Background

Non-competes are terms in an employment contract which provide that once the employment ends the employee cannot work for another employer in the same industry or field (i.e., a competitor), within a specified geographic area, for a specified time.

Non-competes have become increasingly common, in part because they are easier to enforce than other post-employment restraints dealing with confidential information and customer solicitation. Further, as noted by Stewart et al (Reference Stewart, Forsyth, Irving, Johnstone and McCrystal2016), ‘This is a strategy that has been overtly encouraged by courts in recent years’.Footnote ¹

Like other post-employment restraints, non-competes are subject to the common law doctrine of restraint of tradeFootnote ² and as such are presumptively invalid on the basis that they are contrary to the public interest. To rebut that presumption, the employer benefiting from the non-compete must establish that the restriction imposed is no wider than is reasonably necessary to protect a legitimate interest.

In theory, the practical application of the doctrine should seek to balance three overlapping and competing interests:

1. 1. Employers have an interest in protecting their businesses.

2. 2. Former employees have an interest in plying their profession or trade.

3. 3. The public has an interest in the promotion of competition and the efficient allocation of economic resources.

A non-compete which does nothing more than protect the original employer from competition from a former employee is unenforceable as it is the very thing the doctrine prohibits.Footnote ³ However, a non-compete is lawful if the employer can point to an interest they are entitled to protect, such as confidential information or customer connections and if the restraint goes no further than is reasonable to protect that interest.Footnote ⁴

In practice, the common law’s primary concern is to assess whether the employer has a legitimate interest and to determine if the non-competeFootnote ⁵ is commensurate with that interest. The employees’ position is generally treated as irrelevant.Footnote ⁶ As Stewart notes, ‘it is rare for a court to concern itself in any detail with the relative bargaining power of the parties; or with the overall “fairness” of the agreement; nor is it necessary that the employee receive any additional consideration for entering into the restraint’.Footnote ⁷ Consequently, in Australian courts, the majority of non-competes are upheld.Footnote ⁸

The doctrine of restraint of trade is also intended to protect the public from the anti-competitive consequences of private contractual arrangements. Yet the public interest is often forgotten in contemporary judgments in which the central focus is on the interests of the employer seeking to enforce the non-compete.Footnote ⁹ As Stewart (Reference Stewart1997 at 182) notes: ‘in practice, reasonableness in the public interest is almost never considered as a distinct issue and it is hard to find a single case in which a restraint has been struck down on that ground’.

Even those who contend that the common law, if properly applied, strikes an appropriate balance between the post-employment interests of employers and their former employees, acknowledge that ‘there is a tendency in some recent cases to give greater weight to the terms of the contract as opposed to the public policy that militates against enforcement’.Footnote ¹⁰

The critique of non-competes can be reduced to four broad issues:

1. (i) confusion and uncertainty is created by the use of overly broad non-competes, particularly the use of ‘stepped’ or ‘laddered’ clauses (Confusion and Uncertainty);

2. (ii) ready access to injunctive relief disadvantages employees and fails to take sufficient account of the public interest (Injunctive Relief);

3. (iii) the use of non-competes has become widespread including low-wage occupations, such as hairdressers and the types of interests protected by a non-compete have expanded (Proliferation of Non-competes); and

4. (iv) non-competes reduce competition and job mobility and have consequential negative impacts on wages and productivity (Economic Consequences).

Confusion and uncertainty

To enforce a non-compete, the employer must show that the restraint is reasonable in the sense that it is commensurate with a legitimate interest and is no wider than strictly necessary to protect that interest. The ‘reasonableness’ of a non-compete is assessed having regard to the three elements common to such terms:

• the nature and extent of the particular activities sought to be restrained;

• the geographic area in which those activities must not occur; and

• the duration of the restraint.

There are no set rules about what constitutes a ‘reasonable’ geographic area or a ‘reasonable’ duration and the scope of each element is considered having regard to the other elements of the non-compete. Each non-compete must also be assessed with particular reference to the legitimate interest the employer is seeking to protect. Whether a court upholds the validity of a non-compete is dependent on the facts in each case and past cases provide little guidance.Footnote ¹¹

The subjective nature of the test has been the subject of academic criticism; for example, Riley describes it as a ‘very flabby test’Footnote ¹² and Pivateau (Reference Pivateau2008) describes the test as ‘a standard [that] holds minimal value in the construction of non-compete agreements’.Footnote ¹³ Fell and Rudz (Reference Fell and Rudz2023:1254) argue that the test has given rise to ‘inconsistency in the enforcement of post employment non-compete restraints…to the detriment of employees’. One court characterised the task of assessing the reasonableness of a non-compete as ‘a swampy morass of conflicting interests and policies into which a court may eventually need to plunge to resolve the problems these covenants present’.Footnote ¹⁴

The fact-dependent nature of the proceedings and the general nature of the test give rise to a diversity of judicial opinion. An authority can usually be found to support any particular point of view; as is apparent by comparing the cases relied on by Riley (Reference Riley2012) and Stewart (Reference Stewart1997), as opposed to Neil and Saady (Reference Neil and Saady2018).

In addition to the uncertainty generated by the very nature of the test and its application in particular cases, the ability of courts to ‘sever’ offending aspects of a non-compete creates an additional layer of uncertainty.

At common law, an invalid part of a non-compete may be severed if a ‘blue pencil’ can be run through the offending part without affecting the original nature of the clause and contract.Footnote ¹⁵

The capacity to sever offending clauses encourages employer overreach in drafting non-competes and increases the use of overly broad clauses which, absent the blue pencil doctrine or, in New South Wales, the Restraints of Trade Act, would be unenforceable.

It has also become common for non-competes to be drafted to facilitate the process of severance by the adoption of ‘cascading’ or ‘laddered’ non-competes. Fell and Rudz (Reference Fell and Rudz2023 1270) describe the practice as ‘ubiquitous’. Such terms set out a series of overlapping or cumulative restraints comprising multiple versions of different non-competes which vary as to geographic breadth, duration, and/or activities affected. Any restraint that is too wide can be severed, leaving what remains enforceable.

Cascading or laddered non-competes have been the subject of judicialFootnote ¹⁶ and academicFootnote ¹⁷ criticism for creating uncertainty. For example, Stewart (Reference Stewart1997 at 218) argues:

The problem for an employee bound by a laddered non-compete is that, absent a judicial determination, they have no way of knowing which of the restraints will be found to be reasonable and which go too far and be unenforceable. The impact of such uncertainty is amplified by the inequalities between the employer and employee.

Neil and Saady (Reference Neil and Saady2018) contend that the uncertainty inherent in the current law is a testament to its fairness:

However, this view ignores the chilling effect created by the uncertainty inherent in the application of the current law. The cost of legal proceedings, in financial and emotional terms, presents a significant deterrent to employees seeking to challenge the validity of a non-compete.Footnote ¹⁸ In terms of the financial cost, the legal practitioners interviewed by Arup et al in 2013, put the cost of opposing an application for an interlocutory injunction at between $20,000 and $100,000. Such costs are a significant disincentive for most employees.

For many employees, the mere threat of legal action by the employer is enough to secure compliance, whatever the lawfulness of the non-compete, as Stewart has observed:

An in terrorem effect occurs when individuals adhere to a contractual term in anticipation of legal action if they choose not to comply. In the case of non-competes, the in terrorem effect is such that former employees comply with more non-competes than would be upheld if they went to trialFootnote ²⁰ and settlements are generally made before proceedings are issued.Footnote ²¹

Starr et al (Reference Starr, Prescott and Bishara2020) provide empirical evidence of an in terrorem effect, including with respect to unenforceable non-competes. Using nationally representative data for 11,500 US labour force participants, the authors found that non-competes are associated with reductions in employee mobility and changes in the direction of that mobility (i.e. towards non-competitors) in States that do and do not enforce non-competes. Indeed, they found no statistical differences in mobility patterns between States where non-competes are enforceable and States where they are not.Footnote ²² When asked how important their non-compete was in determining whether or not to leave their employment and go to work for a competitor, some 58.1% of respondents in States that do not enforce non-competes answered that it was ‘somewhat, very or extremely important’, compared to 53.5% of respondents from states that do enforce non-competes. The authors conclude: ‘a non-compete is associated with both a longer tenure and a reduced propensity to leave for a competitor even when the non-compete in question is unenforceable under state law’.Footnote ²³

In sum, uncertainty is an inherent by-product of the current legal framework for assessing the validity of non-competes. The generality of the legal test and the fact-dependent nature of the proceedings lead to a diversity of judicial opinion. This uncertainty is compounded by the ‘blue pencil’ approach to severance which encourages employer overreach in drafting non-competes and has given rise to cascading non-competes. Consequently, in most cases, the parties cannot be certain that their particular non-compete will be enforceable; absent a judicial determination. This uncertainty weighs more heavily on employees and, for many, the mere threat of legal action is enough to secure compliance, irrespective of the legal merits or enforceability of the particular non-compete. The US evidence suggests that in States where non-competes are unenforceable, employers still use them; they have an in terrorem effect on employees and are associated with reduced employee mobility. The unfairness of such an outcome is manifest and is contrary to the public interest.

Interlocutory injunctive relief

The initial enforcement action in respect of a non-compete is typically an interlocutory proceeding for injunctive relief. The interlocutory decision effectively determines the matter as very few cases proceed from the interlocutory to the trial stage.Footnote ²⁴ This is particularly problematic for defendants, as a former employer need only show that it has an arguable case and the balance of convenience favours injunctive relief.Footnote ²⁵ Few cases give serious consideration to whether damages would constitute an adequate remedy such that injunctive relief ought not be granted.Footnote ²⁶

The role of injunctive relief in the enforcement of non-competes has been the subject of academic criticism. For example, RileyFootnote ²⁷ argues:

Arup et al make a similar point, proposing that ‘it would be preferable for the courts to require the employer to make out a stronger case before an interlocutory injunction is granted’.Footnote ³⁰

In sum, injunctive relief is typically used to enforce non-competes and few cases proceed to the trial stage at which the merits of the employer’s case can be fully tested. In interlocutory proceedings, the employer need to only establish an arguable case and that the balance of convenience favours injunctive relief. A review of the relevant cases suggests that the balance of convenience is weighed in the employer’s favour.

Proliferation of non-competes

The ‘reach’ of non-competes has expanded in recent times, both in the number and type of employees covered; and the type of interest said to be protected by a non-compete.

Economic consequences

A number of Australian labour law scholars have criticised non-competes as ‘legal handcuffs’ that reduce competitiveness, labour mobility and, hence, productivity.Footnote ⁴⁷ The impact of non-competes on productivity is particularly important.

Productivity matters; labour productivity growth is the main driver of higher living standards over the medium term. In recent decades, in Australia and other advanced economies, growth in labour productivity has slowed markedly. If sustained, lower productivity growth will negatively impact living standards and will mean lower potential growth.

The research literature consistently highlights two factors associated with Australia’s productivity slowdown:

1. 1. Non-mining investment was weaker than expected over much of the 2010s despite declines in interest rates and the end of the mining investment boom. The decline reflected a broad-based weakness in average investment across firms and industries (Hambur & Jenner, Reference Hambur and Jenner2019). Generally speaking, if the amount of capital available to workers increases – capital deepening – they will be able to produce more output and hence be more productive.

2. 2. There has been a decline in business and economic dynamism in Australia (Deutscher, Reference Deutscher2019; Andrews & Hansell, Reference Andrews and Hansell2021; Andrews et. al Reference Andrews, Hansell and Wheeler2022) and overseas (Calvino et. al Reference Calvino, Criscuolo and Verlhac2020), as evidenced by the slower adoption of new technologies (Andrews et al Reference Andrews, Criscuolo and Gal2019; Akcigit & Ares, Reference Akcigit and Ares2019); declining firm entry rates (Gutierrez & Phillippon, Reference Gutierrez and Phillippon2019); and a slowdown in resource allocation efficiency. Job mobility and labour reallocation rates have declined, ‘trapping’ scarce labour in lower productivity firms. Andrews & Hansell (Reference Andrews and Hansell2021) found that the pace of labour reallocation from low-to-high-productivity firms has slowed since 2012, lowering labour productivity growth by around 0.15 percentage points per year in the mid-2010s compared to the early 2000s and accounting for about a quarter of the slowdown in non-mining non-financial private sector labour productivity growth from 2012 to 2014.

Non-competes are associated with reduced employee mobility and with changes in the direction of that mobility (ie towards non-competitors);Footnote ⁴⁸ with consequential negative impacts on wages and productivity. A recent e61 research noteFootnote ⁴⁹ examined the relationship between job mobility and firm entry rates and the prevalence of employment restraints at an industry level in Australia. The authors found that:

1. 1. Job mobility appears to be lower in industries where the use of restraint clauses is higher.

2. 2. There is a negative correlation between the current prevalence of restraint clauses and the change in firm entry rates over the past 15 years.

Prohibiting or restricting non-competes enhances employee mobility and knowledge spillovers between firms. Gilson (Reference Gilson1999) examined the economic effect of the law with respect to non-competes by comparing two high-technology industrial districts, California’s Silicon Valley and Massachusetts’ Route 128. He contends that the continued success of Silicon Valley and the decline of Route 128 is due to the fact that California prohibits non-competes and Massachusetts enforces them.

A paper by Marx et al (Reference Marx, Strumsky and Fleming2009) examines the impact of non-competes on employee mobility by using Michigan’s 1985 reversal of its non-compete enforcement policy as a natural experiment. The authors found ‘a strong decrease in average Michigan mobility once non-competes began to be enforced’.Footnote ⁵⁰

A recent paper published by the US National Bureau of Economic Research (Gottfries & Jarosch, Reference Gottfries and Jarosch2023) assessed the consequences of an outright ban on non-competes in the US labour market using a new model on wage-posting and on-the-job search, drawn from the Burdett–Mortenson model. The model used was validated by testing with existing empirical evidence on firm mergers and non-competes. The model predicts that wage gains are typically 2% to 6% but can be as high as 15% when non-competes are common and hiring costs are higher.

The baseline analysis by Gottfries & Jarosch (Reference Gottfries and Jarosch2023) suggests that a ban on non-competes between workers and firms in the US would increase wages by 4% as a consequence of the rise in competition, with strong wage spillovers to firms that did not initially use non-competes and a large increase in worker turnover. The authors also note that while a ban on non-competes is likely to increase wages and reduce labour misallocation, it also generates a sharp rise in worker churn, increased turnover costs, and reduced labour demand.

Similarly, Johnson et al (Reference Johnson, Lipsitz and Pei2023) posit that average earnings of all US workers would likely increase by 3.2% to 14.2% (midpoint of the interval: 8.7%) nationally, if non-competes were made unenforceable.

An outlier is Young (Reference Young2021), who found that a ban on non-competes in Austria for low-wage workers was associated with a 1.7% increase in annual job-to-job transition rate, disproportionally to higher quality and higher paying jobs but had limited effects on earnings. It is worth noting that the ban on non-competes in Austria only applied to those earning below the 52nd percentile of the earnings distributions.

As mentioned earlier, the slowing in Australia’s productivity performance in recent decades has coincided with a decline in job-to-job transitions.Footnote ⁵¹ Job-to-job transition, sometimes referred to as job switching, occurs when a worker changes jobs without going through a period without paid employment. Andrews and Hansell (Reference Andrews and Hansell2021) suggest that the observed decline in productivity-enhancing labour reallocation is holding down overall productivity growth and is consistent with a rise in adjustment frictions. Non-competes are a source of friction in labour markets, creating a barrier to labour mobility.

International research suggests that job-to-job transitions can increase aggregate productivity by moving workers to more productive firms.Footnote ⁵² In the Australian context, Buckley (Reference Buckley2023) finds that the share of job switching that involves workers moving to higher productivity firms has fallen over time, from 54.2% between 2003 and 2006 to 52.8% between 2015 and 2019.Footnote ⁵³ Buckley contends that making it easier for workers to switch jobs could boost productivity:

Competition among firms for employees, as reflected in higher job-to-job transition rates, is an important driver of higher wages. In the Australian context, Deutscher (Reference Deutscher2019) found that a 1 percentage point increase in the rate at which workers switch jobs is associated with a 0.5 percentage point increase in growth in average wages.

A recent Australian study found that switching jobs is associated with pay increases that are nine percentage points higher on average than for non-switchers and that the largest beneficiaries are workers aged between 21 and 34 years old. When such workers switch jobs they earn, on average $7,500 more per annum than ‘job stayers’.Footnote ⁵⁵

The next section considers whether a regulatory response is needed to address the deleterious impact of non-competes and, if so, what policy options are available.

Is there a need for a regulatory response?

The case in favour of a regulatory response to curtail the use of non-competes rests on two broad propositions. The first is that the existing law and practice in respect of the use of non-competes in Australia is manifestly unfair and contrary to the public interest. In most cases, the parties to a non-compete cannot be certain of its enforceability without a judicial determination and such uncertainty weighs more heavily on employees than employers. The uncertainty inherent in the application of the current law has a chilling effect and for many employees, the mere threat of litigation is enough to secure compliance, irrespective of the enforceability of the non-compete. Further, employers have ready access to injunctive relief to enforce non-competes, to the disadvantage of employees and the public interest. Few cases proceed to the trial stage, where the merits of the non-compete can be fully tested.

The second proposition in favour of a regulatory response is that non-competes reduce employee mobility with consequential negative impacts on wages and productivity.

The case against a regulatory limitation on non-competes rests on four broad propositions.

1. (i) Non-competes are necessary to protect trade secrets, particularly in high-skilled labour markets.

Two points may be made in response to this proposition.

First, the ‘reach’ of non-competes extends well beyond the highly skilled and highly paid. Starr et al (Reference Starr, Prescott and Bishara2021) report that 14.3% of US workers without a college degree and 13.3% of US workers with annual earnings of less than $40,000 are covered by a non-compete. A similar pattern emerges in Australia. About one in five Australian workers are subject to a non-compete and they are prevalent across different societal groups, including low-paid employees. In short, the ‘reach’ of non-competes is inconsistent with their stated justification; as Gottfries & Jarosch (Reference Gottfries and Jarosch2023) observe ‘it seems hard to argue that the millions of low-skilled, low-pay workers have access to important trade secrets’ (p22).

Second, there are other ways to protect trade secrets. An employer wishing to restrain the post-employment use or disclosure of confidential information can rely on the common law duty of confidentiality and the equitable doctrine of breach of confidence. As Stewart (Reference Stewart1997) points out (at p 188):

It is acknowledged that these alternate means have limitations. The duty of confidentiality is only breached by the misuse of ‘secret’ information and may not cover information which is only ‘confidential’.Footnote ⁵⁶ Further, an injunction will only be granted to restrain the use of trade secrets by a former employee if the precise material to be covered by the injunction can be specifiedFootnote ⁵⁷ and to claim damages for such a breach the employer must show that any loss of business is attributed to the disclosure of the secret information.Footnote ⁵⁸

As mentioned earlier, one of the reasons that non-competes have become more common is that they are easier to enforce than other post-employment restraints dealing with confidential information and customer solicitation. Indeed courts have encouraged this approach, for example in Littlewoods Organisation Ltd v Harris Footnote ⁵⁹ the court said:

1. (ii) Any further limitation on non-competes undermines the sanctity of contract.

This argument is advanced by Neil and Saady (Reference Neil and Saady2018), who contend that employees ‘consciously and freely chose to be bound’ by non-competes when they entered into a contract with their employer and refusing to enforce such a contractual obligation ‘undermines the authority and sanctity of contract’.

There are two problems with this argument. The first is that the common law doctrine of restraint of trade already ‘undermines the … sanctity of contract’ as non-competes are invalid unless the non-compete is no wider than reasonably necessary to protect a legitimate interest. Further, both the common law and a range of statutory provisions routinely imply and prohibit certain contractual terms.

The second, and more substantive point, is that the premise of the argument – that employees ‘consciously and freely chose to be bound’ by non-competes – ignores the inequality in bargaining power inherent in most employment relationships and is contrary to the available evidence.

Starr et al (Reference Starr, Prescott and Bishara2021) found that only 10% of employees report attempting to negotiate over the terms of a non-compete or asking for additional compensation or benefits in exchange for agreeing to such a condition. When presented with a non-compete, most respondents report just reading and signing it, and some not even reading it.Footnote ⁶¹ Starr et al (Reference Starr, Prescott and Bishara2021) conclude that ‘the evidence … indicates that employers present (or employees receive) non-compete proposals as take-it-or-leave-it propositions’.Footnote ⁶²

Further, as mentioned earlier, the proposition that employees ‘consciously and freely chose to be bound’ by non-competes is plainly wrong in respect of non-compete terms in enterprise agreements and their application to ‘future employees’.

1. (iii) Workers are better off being bound by a non-compete.

There are two elements to this argument, namely that workers bound by non-competes earn higher wages and that they receive additional training.

Whether or not workers are better off being bound by a non-compete is somewhat contentious. A number of US studies have found that workers bound by non-competes earn higher wages than those without non-competes.Footnote ⁶³ There is an obvious tension between these studies and those discussed earlier in Section 2.5 of this paper which report an increase in wages following the banning of non-competes. This tension is discussed by Starr (Reference Starr2023) who observes that those asserting non-competes result in higher wages are ‘confusing correlation with causation’:

Similarly, Balasubramanian and Yamaguchi (Reference Balasubramanian and Yamaguchi2023) find that positive wage relationships with non-competes are likely driven by selection and should not be interpreted causally and that a negative average wage effect is more likely.

Further, as Starr (Reference Starr2023) points out, if it is the case that enforcing non-competes is likely to lead to better outcomes for workers, we would expect non-competes to be associated with relatively higher wages where they are enforceable compared to where they are not. But this is the opposite of the results of Rothstein and Starr (Reference Rothstein and Starr2022) who find that the non-compete-wage differential in states that might enforce non-competes is 6% lower than in states that will not enforce them.

Starr (Reference Starr2023) convincingly concludes:

The proposition that workers bound by non-competes receive more training is supported by two studies, which find that non-competes and their enforceability are associated with more training.Footnote ⁶⁴

While it may be accepted that non-competes are associated with the provision of additional training the reasons for that association are less clear. Starr et al (Reference Starr, Ganco and Campbell2018) suggest that one reason there is more training in US states where non-competes are enforceable is because non-competes prevent firms from hiring experienced workers thus causing them to hire inexperienced workers who require more training.Footnote ⁶⁵ Further, the existence of such an association does not mean that imposing further restrictions on the use of non-competes will necessarily reduce the extent of training provided to employees.

1. (iv) Non-competes foster innovation.

A number of commentators have suggested that non-competes give firms incentives to develop and share valuable information with workers that may make those workers more productive because they provide protection against their workers providing that information to a competitor.Footnote ⁶⁶ However, the evidence from recent studies suggest that non-competes do not foster innovation.

Johnson, Lipsitz, and Pei (Reference Johnson, Lipsitz and Pei2023) suggest that an average-sized increase in non-compete enforceability reduces patenting by 16–19% over the ensuing 10 years. Other recent studies report similar findings. Reinmuth and Rockall (Reference Reinmuth and Rockall2023) find that an average increase in the enforceability of non-competesFootnote ⁶⁷ reduces patenting by 11.6% after 5 years.

In summary, there are factors weighing for and against curtailing the ‘reach’ of non-competes and the type of interest which may be protected by post-employment restraints, but the weight of the evidence favours a regulatory response to ameliorate the unfairness inherent in the existing law and practice with respect to the use of non-competes.

Despite the fact that the doctrine of restraint of trade is intended to protect the public from the anti-competitive consequences of non-competes and to take account of the interests of the affected worker, these considerations are often forgotten in contemporary judgments in which the central focus is on the interest of the employer. A regulatory response is required to correct this imbalance.

The options

A number of jurisdictions within the Organisation for Economics Co-operation and Development have imposed restrictions on the use of non-competes ranging from the general prohibition of such terms to more limited regulatory interventions, such as the payment of mandatory compensation to the former employee (by their former employer), while a non-compete operates to prevent them working for a competitor.Footnote ⁶⁸

A number of reforms have been proposed in the US, including banning non-competes for some or all employees and regulating the non-competes contracting process,Footnote ⁶⁹ and in recent years, many States have passed laws limiting employers’ ability to impose non-competes on their employees.Footnote ⁷⁰

At present, the restriction of non-competes across the US is under active consideration by the Federal Trade Commission (the FTC).

In January 2023, the FTC released a ‘Notice of Proposed Rulemaking’ to prohibit employers from imposing non-competes on workers. The proposed rule would:

• provide that non-competes are an unfair method of competition and would ban employers from entering non-competes with their workers, including independent contractors; and

• require employers to rescind existing non-competes with workers and actively inform their employees that the non-competes are no longer in effect.

The FTC estimates that the proposed rule would increase workers’ earnings by nearly $300 billion per year. FTC staff are currently considering comments received on the proposed rule and will present any proposed revisions to the FTC for its determination.

The regulation of non-competes has also received attention in the UK where the government has announced its intention to introduce a statutory limit on the length of non-competes of 3 months.Footnote ⁷¹

Australian labour law scholars have suggested a range of measures to mitigate the deficiencies in the current legal framework. For example, Arup et al suggest placing an upper limit on the duration of non-competes and requiring employers to pay their former employees for the period the non-compete operates.Footnote ⁷² They also propose a policy of ‘no modification of restraints – or, at least only modification to make good the restraint if the parties can show they had genuine doubts about the appropriate restraint to apply in a particular position’.Footnote ⁷³

Riley (Reference Riley2005) argues that clauses which prohibit the solicitation of former co-workers be ‘entirely unenforceable’ and that more rigid requirements be introduced for assessing the balance of convenience in applications for injunctive relief to enforce non-competes. Arup et al (Reference Arup, Howe and van Caenegem2013) suggest that a ‘cleaner reform… would be to withhold interlocutory injunctive relief altogether from employers and require them to go to trial (on an expedited basis) to plead the merits of the restraint’.Footnote ⁷⁴

In April 2024, the Australian Government released an Issues Paper, ‘Non-Competes and other restraints: undertaking the impact on jobs, business and productivity’.Footnote ⁷⁵

The Issues Paper outlines the existing research and evidence in Australia and overseas on the use and effects of restraints of trade on workers, and no-poach and wage-fixing agreements made between businesses. Several issues are identified relating to the use and impact of non-compete clauses including:

• the ‘chilling effect’ of restraint clauses on worker mobility, particularly among lower-income workers, to choose better-paying jobs, and the ability for businesses to start up, recruit talent, and grow;

• the high cost of litigation, the lack of clear guidance and ‘bright line’ rules, and the use of cascading clauses or the ‘blue pencil test’, which can leave both workers and businesses with an unclear understanding of whether an agreed restraint will be upheld as reasonable and enforceable; and

• the economic consequences of potentially inefficient allocation of labour and information, which may be hampering productivity growth and innovation.

The public consultation process concluded in May 2024 and Treasury will advise the Government on the outcomes from the consultations by the end of 2024.

Some potential reform options in the Australian context are discussed below.

The various policy options canvassed can be located on a two-axis matrix, depending on the complexity of the option and the extent to which it is likely to encounter resistance (see Figure 1).

Figure 1. Policy options – complexity vs likelihood of resistance.

Monetary thresholds

A common regulatory response is to render unenforceable non-competes with employees who earn less than a prescribed amount. The argument advanced in favour of such measures is that ‘low-wage’ non-competes are unfair, as Hiraiwa et al (Reference Hiraiwa, Lipsitz and Starr2023) put it:

To these arguments, one could add that ‘low-wage’ employees often lack the bargaining power to resist a non-compete or to negotiate its terms.

Non-competes with ‘low-wage’ employees are unenforceable in 11 States in the US,Footnote ⁷⁷ but there is no particular consistency in the threshold chosen or the method for determining that threshold. The criteria adopted in each state are summarised in Table 1.Footnote ⁷⁸

Table 1. Non-competes limited by wage threshold

The selection of an appropriate non-compete enforcement threshold in the Australian context is a policy choice.

As shown in Table 1, the higher the threshold, the more jobs affected.

Chart 1. Share of Australian jobs earning below any given level.

The ‘high income threshold’ is a concept used in the FW Act. If an employee (defined as a ‘high income employee’) has a guarantee of annual earnings which exceed the high-income threshold, the unfair dismissal provisions of the FW Act do not apply to that employee (s.382). The high-income threshold is indexed and is currently $167,500. If that figure was used as a non-compete enforceability threshold, it would have the practical effect of prohibiting the enforcement of non-competes in over 90% of Australian jobs. A threshold set at ‘average earnings’ covers just under 80% of jobs.

The evidence from Hiraiwa et al (Reference Hiraiwa, Lipsitz and Starr2023) suggests that a monetary threshold, which covers about 80% of workers, does not reduce average firm value and firms do not appear to value the enforceability of non-competes for workers earning around the threshold.

In the event that an enforcement threshold is adopted, it should be indexed.

Term limitations

Regulatory responses to non-competes can include the imposition of a limit on their duration; a requirement that the former employee be compensated for the duration that the non-compete applies; or a combination of these two measures.

As mentioned earlier, the UK has announced an intention to introduce a 3-month term limit to all non-competes. In Germany, employers are obliged to pay the restrained employee 50% of their remuneration for the entire restraint period (a maximum of two years).

The advantage of a requirement that the former employee be compensated for the duration of the non-compete is that it, in effect, applies a market solution to the problem. The employer is required to place a value on the restraint and to pay that amount to the worker who is subject to the restraint.

An appropriate policy intervention may be to introduce a non-compete term limit of up to 6 months subject to the restrained employee being compensated for the duration of the restraint.

Such a term limit broadly aligns with how Australian courts have actually applied the reasonableness standard in particular cases. Fell and Rudz (Reference Fell and Rudz2023) analysed all Supreme and Federal Court decisions between 1 July 2016 and 22 February 2023 in which the court made a final (as opposed to interlocutory) determination about the reasonableness of the duration of a non-compete. As the authors caution, the determination that a particular duration was reasonable in one case does not mean the same conclusion automatically applies in a different context, the relevant considerations are highly fact-dependent. Nevertheless, the results indicate that long periods are more likely to be unenforceable:

• all 24 months restraints were unenforceable;

• only half of the 12-month restraint were enforceable and nearly all of those involved senior employees were likely to possess significant confidential information, form connections with significant clients, and receive substantial benefits under their employment contract.

• in no case was a 12-month restraint upheld against an employee who had no significant management or strategic responsibilities.

• 6-month restraint are likely to be enforced against senior employees but likely not enforceable against non-senior employees.

The amount of compensation provided also presents a policy choice – ranging from the remuneration the employee would have received had the employment relationship continued (i.e. full compensation), to some proportion of that amount (partial compensation). Any determination of the appropriate amount of compensation should consider:

1. ➢ the fact that the former employee will not be performing any work for their former employer during the restraint period; and

2. ➢ the former employee will not be able to commence working for a competitor (or to operate their own business) during the restraint period. Further, job switching usually results in higher remuneration and so the former employee will be denied access to that higher remuneration for the duration of the restraint.

Consideration should also be given to the interaction between the compensation paid during the restraint period and any payments in lieu of notice of termination or any ‘gardening leave’ arrangement.Footnote ⁷⁹

Injunctive relief

The criticism of the current law with respect to injunctive relief is that it is too readily available to employers seeking to enforce non-competes, to the detriment of the public interest, and the employee to whom the non-compete applies.

The reform options range from prohibiting access to injunctive relief altogether, which would require employers to go to trial (on an expedited basis) where the merits of the non-compete can be fully tested; to ‘lifting the threshold’ for the grant of injunctive relief.

As Arup et al (Reference Arup, Howe and van Caenegem2013) note, prohibiting access is a ‘cleaner reform’ but would be a much bigger step than requiring employers to make out a stronger case before injunctive relief is granted or ‘tilting’ the balance of convenience requirement towards the affected employee.

A middle path may be to expressly require courts to take into account the public interest in the promotion of competition and the interests of affected employees in deciding whether the balance of convenience favours the grant of injunctive relief. There is, however, some complexity and risk in constraining judicial discretion. Depending on the other policy responses adopted, it may not be necessary to pursue this particular option.

Prohibition

There are a range of options within the prohibition policy mode, including:

• prohibiting all non-competes;

• prohibiting particular aspects of non-competes – such as terms prohibiting the solicitation of former co-workers;

• prohibiting the severance of unlawful aspects of non-competes by the courts; and

• prohibiting the inclusion of non-competes in enterprise agreements.

Each of these options is considered below.

1. (i) Prohibiting all non-competes

Subject to limited exceptions, some States in the US provide that non-competes are unenforceable. For example, s.16600 of Californian Business and Professions Code states:

The compete prohibition of non-competes may undermine the capacity of employers to take reasonable steps to legitimately protect their business and accordingly is likely to encounter strong resistance.

1. (ii) Prohibiting employee non-solicitation terms

Riley convincingly argues that such terms should be ‘entirely unenforceable’,Footnote ⁸¹ on the following basis:

There is a strong case for prohibiting the use of terms which prohibit the solicitation of former co-workers.

1. (iii) Limiting judicial discretion

The common law approach to severance encourages employer overreach in drafting non-competes and has led to the adoption of cascading or laddered non-competes.

Pivateau (Reference Hambur and Jenner2008) proposes that ‘courts put an end to the blue pencil doctrine… because it creates an agreement that the parties did not actually agree to [and] does nothing to address the underlying problems of non-compete agreements’.Footnote ⁸³ Pivateau also contends that employers should be required to nominate precisely the position from which the employee would be barred, the interest that is worthy of protection, and the extent of the restraint that is considered reasonable.Footnote ⁸⁴

Some US states such as Georgia, Virginia, and Wisconsin follow a ‘no modification’ approach to non-competes, also known as the ‘all or nothing’ rule. Under these provisions, courts must refrain from either rewriting or striking out terms in non-competes which are wider than strictly necessary to protect the employer’s legitimate interest.Footnote ⁸⁵

There is a reasonable case for limiting the capacity of courts to sever unlawful aspects of non-competes, but such an approach brings with it some risk and complexity. It would, in effect, mean overriding parts of the Restraints of Trade Act and constraining the operation of a common law judicial discretion is not a task to be undertaken lightly.

Careful thought would need to be given to the drafting of such a provision. Depending on the other policy responses adopted, it may not be necessary to pursue this option.

1. (iv) Prohibiting the inclusion of non-competes in enterprise agreements

As mentioned earlier, the inclusion of non-compete terms in enterprise agreements is an important development. It is likely that such terms have no legal effect, as they are not about a ‘permitted matter’, but they have an in terrorem impact. On the understanding that non-competes are not ‘permitted matters’, it follows that the FWC cannot refuse to approve an enterprise agreement merely because it includes a non-compete. Nor can the FWC require an employer to give an undertaking in relation to a non-compete or amend an agreement to remove a non-compete.

One means of addressing this unsatisfactory state of affairs is to amend the FW Act, as follows:

1. 1. Amend s.194 to make a non-compete an ‘unlawful term’ (the FWC can only approve an enterprise agreement if it is satisfied that it does not contain any ‘unlawful terms’: s.186(4).

2. 2. Amend s.191A (or insert a new section) to provide that the FWC must amend an enterprise agreement to remove a non-compete term as part of the approval process.

These amendments would remove the risk that employees may mistakenly believe that a non-compete term in an enterprise agreement is effective and enforceable.