World@Work: Post-employment restraints

Jennie Mansfield:

Hello, and welcome to Ashurst Legal Outlook and the next episode in our World@Work series. My name is Jennie Mansfield and I'm a partner in Ashurst's Employment group in Sydney. In this episode, I'll be speaking to my Ashurst Employment colleagues across the globe to discuss post-employment restraints, touching on issues like limits on the length of prohibitions in the UK and Spain, and their impact on lever clauses in stock option plans in Germany. I'm delighted to have joining me a number of colleagues from our global Employment team; Crowley Woodford, partner from our London practice, Andreas Mauroschat, partner from our Frankfurt practice, Cristina Grande, counsel from our Madrid practice, and Muriel Pariente, partner from our practice in Paris. Welcome to all of you, and thank you for joining me. Before we begin, I would like the opportunity to pay my respects to the traditional custodians of the land in which I'm joining this conversation today.

And in particular, I'd like to pay my respects to elders past, present, and emerging, and to all First Nations people listening today. In this episode, we're going to consider developments in the use and enforceability of post-employment restraints across each of our regions. When we talk about restraints, we're usually looking at restrictions on competing with your former employer or on soliciting clients and on soliciting staff away from that former employer. In Australia, there are three key components to consider when drafting a post-employment restraint, the length of the restraint, the geography within which the restraint applies, and the activities restrained. Just to pick up on one of those elements, in Australia, the trend towards remote working and work from anywhere policies can make it difficult to draft a workable geographic limitation on the operation of a restraint. Crowley, does the UK have the same three components in its post-employment restraints, and are you seeing similar uncertainty about the geographical element with post-employment restraints in the UK?

Crowley Woodford:

Yes, in the UK, the three key elements that you mentioned, the length of the restraint, the geography within which the restraint applies, and the activities restrained, they're all factors which the UK courts use to determine whether or not to enforce a restraint. The key test that the UK courts apply regarding enforceability is that the restraint is no wider than reasonably necessary for the protection of an employer's legitimate business interests.

So for example, a non-compete covenant may be the only practical way of safeguarding confidential information, but in order to enforce that covenant, an employer will need to distinguish between information that is company property and the employee's own skill, experience, and knowhow to establish their legitimate business interests. And certainly for our global clients, it is sometimes the case that a worldwide geography restraint may be reasonable to protect a client's legitimate business interests. But the issue we have and we've seen developing, especially since Brexit, is the relevance of the governing law and jurisdictions clauses within the employment contract. We haven't got time, unfortunately, to go into all the detail today, but there may well be cross-border implications of agreeing to the exclusive jurisdiction the courts of England and Wales. So for example, if an employee moves outside the UK, depending on the jurisdiction they relocate to, the company may well lose the ability to sue them.

Jennie Mansfield:

And Crowley, I've heard there might be a move to limit the length of non-compete clauses in the UK.

Crowley Woodford:

Yes, that's right, Jennie. When parliamentary time allows, the UK Government has confirmed that it's going to introduce legislation to limit the length of non-compete clauses to only three months, and that would be quite a radical change to the current position. But it appears that employers will still be able to use paid notice periods, garden leave, and non-solicitation clauses, and the change won't impact confidentiality provisions in employment contracts. As far as I'm aware, the legislation will only apply to employment contracts and not to non-compete clauses in other contracts like shareholders agreements, but obviously it's a material change and we just have to watch this space as to developments.

Jennie Mansfield:

Thanks, Crowley. Those legislative developments will be closely watched from Australia. At the moment here, restraints of up to 12 months are quite commonly found to be enforceable if they're otherwise reasonable and in very rare cases, this has extended up to two years. Cristina, what about in Spain? Does Spain have the same three components to a post-employment restraint, and are you seeing challenges today?

Cristina Grande:

Thank you very much, Jennie. In Spain, there are also three components, but they are not exactly the same. As regards to the length, non-compete components, they can last a maximum of two years for qualified employees, and six months for non-qualified employees. There must be also an effective commercial and industrial interest to be protected, and an extent of this restriction, employees must be paid an adequate compensation. So the challenge here is the term "adequate compensation", because the specific amount of the compensation is not defined ] in Spanish law. So there has been a lot of judicial resolutions in this regard. And now, we can say that a majority of case law establishes that a minimum of around 40% of the fixed salary corresponding to the non-compete period [is the pay. And also concerning the payment, the time of the payment, there's flexibility. The payment can be made upon termination of the contract, during the non-compete period, upon the termination on the non-compete period, during the validity of the contract, or some hybrid assistance can be agreed.

For example, any amount spent during the validity of the contract, the salary item must be specifically disclosed in the employee's payslip. A common practice that we usually do is to agree a global salary with a senior employee and state that a certain percentage of the salary is already assigned to compensate this restriction. Under this approach, the company avoids assuming, at least partially, additional costs. Other restrictions that are becoming more popular are the non-solicitation clauses. These restrictions are not regulated under the Spanish law. However, in practice, we have detected some non-solicitation clauses . So in practice, in order to be enforceable, these restrictions should be also covered by the above-mentioned three components.

Jennie Mansfield:

That's a big range, Cristina, from six months to two years. Andreas, moving on to you. What are the guardrails for restraints in Germany?

Andreas Mauroschat:

The guardrails for restraints in Germany are based on legal provisions which are over 100 years old and an abundant body of case law. So our law is not in any way prepared for the challenges of a modern working environment, such as remote working, which you and Crowley talked about. We are working with clients to find creative ways of navigating these seas. However, drafting an effective restraints clause is known to be one of the toughest challenges for legal advisors in Germany. That's because restraints are subject to review under the terms and condition laws and therefore they must meet transparency and fairness tests.

And the courts have taken quite diverse and frequently even contradicting views on when a restraint clause is ineffective or not binding. Just to give you a flavor of how critical our courts are in Germany, the clause which would be typical in an international context prohibiting the employee to become active for a competitor as an employee on a freelance basis or in any other manner, may be considered overreaching, as it would also prohibit activities which are not related to the employee's specific prior activities for their employer.

Also, a clause which prohibits the employee to establish, acquire, or directly or indirectly hold an interest in a competitor has been considered unfair, as it would restrict the legitimate personal investment interests of the employee. And finally, the typical clauses which would include affiliates of a competitor in a restraint, which are customary to avoid circumvention, may be considered excessive and void as well. So since this case law is a bit unpredictable and also constantly evolving, a clause which is compliant today may be considered void tomorrow.

We therefore advise our clients to use restraints cautiously and restrictively and, where possible, to consider safer alternatives, such as an extended notice period. Having said that, the general legal guardrails for restraints are quite simple. Restraints are permissible for a maximum term of two years. They must be limited in territorial reach and scope, and the employer must pay a mandatory minimum compensation of 50% of the total compensation the employee has last received. And finally, it's worth noting that the effectiveness of a restraints clause may not be made subject to any conditions, and may only be waived by the employer prior to termination of employment. If the employer waives, they would have to pay the compensation for 12 months after the waiver, while the employee is free to compete if they leave.

Jennie Mansfield:

Thanks, Andreas. Lastly to you, Muriel. How do post-employment restraints operate in France?

Muriel Pariente:

Under French employment law, a non-compete provision must be justified by the legitimate interest of the company, limited in time and space, and provide for the payment of financial compensation. The amount of financial compensation is not set by law. However, some collective bargaining agreements specify the financial compensation for a non-compete clause. It's common for financial compensation to amount to at least 40% of the employee's average gross monthly salary. This amount recently tends to increase to 50%. However, this amount must always be assessed on a case by case basis, depending on the geographical scope and length of the restraint, as well as the specific nature of the prohibited activity.

According to case law, the geographical scope of a non-compete obligation may extend to the whole of France or even to a wider scope, provided that the employee can continue to exercise a professional activity. A non-compete clause covering almost 100 different countries has already been accepted by case law due to the employee's very, very specific activity. On the other hand, a worldwide non-compete clause is not enforceable. It's really a case by case basis. It is sometimes difficult to properly assess the geographical scope of a non-compete clause, as it is very difficult to predict what a court might consider acceptable.

Jennie Mansfield:

Thank you, Muriel. The development we're awaiting in Australia is a report from the Australian Competition and Consumer Commission (ACCC) into post-employment restraints. That report will come after the Minister for Competition, Andrew Leigh, and Chairwoman of the ACCC, Gina Cass-Gottlieb, criticized the use of post-employment restraint clauses as anti-competitive and inhibitors of economic growth. The Minister said that these clauses hold back wage growth and stifle job mobility by preventing employees from taking higher paying positions at competitive firms, which he says has the flow-on effect of inhibiting the economy. They argue that businesses are using these clauses to keep salaries low while increasing profits, which negatively impacts Australia's productivity and employee innovation. This type of criticism may be picking up on some recent moves in the US to outlaw post-employment non-compete clauses altogether. In some US states, they're already entirely unenforceable. Many commentators in Australia are skeptical about these views.

The contrary view being put is that restraint clauses are a lawfully designed mechanism for employers to protect their goodwill, and are unlikely to inhibit the wider economy. These commentators also highlight that Australia's laws are sufficient to protect employees, as a restraint clause must only protect the reasonable and legitimate interest of the company in order to be enforced. For example, in New South Wales, restraint clauses are prima facie unenforceable under the Restraints of Trade Act and courts have a specific power to read them down. Commentators could say that restraint clauses are not commonplace and are mostly found in the contracts of highly remunerated professional. I'd have to say that my own experience tends to reinforce the view that restraints are usually only enforced where the employer has a clear legitimate interest to protect either its confidential information or customer connection, in the same way Crowley was describing for the UK.

Coming back around our speakers again, Muriel, I've heard that non-compete clauses automatically end in France where there's a settlement agreement. How does that work?

Muriel Pariente:

Thank you, Jennie. In France, if the employer has forgotten to waive a non-compete clause, it will only be possible to rectify this error by signing a settlement agreement. But this could be costly, as the employee will probably claim financial compensation. Indeed, even if a non-compete clause has not been correctly waived, a settlement agreement, even in general terms, puts an end to the obligations related to a non-competition clause. However, our recommendation is to provide for a specific mention regarding the non-compete clause to avoid any difficulties on the validity of the settlement agreement. Generally speaking, it is very important to ensure that non-compete clauses are properly weighed, meaning in due time, it really depends on the labour contract or the collective bargaining agreement, but employer has to be very cautious with the non-compete and the way they waive it. If not, the employee is entitled to full payment of the financial compensation for a period that can be up to two years.

Jennie Mansfield:

Andreas, what about in Germany? I've heard the restrictive rules on restraints may also apply to clauses providing for forfeiture of benefits if the employee competes, such as labour clauses in stock option plans. Can you tell us more?

Andreas Mauroschat:

Yes, that's correct, Jennie. Provisions which establish golden chains may be considered unfair if they unduly restrict the employee's freedom of work. So an example for that would be paying a monthly special bonus to an employee, which they would have to pay back if they join a competitor. Given that such payments would accrue over time and increase the pressure not to join a competitor, the repayment obligation would be void in that case. In which circumstances a forfeiture of a benefit would be considered to be an unfair golden chain is somewhat unclear, however, the courts have accepted such clauses in stock option plans offered by a foreign parent company, because such plans are not considered to be part of the employment relationship with the German employer, therefore, they would not be subject to German law and German rules of business tests. Generally, we advise our clients to be quite cautious when linking any performance-related remuneration to restraints by means of a leaver clause or similar arrangements, as such arrangements will, in many cases, not be effective.

Jennie Mansfield:

And Cristina, I've heard that in Spain, an employer cannot unilaterally waive a restraint once agreed. How does that work?

Cristina Grande:

Yes, that's right. Under Spanish law, once the post-contract and non-competition clause is agreed, companies cannot unilaterally waive it. So unless an agreement is reached between the parties, the company will be obliged to pay their non-competition compensation. For example, in a scenario such as disciplinary dismissal or in a case of the employee being made redundant, it is important to leave it clear in the initial non-competition clause the scenarios in which the clause could not apply because otherwise, we are dealing with contractual obligations, and therefore their performance cannot be left at the discretion of one of the parties.

However, it is true that there has been a recent resolution where the court considered valid a non-competition clause, but it was specifically for a scenario that if upon the termination of the employment contract there is not an effective industrial interest to protect, the clause could not apply. So it is true that this was a very specific case, because the contract lasted less than one year, and therefore the employee had not gained enough knowledge to be able to cause damage to the employer if he was going to render services for a competitor. But it is true that this provides some certain discretion in certain scenarios for employers, and we are seeing that we are including this kind of scenario in the non-competition clauses that we are drafting nowadays for our clients.

Jennie Mansfield:

And Crowley, back to you. What other developments have happened in the UK affecting post-employment restraints?

Crowley Woodford:

Thanks. Yes, there's been a couple of interesting issues that I wanted to highlight. The first one I wanted to mention relates to widely drafted restricted covenants, and that they're not necessarily always going to be void. In the UK, there's this concept called the "blue pencil test". This allows a court to remove an unenforceable provision from a restrictive covenant, and leave the enforceable part to stand, providing the wording can be removed without adding to or modifying what's left behind. The Supreme Court has recently held that a non-compete clause in an employment contract which contained some unreasonable provisions was not wholly void, and the employer could still rely on those reasonable parts of the clause, so that's reassuring for employers. However, although the Supreme Court agreed to remove the offending words in that case, relying on the courts to effectively correct poor drafting is not a very sensible approach.

It's clearly much better to spend some time drafting a carefully worded non-compete clause and indeed, any other restrictive covenant, which balance the legitimate protection of the employer's business with the employee's right to work. The second point is less a development, but more a reminder that where an employer wants to introduce or change the scope of or the type of restrictive covenant during the course of the employment relationship, rather than on commencement of employment, it will need to allocate specific, adequate monetaryy consideration to the new or varied covenant to ensure that it's not going to be found to be immediately unenforceable. A very important point, which is often overlooked.

Jennie Mansfield:

Thanks, Crowley. It's always so interesting to get a comparative perspective on a tricky issue like post-employment restraints, and those insights from around our offices have been really interesting. Unfortunately, our time has come to an end, so let me now thank our panelists, Andreas Mauroschat, Crowley Woodford, Cristina Grande, and Muriel Pariente, and to you, our audience, for listening. We hope you found this episode both informative and interesting.

You can hear more of Ashurst's podcasts, including more episodes from our World@Work series, by visiting ashurst.com/podcast. If you don't want to miss future episodes, you can subscribe on Apple Podcasts, Spotify, or your favorite podcast platform. While you're there, please feel free to leave us a rating or review. But for now, my name's Jennie Mansfield, and on behalf of my co-panelists, thanks again for listening, and goodbye for now.