Competing with a former employer
Author: Tal Williams, Partner
26 June 2012
When a senior employee leaves a business they are, as a matter of general law, free to compete with the former employer unless they are subject to a valid contractual restraint. The employee may take away and utilise the benefit of any personal relationships built up with particular customers and may seek work from customers that the employee can recall without the aid of a written list taken from the former employer or without deliberate memorisation of a customer list. An employee may not, however, breach the duty they owe to their employer whilst still employed or use confidential information of the former employer for any purpose whatsoever. A recent Federal Court case has highlighted the distinction between a contractual restraint and breach of confidential information.
Background
In 2004 a printing business was sold to a larger organisation in Western Australia. At the time of the takeover a number of senior employees were re-employed by the new owners as a consultant, the general manager, the production manager and the operations manager.
Within four years these employees had become discontented about the way in which the business was being conducted so one of the employees started to develop plans for the establishment of a new company that would directly compete with the employer. These preparations included the drafting of business plans and applications to banks for finance. Negotiations in relation to the new company and the obtaining of finance had occurred during 2008/2009. Such operations and submissions included material information in relation to customers who were likely to move their business to the new company. Detailed estimates of income and forecast service requirements were provided to the funding institutions and during 2008 and 2009. Towards the middle of 2009, two of the employees inspected land and negotiated a lease in respect of new premises for the new operation.
By mid-2009 the new company had been incorporated and each of the employees referred to above were shareholders. Throughout this period all employees remained employed by their old employer but were conducting negotiations mainly (but not solely) from their home computers and on their personal time. They all resigned from their positions and went to work for the new company late in May 2009.
The court case
Upon learning of the activities of their former employees, the former employer commenced proceedings for:
- Breach of contract
- Breach of fiduciary duty
- Breach of confidence
The Court found that the principal agitator had been a senior and trusted employee of the former company but had devised a scheme and planned for and established a new business. He prepared budgets to test viability, sought out investors, solicited clients to transfer their business to the new entity, recruited key employees from the old employer, applied for and obtained finance and was involved in obtaining premises from which a new business could operate. All of this occurred over a period of 18 months whilst he remained employed by the old employer. It was found that this employee breached his fiduciary and contractual obligations owed to his former employer.
Although the other participants played smaller roles in setting up the new enterprise, each were found to have abused the trust that was reposed in them. It was found that each had devoted a good deal of time and effort to the planning of and preparation for the establishment of the business and had abused the former employer’s interest to maximise the benefits available to themselves. While much of what they did was undertaken in their own time this was irrelevant and that the timing of the activities did not afford them any defence against allegations of breach of fiduciary and contractual obligations. One of the employees was found to have played only a minor role – but it was important enough for that employee to be found to have breached the duties owned to his former employer.
In addition to all of the above, it was confirmed that the information that had been used and disclosed by the employees (particularly to banks) was information that was confidential to the former employer. This information included financial information, client contact information, billing, wage and sales information (amongst other things). A fifth employee who emailed home some company material containing this information was also found to have breached the duty owed under her contract of employment
Whilst the Judge recognised that employees are free to compete with the employer after they leave their employment, they can only do so without the use or disclosure of confidential information. In this instance, not only had each employee breached their duty to the employer, each had wrongfully utilised or disclosed confidential information.
The Court found each of the five respondents (together with the company they formed) had breached their legal obligations while they were employed and were accountable to the former employer for loss and damage that it had suffered, or for an account of profits made.
At the time of writing this article the amount of such loss and damage is still being assessed but it is likely to be significant.
Implications
The case highlights the fact that leaving employment in order to compete with a former employer does not cause any legal issue unless there is a post-employment restraint imposed upon the employee or he or she has used and disclosed confidential information in setting up the new competing business. Whilst employed, a duty to act in the interest of the employer, not in one’s own personal interest is implied. Even if the new business does not commence until after the employment ends, the breach of duty occurs if you take significant preparatory steps that are contrary to the interests of the former employer.
More information
Our Workplace Relations team recently published a newsletter discussing the key factors Courts will consider when determining whether a post employment protection clause such as a restraint is valid and enforceable. They also looked at some recent cases where such restraints have been upheld. Click here to read the newsletter.
Tal Williams
Partner
T: +61 2 9390 8331
E: tal.williams@holmanwebb.com.au