Marc is a patent attorney and shareholder of the intellectual-property law firm of Poms, Smith, Lande & Rose in Los Angeles, CA. Marc specializes in computer law and can be contacted at meb@delphi.com.
Competing with your former employer is generally considered part of the American Way. Unfortunately, it also leads to strong feelings of betrayal and sometimes lawsuits. Employers are often angry and want to punish disloyal employees to set an example for others. Win or lose, the lawsuit often drains the employee of the money needed to successfully compete. But pursuing a lawsuit can also be risky for employers, because employees sometimes counter with successful claims of their own.
Consequently, it is best to avoid disputes from the beginning. Let's begin by looking at the legal rights of each party.
Most of the legal restrictions on competition by a former employee are traceable to one of four areas: noncompetition promises, trade secrets, transfers of ownership, and duties of loyalty.
Noncompetition promises. At the beginning of employment, many sign written agreements in which they promise not to compete with their employer after termination of their employment. The agreements typically prohibit us from working for a competitor, consulting for a competitor, or owning or operating a competing business.
In some states, the courts won't enforce these promises at all. Perhaps of greatest importance to the software industry is the state of California, where such agreements are usually unenforceable. Other states enforce the clause, but only if it's "reasonable." The court considers numerous factors, including the length of time during which the employee is prohibited from competing, the geographic areas in which he may not compete, and the scope of the technologies in which he may not compete.
Among states that enforce reasonable restraints on competition, some enforce an unreasonable clause, but only to a reasonable extent. Others enforce the unreasonable promise if it can be made reasonable by striking out words, but not by adding them (the "blue-pencil" rule).
Trade secrets. Trade-secret law does not bar competition; it bars misappropriation of trade secrets owned by a former employer. In practice, this often prevents effective competition.
A vast array of information can be protected by trade-secret law. In addition to technological information, such as flowcharts and algorithms, trade-secret law can protect the identity of customers, suppliers, financing sources, and outside consultants. It can even protect information about the skills and professional interests of other employees in the company--recruiting information a competitor would find useful. To be protected, the trade secret must constitute valuable business information, must be the subject of reasonable efforts to maintain its secrecy, and must, of course, be a secret.
A common obstacle to asserting a trade-secret claim is failure to make reasonable efforts to protect secrecy. Physical security measures are usually necessary. Everyone who comes in contact with the trade secret should be told that it is a trade secret and must be protected. Of particular importance is the need to specifically itemize the trade secrets that must be protected: flowcharts, customer lists, and the like. It is normally insufficient to simply state that all information an employee may come in contact with is a trade secret.
A common approach is to include language in the employment agreement that advises the new employee that he may come in contact with trade-secret information and specifies the categories of that information. The agreement includes a promise to protect the confidentiality of that information and not to use or disclose it, except in connection with his employment. Such a promise substantially increases the chance that a court will find a protectable trade-secret interest. Furthermore, a former employee can be barred from using trade-secret information under certain circumstances, even if he never promised not to.
Transfer of ownership. It's common to require employees to transfer all ownership rights to technology developed during the course of employment to the employer. A typical agreement will require you to assign to your employer all the copyrights, patents, and trade secrets which may arise from any software you develop for your employer. So long as the software relates to the employer's business or your job, this can be required without regard to where or on whose time the software was conceived or developed. It is also reasonable to require you to assign any software conceived or developed using the time or facilities of the employer, without regard to whether the effort is part of the your job or relevant to the employer's business.
These clauses are usually enforced. Although they obviously do not bar competition, they often can effectively prevent it by barring you from using the technology you need to compete.
In some cases, the employer will own copyright, patent, and trade-secret rights, even when you did not expressly promise to transfer these rights. The legal theories that support this generally reflect the common-sense concept that the employer should own that for which he paid.
Duty of loyalty. Employees usually owe a "duty of loyalty" to their employers. Although such a duty rarely bars competition after termination of employment, it often restricts your ability to make plans to compete while you are employed. The duty and associated restrictions are particularly great when you are an officer or director (not merely a shareholder) of the employer. Officers and directors additionally owe employers a "fiduciary duty" (involving confidence or trust).
Carefully review any agreement your employer asks you to sign. If the obligations seem oppressive, unfair, or unacceptable, discuss your concerns with your prospective employer with the goal of making changes.
One effective technique for handling this obviously sensitive problem is to provide the prospective employer with a friendly letter. The letter would thank the employer for the employment offer, specifically identify the problematic clause(s) in the agreement, set forth alternative, acceptable language, and explain very diplomatically why a change is justified. The employment agreement may then be signed, as presented. "Subject to modification(s) set forth in attached letter" should be written above the signature line, and the letter should be attached to the agreement. Keep a copy of all of the documents.
To minimize friction, you might first advise the employer verbally that you have a few concerns with the employment agreement, that you'll provide an outline of them, and that you welcome the opportunity to discuss the matter further.
The employer is usually in a much better position to dictate the terms of the employment agreement. All employers would be wise to have every employee sign an employment agreement containing the types of clauses just discussed, as well as others in clear, specific, reasonable language. However, many employers often use form agreements that do not focus on matters important to the employer's business and are unclear and/or oppressive.
Timing is important. An agreement is most likely to be enforced when you are asked to sign it before you terminate your prior position. But many companies present the agreement to you on the very first day of employment, after you've already quit your old job and, in many instances, moved your family. At this point, your "consent" is often no longer voluntary and might be set aside on this ground.
Sometimes, an employer will ask you to sign a new employment agreement in the middle of the employment. Typically, this occurs because the employer has just experienced a problem (perhaps with a departing employee) that he hopes to alleviate in the future. Unless handled properly, such an interim change may not be enforced.
The best way to ensure enforceability of a revised agreement is to include it in a package along with a raise, an increase in benefits, a promotion or some other type of additional benefit. You should be given the option of not signing the agreement and retaining your present position. If you accept the added benefit and sign the agreement, the likelihood of it being enforced is enhanced substantially.
One last suggestion: If the employee requests changes in an employment agreement before signing it, the employer should proceed cautiously. Although the change may seem minor, the employer should carefully consider its effect if the employee's commitment to his new job turns out to be less than the employer expects.
It is dangerous to plan to compete with an employer while employed by him, particularly if you are an officer or director--an employee who owes the employer a fiduciary duty.
During the course of employment, you should not design software which you intend to use in competition with your employer. Even designing it at home is not always safe. You also should not be recruiting other employees, customers, or suppliers.
The employer should give prompt, serious attention to news of an employee looking for another job or making plans to compete. If such actions are likely to be harmful to the employer, the employer would be wise to immediately consult a lawyer. The legal intricacies of the situation might make it dangerous for the employer to fashion and execute a protective plan without the guidance of counsel.
Employers risk losing the protection of their employment agreement if they fire employees and if the act of firing constitutes a breach of the employment agreement. If there is any doubt, an attorney should be consulted.
If employment is going to be terminated, the employer should consider removing the employee from all further contact with sensitive business information. This does not mean evicting the employee from the premises, but merely transferring his responsibilities to areas that do not involve sensitive business information. The employer should retrieve any sensitive information provided to the employee.
An exit interview should be conducted. If possible and with the utmost diplomacy, the employer should confirm the employee's understanding, if true, that he was not fired and is not quitting because of any breach by the employer of an obligation or because of any type of duress. It would also be beneficial to obtain the name of any new employer. The employee should also be reminded of his obligations under his employment agreement after termination of employment and provided with a copy of his employment agreement with all post-termination obligations underlined.
It might be useful to have the employee sign a document stating that he has been told all of the foregoing and that he has not been fired and is not quitting because of any employer breach or duress.
Obviously, this may not be possible; if not, let it go. Under no circumstances should employees be threatened or otherwise coerced into signing any document. It is of the utmost importance that the interview be as friendly as possible. The employee should be thanked for the efforts made for the employer, and regrets should be expressed about the departure. Any wages owed should be paid immediately.
Departing employees should be extremely careful not to remove any drawings, listings, equipment, data, and so on. To reduce doubt, the employee might ask his supervisor to examine the materials he is removing from his office to ensure that he has not mistakenly taken something he should not.
The employee should politely decline to sign any documents during an exit interview. One diplomatic way to handle this is to explain to the interviewer that this is a very emotional day for the employee and that he would prefer to take the papers home to consider during a more thoughtful and reflective moment. As with the employer, it is also very much in the employee's interest to maintain a good relationship with the former employer.
If the employee has reason to believe that he may be sued if he works for a particular new employer, the employee should consider asking the new employer to indemnify him against any such lawsuit. Without such a promise in writing, the employee might be wise not to accept that new employment.
If the employee is planning to begin a competing business, he should at least purchase a Commercial General Liability insurance policy. In the event of a lawsuit, that policy might fund all or some of the expense of a defense to the lawsuit. Be advised, however, that the standard Commercial General Liability policy often will not cover a lawsuit by a former employer. Again, a lawyer should be consulted when in doubt.
The new employer also needs to act cautiously. Although he is certainly entitled to interview job applicants, it is dangerous to directly solicit employees from a competitor. After hiring a competitor's employee, it is particularly dangerous to allow that new employee to solicit his former associates.
The new employer should also question whether the prospective employee is contractually restricted from accepting the new employment, whether he has been exposed to what the former employer might regard as trade secrets, and what promises he has made in connection with these trade secrets. As a condition of employment, the new employee should be asked to sign a statement indicating that his current employment is not a breach of any prior agreement and that his new employer has not objected to the new employment. It should also state that he has not had access to any trade-secret information or, if he has, that he has not told and will not tell the new employer about it and will not use any of this information in his new employment.
Needless to say, you should not use any information your former employer might regard as a trade secret. Failure to adhere to this rule is one of the most common causes of a lawsuit.
The former employer should send a follow-up letter to the former employee, particularly if the employee did not sign an exit statement. The letter should enclose a copy of any agreement the former employee signed, with important language underlined. The letter should remind the employee of his continuing obligations in a polite, professional manner devoid of any threatening language.
The former employer may also wish to communicate directly with the new employer. This should be considered only if the new employer is a competitor and if the former employee was exposed to information which the former employer has a credible basis for claiming is protectable as a trade secret. Such a communication must be carefully crafted to avoid any allegation of wrongdoing. It should politely point out to the new employer the fact that the former employee was exposed to trade-secret information, and it should specifically describe the categories of that information. The new employer should be thanked for his anticipated cooperation in making sure that the new employer does not obtain or use this information in any way. This communication should only be in writing.
The potential benefit of this communication should also be carefully weighted against its risk. Although the former employer may believe that much of the information discussed in his letter is legally entitled to trade-secret protection, he may be wrong. If he is, he may be charged with having unfairly interfered with the new employment relationship.
A lawsuit against a former employee is dangerous for the former employer. As a practical matter, such a lawsuit usually achieves its goal--to prevent competition--without regard to its merit. For a former employee who is competing on his own, the lawsuit often drains the former employee of the money he needs for his new business. If the former employee is working for a competitor, the lawsuit often strains his relationship with the new employer and makes the new employer more cautious about promoting him.
As a consequence of this foreseeable (and often intended) damage, a former employer who pursues a lawsuit found to lack merit is exposed to a broad variety of counterclaims: malicious prosecution, abuse of process, interference with perspective business relationships, and violation of the antitrust laws.
The former employer should also be cautious about the the lawsuit and statements he publishes about his former employee. To avoid claims of liable, slander, and disparagement, the former employer should circulate a memo to all personnel directing them not to discuss the lawsuit or the former employee with anyone, including customers and competitors.
In framing the lawsuit, the former employer can usually assert a broad variety of claims, some of which are more likely to be covered by insurance than others. To avoid fighting an insurance company in addition to the former employee, the former employer may prefer to omit those claims likely to be covered by insurance.
Employees should also understand that competing with a former employer is inherently dangerous from a legal perspective. As a practical matter, a lawsuit by a former employer can severely damage a new business. Not only does it drain needed capital, but it can sour efforts to develop customer confidence. Even when the employee feels confident that he can weather the storm, the outcome of such lawsuits are often difficult to predict.
The new employer is also subject to a lawsuit. Among the claims the former employer can assert against the new employer are: inducing the former employee to breach his employment contract with the former employer, misappropriation of trade secrets, and unfair competition.
Leaving a job and competing with a former employer is like getting a divorce to marry another--it often creates an emotionally charged situation that can lead to explosive results. The most important goal when terminating employment should be to leave a positive relationship behind. To do this, both the employer and employee must sacrifice and compromise. Neither should ever try to obtain every conceivable benefit to which they feel entitled.
Former employers should not overreact. Often, dangerous lawsuits against former employees are filed based merely on suspicion and rumor. Immediate and decisive action may be needed under certain circumstances; however, care, caution, and deliberation are the best ways to avoid a serious lawsuit in retaliation.
Each side may feel confident in the merit of its position, but the appearance of unreasonableness often turns out to be more important than any legal principal or right. Don't be the party who "looks bad." Act carefully and only after reflection. When in doubt, seek legal advise first.
Copyright © 1995, Dr. Dobb's Journal