Preparing to Compete: The Boundaries of Permissible Conduct
Under our free enterprise system, employees frequently leave their employment to work for a competitor or start a new competing venture. Questions often arise about whether an employee may be deemed to have breached their duty of loyalty owed to his or her employer by taking certain preparatory steps, while still employed, to compete with his or her employer after termination. A related issue has to do with whether an employee or a former employee may be deemed to have breached a non-compete agreement by taking such preparatory measures. I have addressed the issue of the validity of non-compete agreements more generally in my video entitled, Enforceability of Non-Compete Agreements in Wisconsin. This article will focus more on how the law views certain steps taken by an employee while still employed to prepare to compete after employment.
The general rule is that employees, throughout the duration of employment, have a duty to not compete with their employer and to not take action on behalf of or otherwise assist the employer’s competitors. Wisconsin law also holds officers, directors, and certain “key employees” to a higher fiduciary duty of loyalty — a stricter standard than the general duty of loyalty owed by all agents. The controlling question as to whether an employee has a fiduciary duty is whether the employee is vested with policy-making authority or has the ability to make decisions which bind the company.
Courts have consistently found that, in the absence of an enforceable non-compete agreement, and/or the misappropriation of trade secrets, an employee is not bound by any duty to refrain from competing with his or her former employer after the termination of the employment relationship.
The more difficult issue is whether an employee’s duty of loyalty restricts him or her, while still employed, from taking preliminary measures to compete in the future with his or her employer. This scenario creates a tension between two long-standing public policy considerations: An employer’s right to demand and receive loyalty from its employees and society’s legitimate interest in encouraging competition. Courts generally have held that an employee does not breach his or her duty of loyalty by preparing to compete with its employer, provided the employee remains within certain parameters. Unfortunately, the lines between what may be permissible and impermissible conduct are not well-marked. The issue is also often very fact-intensive, taking into consideration the “totality of the circumstances.”
Nonetheless, there are some general principles that we can learn from the courts’ decisions.
Examples of generally permissible preparatory actions include:
- Incorporating a business that will be competing after an employee leaves
- Negotiating for the purchase of a competing entity
- Negotiating a lease for the new business
- Obtaining a telephone listing for the new business
- Purchasing machinery, equipment or supplies for the new business
- Opening a bank account and/or obtaining financing for the new business
- Developing a business plan
- Printing announcements
- Staffing the new business — provided the employee does not solicit co-workers while still employed
- Registering a trademark for the new business
Clear impermissible use of employer resources to prepare to compete include:
- Making preparations to compete during business hours
- Using the employer’s equipment (e.g. phones or computers or other property)
- Use of other employees’ time
Whether an employee may contact existing customers of the employer with whom it had contact with is an area that is more uncertain under the law. Courts generally have held that an employee does not breach his or her duty of loyalty by advising the employer’s clients that he or she is resigning and even generally discussing the employee’s future plans. However, solicitation of the customer steps over the line. The question usually becomes whether the communication was in fact a “solicitation.”
Another area of clear impermissible conduct is soliciting co-workers for employment while still employed. Like communications with customers, the focus on the inquiry is what was said to the co-worker and whether the communication was a “solicitation” or merely a more innocuous disclosure of future plans. However, courts have generally held that it is permissible for two or more employees while still employed to get together off-hours to plan a competing enterprise, provided the plan does not result in an en masse resignation that leaves the employer in the lurch.
Another clear line of impermissible conduct is the use of the employer’s resources to prepare to compete. That would include making preparations to compete during business hours, using the employer’s equipment, such as phones or computers or other property and use of other employees’ time. Corporate officers also cannot usurp or take a corporate opportunity of the company that they learned of while employed and exploit it for a competitor’s financial gain.
Clear impermissible preparatory use of the employer’s confidential information includes:
- Customer lists
- Employee information (e.g., salary information, etc.)
- Terms of customer contracts (e.g., prices, renewal information, penalty clauses, etc.)
- Business and marketing plans
- Any other non-public information tending to give employer a competitive advantage
In addition, if the information used by the employee qualifies as a “trade secret” under the law, the employee may also be liable to the employer for misappropriation of trade secrets.
Preparing to compete by use of unfair means is also impermissible. Some examples of such unfair means include failing to renew contracts, failing to show clients new products, and failing to pass along customer complaints.
Absent an enforceable non-compete restriction, public policy principles of free enterprise support court’s decisions to allow employees to engage in competition with their former employers, using nothing but their general knowledge, skills and experience. This competition must be fair, however, and not place the employer at a competitive disadvantage. For the most part, provided employees have not manipulated their employment relationships with their employers, the law allows for employees to take certain preparatory steps to prepare to compete without a breach of duties of loyalty. What is deemed permissible or not, often depends on whether the conduct in question amounts to “actual competition” or rather is just a preparatory step in the process to compete. Again, the lines of what is permissible or not are not always clear and depend on the totality of the facts and circumstances involved.
For more information on permissible and impermissible conduct when preparing to compete, please contact Michael at email@example.com or by calling (414) 273-1300.