European scrutiny of non-compete and no-poach clauses grows

Scrutiny of these arrangements is advised at a time when the UK government is considering imposing an outright ban on, or statutory limits on the duration of, non-compete clauses, and the European Commission has raised concerns about the impact of no-poach agreements on competition in the labour market.

What are non-compete clauses and what restrictions apply?

‘Non-compete’ clauses in contracts between employers and staff allow businesses to mitigate the risk that an ex-employee will bring its technology, confidential and proprietary information, customers or clients to a competitor after their employment ends.

Such clauses are commonly used in UK employment contracts to restrain employees from threatening their employer’s ‘legitimate interests’ for a certain period after their employment has come to an end. Typically, they prohibit an employee from going to work for a competitor or competing with an ex-employer or dealing with the former employer’s customers using knowledge gained during their prior employment for a certain period after leaving the business. These restrictions are enforceable where certain requirements are met, and they are regularly upheld by the UK courts.

Competition law does not apply to restrictive covenants agreed between employer and employee. Instead, the common law restraint of trade doctrine applies. It provides that a contractual term which restricts an employee's activities after termination is void unless the employer can demonstrate that:

• the restriction is designed to protect its legitimate business interests; and

• it goes no further than is reasonably necessary to protect those interests.

Nevertheless, these non-compete clauses are increasingly being seen as anti-competitive and have led to proposals in the US to curtail the unfair use of these clauses. The UK government also recently consulted on the use and possible reform of non-compete clauses, in particular, with a view to promoting innovation, competition and economic recovery following both the Covid-19 pandemic and Brexit. The results of this consultation are still awaited.

UK HR professionals should be aware of this current direction of travel in relation to such restrictions and keep their employment contracts under regular review to ensure that their legitimate interests are adequately protected by other clauses in their employment contracts, such as confidentiality clauses.

HR managers in Germany are also advised to track developments in this area. German law on non-compete clauses is complex. Generally, post-contractual clauses between an employer and the employee are only binding if the employer pays a certain compensation to the restricted employee; if there is no compensation at all, the clause is void; respective clauses should therefore be reviewed in each individual case.

No-poach agreements under competition law

‘No-poach’ agreements, also known as ‘non-solicitation’ agreements, are agreements made between competitor businesses to coordinate their hiring practices. This might involve:

• agreeing not to hire employees from each other; and/or
• mutually fixing their pay rates or scales.

The incentive for these agreements could be to keep market rates of pay low, to avoid employee attrition and to avoid recruitment costs. However, there is a risk that such agreements could distort the labour market, limit innovation and reduce workers’ ability to extract competitive wages.

No-poach agreements are commonly found in sectors which rely on high-skilled employees, such as technology, engineering, healthcare and sports, where it can be difficult and expensive for employers to hire staff. No-poach agreements have been found to breach competition law ‘by object’ – i.e. restricting competition by their very nature, without the requirement that they have any actual effects – and significant penalties have been imposed on companies which have entered into them.

The mere exchange of information with competitors about pay rates, bands and scales can also breach competition law in certain circumstances, especially where such information is considered commercially sensitive – this could be the case where wage costs represent a significant proportion of a company’s total costs and may therefore impact on a business’s pricing. Nevertheless, benchmarking of wage rates and scales can be lawful in certain circumstances where data is sufficiently aggregated, anonymised and historic.

On the other hand, it is permissible to agree to no-poach provisions strictly in the context of merger and acquisition transactions in cases where such a restriction is necessary to implement a transaction. Such restrictions must be limited to a duration, geographic area, subject matter and persons reasonably necessary to achieve the purpose of the transaction. Generally, such clauses are justified for up to three years where goodwill and know-how is transferred, or up to two years where only goodwill is transferred.

Collective bargaining between workers’ organisations, such as trade unions, and businesses over rates of pay is considered part of a negotiation between worker and employer, not an agreement between undertakings. It is, therefore, distinguishable from no-poach agreements and not considered to be anti-competitive under competition law.

There can be a fine line between what is permitted or may be unlawful under the competition rules in this area.

In Germany, if a no-poach agreement infringes competition law, this will have far more severe consequences than under commercial law and could lead to high fines and damages claims.

Given that the consequences of breaching competition law are serious, businesses are advised to seek specialist competition law advice before entering into any arrangements with competitors that might restrict competition between them, including in relation to any restriction on poaching each other’s staff.

Previous enforcement action

The US Department of Justice (DOJ) has pursued a number of high-profile cases under US anti-trust law. Between 2010 and 2011, the DOJ settled cases with several large US tech and film production companies in relation to so-called “no cold call” agreements not to approach each other’s employees for recruitment purposes. The DOJ subsequently reached a settlement with other companies in two further cases involving similar agreements not to recruit each other’s staff, in both cases with the involvement of senior executives. This year, the DOJ has begun to bring criminal prosecutions in relation to such agreements. There are three US criminal cartel cases from this year due to be heard in 2022 concerning no-poach and wage fixing arrangements in the healthcare market.

Enforcement action against no-poach agreements has not yet been taken by competition authorities in the UK or at EU level. However, there has been significant enforcement activity at a national level across the EU, for example:

• In 2017, the French competition authority fined three significant flooring manufacturers a total of around €300 million for a no-poach agreement and the exchange of salary information, allowing them to coordinate strategy, as part of a wider cartel arrangement.
• In 2020, the Hungarian competition authority fined the Association of Hungarian HR Consulting Agencies HUF 1 million (€2,700) for unlawful provisions of its ethical code which amounted to a mutual no-poach agreement.
• More recently, this year the Portuguese competition authority issued a statement of objections to Portugal’s Football League and 31 clubs concerning an alleged mutually agreed prohibition on hiring players who terminated their contract with another team for reasons relating to the pandemic. This was followed by guidance from the authority on the prevention of anti-competitive agreements in the labour market.
• In the Netherlands, the Dutch regulator had been investigating alleged wage-fixing by supermarkets but has now announced the suspension of its investigation after the businesses and employees reached a pay deal that has retrospective effect.

Towards further competition law enforcement in the UK and EU?

There are some signs that there may be increased scrutiny of anti-competitive agreements in Europe in this area on the horizon. The EU competition commissioner, Margrethe Vestager, when speaking in October 2021 about the future of cartel enforcement, alluded to an increased focus on enforcement against no-poach cartels on the basis that they “restrict talent from moving where it serves the economy best… [and are] effectively… a promise not to innovate”. Her comments have been taken as a signal that the Commission may be set to launch specific investigations in the near future.

Additionally, as the labour market in many countries has stagnated following the Covid-19 pandemic, it is likely that the effective enforcement of competition law breaches relating to employees will become increasingly relevant to governments and regulators as a tool to free up labour markets and increase innovation. In the UK, where the country’s exit from the EU has further exacerbated labour shortages, this may shortly become a much higher political and regulatory priority.

In addition to anticipating the possible new legislation banning the use of non-compete clauses in employment contracts, businesses and HR professionals should therefore ensure that they seek specialist competition law advice before entering into any arrangements with competitors that might restrict the free movement of employees between competitors.

Co-written by Aisleen Pugh, Alan Davis, Lara-Christina Willems, Dr. Mathias Greupner, Ewan Bruce and Polly Whitelam, of Pinsent Masons.