, a recent separate decision of the US National Labor Relations Board has affected the ability for employers to include non-disparagement and confidentiality provisions in separation agreements and employment-related documents.

Non-compete clauses between the seller and purchaser of a business will be exempt from the FTC proposal where the party restricted by the non-compete clause holds at least a 25% ownership interest in a business entity.

The proposed rule would also require employers to rescind existing non-competes within 180 days of the proposed rule coming into effect and actively inform workers that they are no longer in effect.

The proposal (which would apply to independent contractors, as well as paid and unpaid employees) would affect 20% of all employees in the US.  Some States in the US like California has already banned such non-competition clauses, except in limited cases such as in connection with a sale of business.

The Australian position

Citing the US proposal and in light of recent low wage growth, Assistant Minister for Competition, Charities and Treasury, Andrew Leigh MP has called on the Australian Competition and Consumer Commission (ACCC) to consider the competitive impacts of non-compete clauses, and provide advice and recommendations about any necessary action to be taken.

Mr Leigh has argued that non-compete clauses contribute to an employer’s market power and constitute a form of monopsony market power – the power a buyer (the employer) has over their supplier (the employees supplying skills/labour). This employer power is restricting employees’ ability to switch employers which is applying downward pressure on Australian wages.

Could non-competes actually be a breach of competition law?

No-poach or non-compete clauses between businesses (outside of mergers and acquisitions) may constitute cartel conduct on the basis that it involves an agreement between two competitors that they will not supply labour services to the individuals who are the subject of the restriction.

For example, four Silicon Valley companies, Apple, Google, Intel and Adobe in the US had formed a no-poach arrangement to avoid soliciting each other’s employees, with a class action brought on behalf of the restricted workers settling for US$415 million in 2015.

Non-compete clauses can also harm competition by hindering talent attraction (blocking employees from pursuing better opportunities) and therefore reducing a company’s ability to compete on service dimensions with its rivals.

They can also hinder innovation, preventing entrepreneurs from forming new businesses or bringing innovative ideas to new companies, leading to fewer new entrants and increased prices/quality decreases for consumers. 

What will happen next?

The Government’s request is not entirely unsurprising, considering the global interest in the competitive impacts of restrictive employment clauses, the global trend towards increased enforcement in this area, and the Government’s focus on increasing fairness in competition and consumer law over the last year.

However, it is not yet clear whether Australia will follow the US, particularly given that non-compete clauses affect relatively few Australian workers.

We anticipate that the ACCC will undertake a review of the effects of including and enforcing non-compete clauses in Australia but is unlikely that the ACCC will propose that such clauses be anti-competitive in the same way as the FTC is doing in the US. 

While no-poach agreements between competitors may raise competition concerns, typical non-competes at this stage are unlikely to be problematic and will continue to be assessed by way of a reasonableness test.

What should you do now?

Given the current scrutiny on non-competes, it would be prudent to have these reviewed to ensure they are not in breach of common law restraint of trade doctrine as well as competition law more generally and to ensure they are enforceable to their maximum extent by tailoring them to protect only legitimate business interests.

In particular, any non-compete obligations that extend to an employer’s business activities in the US should be reviewed to ensure they do not impact on the enforceability of the entire restraint provisions. Employers will need to determine how existing employees’ restraint clauses can be amended and how template contracts should be amended going forward for new employees.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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