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Competition, Customers and
Confidential Information
(March 2000)
by Del Elgersma
Employee mobility is at an all time high. As employees look for
better opportunities they are moving between jobs and employers
more than ever. Many employers are concerned about losing customers
and confidential information when employees leave. It is now
common for employers to require new employees to sign non-competition
agreements (also called restrictive covenants) and confidentiality
agreements. The courts are increasingly being asked to decide
if these agreements are enforceable.
The General Rule
In the absence of a non-competition agreement, there is no general
restriction on an ex-employee soliciting or doing business with
customers of a former employer. However, employees owe a duty
of good faith to their employer. This duty is broken if, for
example, an employee (while still employed) copies customers
lists for use after the employment has ended. On the other hand,
the duty is not broken if, after termination, the ex-employee
obtains customer names from memory or from public directories
such as the phone book.
In addition to the duty to act in good faith, company directors,
officers and "key employees" owe a fiduciary duty to
their employer. These employees may not compete "unfairly"
against their former employer.
A B.C. judge was recently asked to stop two investment portfolio
managers from competing against their former employer. The former
employer claimed that the two employees owed it a fiduciary duty.
The fiduciary duty would prohibit the employees from soliciting
the clients of the former employer. The two employees collectively
managed about $350 million, accounting for 25% of the employer's
assets under management. However, they were simply two of eleven
portfolio managers, without any special status and no supervisory
or executive duties. As a result, the court ruled that they did
not owe fiduciary duties to the employer.
Non-Competition Agreements
To protect its customer base and goodwill, an employer may require
that its employees sign non-competition agreements, which prohibit
competition against the employer after the employment is terminated.
Every non-competition agreement includes a geographic area and
a period of time within which the employee promises not to do
certain things.
When the agreement limits the freedom of the employee to use
his or her skills and expertise after the employment has ended,
the question arises whether the agreement is illegally in restraint
of trade. The courts will hold a non-competition agreement to
be in restraint of trade and therefore unenforceable unless the
employer can prove that:
- it has a legitimate "proprietary interest" (e.g.
goodwill) that deserves protection;
- the agreement is reasonable in terms of geographic area and
duration; and
- the agreement is not otherwise contrary to the public interest
(for example, would upholding the agreement deprive the local
community of the services offered by the ex-employee).
The question for the courts really comes down to this: "Is
the purpose of the agreement to protect the employer's legitimate
trade secrets and customer data, or to simply eliminate competition?"
What is Reasonable?
What is a reasonable geographic area and period of time depends
on the particular circumstances for each agreement. A U.S. judge
recently refused to uphold a non-compete clause that would have
prevented an employee from working for any competitors of the
employer, an internet service provider, for a 12-month period
following termination of employment. The judge ruled that a one-year
restriction was unreasonable, commenting that in the internet
industry, one year "is several generations, if not an eternity."
Judges are less likely to uphold non-competition agreements contained
in employment contracts than those contained in contracts for
the sale of a business, recognizing that the parties to employment
contracts are often not on an equal footing. If an employer requires
a non-competition covenant, an employee often has little choice
in the matter.
Confidentiality Agreements
There is no general restriction on an ex-employee using the skills
and general "know-how" acquired in the course of employment
in future employment. Any agreement imposing such a restriction
would be against public policy and unenforceable. However, the
use of an employer's trade secrets by former employees is restricted.
The distinction between the proper use by former employees of
their skill and general "know-how" and the improper
use of trade secrets can be difficult to make. A confidentiality
agreement can reinforce the restriction against the use of trade
secrets and clarify what type of information is protected.
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