Is your business ready for the non-compete clause ban?

As part of the recent Federal Election Campaign, the ALP announced its intention to ban non-compete clauses for workers earning less than the high-income threshold under the Fair Work Act 2009 (Cth) which is currently $175,000.

This policy is a response to increasing public and expert concern in Australia and overseas that non-compete clauses act as a drag on productivity by inhibiting job mobility, innovation and wages growth.

The ALP has also stated that it will, at a later date, consider and consult on the broader issue of non-compete clauses for high-income workers, as well as non solicitation clauses for clients and co workers.

Given the election outcome, it is timely to explore this issue in further detail and look at how you can prepare and protect your business for the ban on non-compete clauses.

What is a non-compete clause?

A non-compete clause in an employment contract prevents or limits an employee from working in a position that is (or might be) competitive with the employer, or in a similar position with another employer, following the end of their employment.

This restraint is typically for a specified period after the termination of employment with the current employer and within a specific geographic location. Depending on the seniority and degree of specialty of the employee’s role, the period of restraint may be as little as a few months or as long as several years, and the geographical restriction may range from a few kilometre radius to a State, or the entire country, or even a larger region.

The primary objective of a non-compete clause is to protect the employer’s business interests. A former employee will know the employer’s customers, its suppliers and its particular business methods that give it a competitive advantage in the market in which it operates. These are all part of the employer’s intellectual property that underlies the goodwill of the business.

Every employee owes a duty of confidentiality in relation to the employer’s proprietary information that he or she acquires in the course of employment, and this lasts indefinitely, long after the end of the employment, as long as the information remains confidential and valuable. This obligation does not simply mean that the ex-employee must not pass on the confidential information to anyone else. Equally important, they must not use the confidential information – the customer lists, the terms of supply, the methods of business – for their own advantage.

However, in the real world it can be difficult for an employer to detect breaches of confidentiality by an ex-employee, let alone to enforce the available remedies. Non-compete clauses have developed as a practical response – the ex-employee is removed from competing with the employer for a period sufficient to neutralise any advantage from using the employer’s proprietary information. That, at least, is the theory.

The courts have traditionally viewed any kind of restraint of trade with distaste, as fettering the efficient operation of the market and thereby increasing the cost of goods and services. However, the courts have also recognised that employers have a legitimate interest to protect, and that the contractual arrangements between employers and employees should generally be respected. The courts have thus constantly balanced those competing interests in finding a reasonable middle ground.

Traditionally non-compete clauses have applied to senior-level management and executives, and in that context the courts’ balancing act has worked reasonably well. Increasingly, however, these types of clauses have been routinely included in the employment contracts of workers across all skill and income levels, regardless of whether they have access to sensitive or confidential information. That has led to concern at a policy level, in Australia and internationally, that non-compete clauses are not only detrimental to productivity, but they are just unfair when applied to workers who may, at most, cause their employer some inconvenience by leaving, but whose departure does not in any way threaten the goodwill of the employer’s business. This uncritical application of non-compete clauses to these low to middle income employees limits their ability to seek new and often better-paying opportunities and places an unfair financial burden on them if they try to dispute the enforceability of a restraint.

However, as is often the case, a response to a genuine problem can result in over-reach. In proposing to ban non-compete clauses based on a monetary threshold (and quite a high one at that, at $175,000 per year) the ALP policy uses a shotgun, rather than a rifle. Although the imposition of non-compete clauses on many low to middle income employees is unfair and inappropriate, it is not inevitably so. There are some situations where these employees necessarily develop close relationships with clients of the business, and are well placed to take those clients with them if they move to a competitor – thus increasing their own value at the expense of the former employer. Hairdressers are a good example.

Therefore, a more even-handed response to the problem here would be to relate the enforceability of a non-compete clause to the extent to which an employee actually has access to the employer’s valuable proprietary information, and their ability to benefit from that information at the employer’s expense. However, such a regime can be complex and difficult to manage and enforce, so it may be that the monetary threshold approach proposed by the ALP is the only practical way of dealing with the problem.

Now and then

Given this recent announcement, it is worth asking the question: how enforceable are restraint clauses now in Australia?

Generally speaking, a post-employment restraint clause is unenforceable unless it goes no further than necessary to protect the legitimate business interests of the employer.

The Courts determine the enforceability of restraint clauses on a case-by-case basis and take into consideration: the nature and extent of business interests being protected, the geographic scope, the length of the restraint and personal situation of the employee.

In essence, it is a matter of weighing up the potential harm to the employer should the restraint not be upheld VS the potential harm to the former employee if the enforceability of the restraint was granted.

What are the potential consequences?

The ALP’s announcement makes it clear that a non-compete clause is no longer applicable to or enforceable against an employee whose income does not exceed the high-income threshold.

It is much harder to foresee the long-term implications for the business community, as employers. However, a number of issues can be identified:

• Employees with access to valuable information
  There will be a significant number of employees whose incomes are below the high income threshold – particularly, but not only, those who earn close to the threshold – who have access to their employer’s confidential and sensitive business information. This is especially the case for those in small businesses or start-up companies. If these employees can move to a competitor, free of any restraints, the potential damage to their former employer could be real and substantial.
• Workers on incentive-based payments
  Businesses may need to consider how to approach the issue of restraint clauses with regards to workers whose remuneration is a combination of a base salary plus incentive-based payments, especially if the latter are excluded from ‘earnings’ for the purpose of the high-income threshold.
• Which workers are included?
  At this point in time, it is unclear if the non-compete clause change will only apply to employees or if it will also apply to other categories of workers such as contractors, labour hire etc.
• Business sales and key person exits
  Direction is yet to be provided around the application of the non-compete clause in the event of the sale of a business which frequently involves the exit of key individuals (such as founders, directors and more) if they are not earning any salary and therefore will be exempt from the high-income threshold.
• Confidentiality provisions
  There has been no suggestion that employees will be relieved of their confidentiality obligations, and indeed it is difficult to imagine this happening. An employer’s confidential information is its property, as much as its desks and chairs and the money in its bank account. Therefore, we may see the focus move from non-compete in contracts, to confidentiality clauses that are at the same time more comprehensive in the subject matter covered and more precise in the steps that must be taken by the employee to protect and respect the employer’s rights in that confidential information.

Where to from here? 

Several countries already regulate non-compete clauses, including Austria, India, Finland, Mexico and Germany, whilst others, such as the United Kingdom, are currently discussing reforms around the restriction of their use.

Closer to home, the ALP has announced that it will consult on policy details including the introduction of penalties, exemptions and transitional arrangements that will allow employers and employees to navigate these changes without being in breach of the law.

However, based on the assumption that these new non-compete clause conditions are due to take effect from 2027, businesses need to take several steps to ensure they are prepared.

In the case of senior employees, whose salaries exceed the threshold, it is critical to continue to use post-employment restraint clauses for their traditional purpose: to protect your legitimate business interests against potential exploitation by those employees post their employment.

For all employees, whatever their income level, you should ensure that employment contracts properly address the protection or disclosure of confidential information and the ownership of intellectual property.

In addition, it is prudent to review the contracts of employees whose contracts and remuneration may not fit within the traditional definition of the high-income threshold (e.g. those with incentive-based payments) and implement regular reviews of any non-compete restraints to ensure ongoing compliance, given the high-income threshold is adjusted annually from 1 July every year.

Whilst these reforms aim to foster innovation, competition and higher wages, they also have the potential to create a more challenging environment for businesses with regards to employment contracts and the protection of businesses interests.

Therefore, it is important to take the necessary steps now to protect your business in the future.

If you need any assistance,  please contact the team at Antcliffe Scott.