Navigating non-compete clause in an employment contract

In this highly competitive world, if a company or a business venture wants to survive in the market, merely maximizing the consumers’ satisfaction is not enough. The methods, technologies and strategies adopted by the company plays a crucial role. This is where the concept of a non-compete clause comes into play. 

Sometimes also referred to as restrictive covenant, non-compete clause is a part of an employment contract that aims to restrict the ability of an employee, generally those who hold senior level, to join a competitor during and after the termination of a job. These clauses vary in their components but they typically include a specified time period, geographic restrictions specifying prohibited work areas, a description of  prohibited services or proprietary information, identification of competitors or general industry restrictions, and provisions regarding damages in the event of a breach. The idea is that an employer generally invests a significant amount of time in an employee’s training. So, an employer doesn’t become interested in training such employees who will later turn around and seek other competing options of employment. Meanwhile, the main purpose of incorporating such clauses in an employment contract is to protect trade secrets, confidential information, proprietary information and intellectual property of an employer. By safeguarding such valuable assets, a competitive edge of a company is maintained. 

The practice of non-compete clauses is more common in sectors like IT, tech, finance and professional services, as employees in such industries often have to deal with sensitive information, client information and also there is prevalence of immense competition within such sectors.  A non-compete clause helps the company maintain their market share by putting a restriction on the movement of an employee to a rival company. However, recently such a clause has expanded into medium and small sized enterprises as well. 

Enforceability of non-compete clause in different jurisdictions

Irrespective of the ever-expansion of the non-compete clause in an employment, there has been a constant ongoing debate regarding its enforceability post the termination. Supporters of this clause claim that, non-compete clause is essential in order to protect the confidential information of the employer while critics argue that post-termination non-compete clause restricts an employee’s right to employment and living by limiting entrepreneurship and innovation, ultimately obstructing economic growth of the country. The enforceability of this clause varies widely across jurisdictions, influenced by different criterias like reasonableness of their scope, time duration and geographical limitations. 

USA: In the USA the Federal Trade Commission (FTC) banned a non-compete clause nationwide on 23 April 2024. According to Lina M Khan, the chairperson of FTC, “Non-compete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from more than 8,500 new startups that would be created a year once non-competes are banned. The FTC’s final rule to ban non-competes will ensure that Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” Thus, the final rule by FTC bans nearly all the non-compete agreement between an employer and an employee. However, it hasn't explicitly kept a bar on non-disclosure agreements. 

UK: In the UK,  non-compete clauses are only enforceable to the extent that is necessary to protect the legitimate interest of an employer and is no wider than reasonably necessary. Simply demonstrating that the employer will endure from “more competition” isn't considered as a legitimate business interest. In wide terms, the courts have perceived that a legitimate business interest may incorporate protecting trade connections and, more by and large, goodwill, trade secrets and confidential information. The UK government in the policy paper “Smarter Regulation to Grow the Economy” proposed to limit the time duration of non-compete clauses in an employment contract to 3 months. 

One of the interesting concepts brought forth by the UK is the garden leave clause. It  is a practice where an employee who has resigned or been terminated  is required to stay away from the work during a notice period, while still being paid. 

Nepal: The Constitution of Nepal states in Article 33(2) that “Every citizen shall have the right to choose his own employment”. Similarly, Article 517 2(a) of the National Civil Code, 2074 makes a contract void that prevents anyone from engaging in any profession, trade  or business  not prohibited by law. However, as an exception, Section 517 2(a)(4) of  the same Code provides that an employment contract in which a person agrees not to work  for a competitor while he is still  employed or for a specified period after his retirement can be considered as a valid contract. It is noteworthy that the above provision of Nepal has confirmed both  pre- and post-termination non-compete clauses. But such  a clause must be for a specific period  and cannot be extended indefinitely.

Under Article 535 of the National Civil Code 2074, if one party breaches a contract, including a non-compete clause, the other party may claim compensation for any loss suffered. This provision is intended to protect businesses by providing  legal recourse for breaches  that harm their interests. In addition, Section 537 grants the injured party the right to recover actual loss or damage from the breaching party. However, it should be noted that the burden of proving the actual loss occurred due to the breach of the non-compete clause rests with the employer itself.

Potential alternatives to non-compete clauses 

There are viable alternatives to non-compete agreements which rather than restricting, support ideas, innovation and entrepreneurship. Non-Disclosure Agreements (NDAs) are one option to protect confidential information without limiting an employee's future employment opportunities. Another strategy is to introduce garden leave agreements, in which departing employees are paid time off during a notice period, but are not prevented from joining a competitor at a later date.

Nevertheless, it can be said that in practice, the enforceability of a non-compete clause is dependent upon different factors like reasonability, necessity and legitimate business interest of the employer. A nuanced approach shall be taken by carefully evaluating each case in order to ensure that these agreements or clauses strike a fair balance. While aiming to strike a fair balance, the bargaining power between the employer and an employee must be well inspected. This approach aims to prevent non-compete clauses from unfairly restricting individuals’ opportunities to earn a living while still safeguarding businesses from unfair competition.