Competition, Customers and Confidential Information

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:

  1. it has a legitimate “proprietary interest” (e.g. goodwill) that deserves protection;
  2. the agreement is reasonable in terms of geographic area and duration; and
  3. 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.