Restraining restraints: The uncertain future of non-competes

This article was co-authored with Anastasia Gravas and Yasmine Sahihi.

On 23 April 2024, the United States Federal Trade Commission (FTC) voted to ban non-compete clauses, which prevent a worker from seeking or accepting new employment within an industry after the termination of their employment. The ruling, while already subject to legal challenge, stands as one of the most expansive measures taken by a growing list of international jurisdictions that have moved to restrict the use of non-compete clauses. A legal update on the FTC ban written by our US colleagues can be accessed here.

The Australian Government also looks to follow this momentum.

In August 2023, the Australian Treasurer announced a Competition Review to be conducted by a dedicated Taskforce, with the aim of assessing whether Australian competition laws, policies and institutions remain fit-for-purpose.

As part of that review, the Treasury released an Issues Paper on 4 April 2024 regarding the use of non-compete clauses and other restraints of trade (Issues Paper).¹ The Issues Paper notes growing concern with the prevalence of non-competes and other restraint of trade clauses in Australia, citing evidence that these terms of employment negatively impact job mobility, innovation, and wage growth.

The Competition Review Taskforce is currently seeking feedback from stakeholders in response to the Issues Paper on the impact of non-competes and other restraints of trade. Public submissions are open until 31 May 2024.

Other aspects of the Competition Review and significant developments in the Australian competition regulatory landscape were recently discussed in this article by our Competition law team here.

• Legal status of restraint of trade clauses in Australia
• What might potential reform look like: International examples
• Next steps

Legal status of restraint of trade clauses in Australia

Restraint of trade clauses are a common feature of Australian employment contracts.

Non-compete clauses are a restraint condition which seek to restrict former workers from working for a competitor or establishing a competing business, typically for a period post-termination and within a defined geographic area.

Other common restraints of trade include non-solicitation clauses which seek to restrict former workers from soliciting former clients and former co-workers, and non-disclosure clauses which seek to restrict former workers from disclosing confidential information gained during their employment.

There is a presumption at law in Australia that restraints of trade are void and unenforceable unless they are reasonably necessary to protect the legitimate business interests of the employer.² When determining what is reasonably necessary, a court will evaluate whether the scope of the restriction, such as the geographic area and duration of the restraint, is reasonable given the nature and extent of the protected business interest (for example, trade secrets, confidential information regarding suppliers and customers).

Both non-compete and non-solicitation clauses have traditionally only been included in employment contracts for senior staff and key employees with access to confidential and commercially sensitive information. However, these clauses have become increasingly common in employment contracts for low-income workers in industries such as fast-food, childcare, and security.³ According to recent data from the ABS, approximately 46.9% of all Australian businesses use at least one type of restraint of trade clause with 25.4% of businesses using non-solicitation clauses for some employees, and 20.8% of businesses used non-compete clauses for some of their workers.⁴ The ABS survey reported that 45.3% of businesses used a non-disclosure clause for some of their workers in 2023.⁵

Considering the widespread use of restraint clauses, the Issues Paper acknowledges concerns regarding the current legal framework and uncertainty about the enforceability of restraint of trade clauses. This uncertainty may particularly disadvantage lower-paid workers who lack the resources to challenge non-compete clauses, even if they may be unenforceable.

Even for restraints which are legally enforceable, the Issues Paper suggests that the use of these clauses may substantially impact labour mobility, innovation, and wage growth. A policy question is posed by the Issues Paper as to whether the benefits to business of non-competes and other restraints outweigh the broader costs to the economy. The consideration of these issues is likely to inform potential legislative reform to these clauses.

What might potential reform look like: International examples

In the US, the recent FTC rule makes it illegal to include or maintain a non-compete clause in an employment contract. The rule also applies retrospectively and provides that existing non-competes will become unenforceable 120 days after the ban comes into effect. However, an exception to the ban on non-competes is carved out for senior executives, defined as workers making more than US $151,164 annually in "policy" making roles. In addition, the rule also does not affect non-competes between franchisors and franchisees, and non-competes related to the sale of a business.

Other jurisdictions have taken a more conservative approach to restraining non-competes by implementing selective or limited bans. For example, non-compete clauses have been banned for employees below an income threshold in some EU nations such as Austria and Luxembourg. Prior to the FTC's ban on non-competes, the state of Hawaii banned non-competes in the technology sector.

The UK Government has also recently announced a proposal to impose a statutory limit on the duration of non-competes to three months. If passed by Parliament, employers may only impose a non-compete for up to three months, while existing English legal limitations on enforceability will still apply for clauses less than three months in duration.

Another alternative which may be considered by legislators in Australia is mandatory compensation. In the EU, many states impose mandatory compensation for the duration of the non-compete. For example, EU nations such as Germany, the Netherlands and Spain require that post-employment non-competes be paid to workers at a portion of their pay for the duration of the non-compete. In Germany, a non-compete clause will only be enforceable if the employer agrees to pay at least 50 percent of the renumeration received during employment.

Next steps

There is evidently growing international momentum to regulate non-competes, but at this time, the impact of this in Australia remains uncertain. For large multinational corporations, reduced appetite for the use of non-competes may already be influenced by global developments, particularly the FTC's ban on non-competes in the US.

Nevertheless, while many international jurisdictions have regulated non-competes, they typically have preserved the ability for employers to use longer paid notice periods and garden leave (ie where an employee is not required to do any active work during their notice period). Other restrictive covenants, such as non-disclosure and non-solicitation clauses, have been largely unaffected. For instance, the focus of the UK legislation is on limiting the duration of non-compete clauses, rather than other restraint conditions.

While reform to restraint clauses would require considerable support, the Government has demonstrated appetite for reform. In recent years we have seen a willingness of the Government to regulate contractual relationships, such as the recent prohibition on pay secrecy clauses in employment contracts. In any event, even if Australia does not legislate to impose a ban on non-competes akin to the US, it remains prudent for employers to review and consider employment contracts and reliance on restraint clauses. From an operational perspective, we have already seen an increasing number of clients moving away from blanket non-competes, reserving such clauses only for the most senior of employees, and instead focussing on well-crafted non-solicitation restraints - designed to address and protect their key assets and proprietary interests. Such moves may be prudent in anticipation of potential restrictions on the use of such clauses and potentially greater regulatory oversight.

In reviewing contracts and protection of their business and proprietary interests, employers should ensure that they have well-drafted non-solicitation and confidentiality provisions, and consider the strategic use of notice periods and alternatives such as garden leave.

If you would like to discuss effective protection of your organisation's proprietary interests, or you would like to make a submission to the Competition Review's Issues Paper, please contact us for a confidential discussion.

Footnotes