When hiring employees of a competitor, you should take care to minimize the risk of that competitor suing your organization, and your newly hired employees. A little foresight can help avoid a long and costly lawsuit.
When hiring from the competition, there are no less than three grounds upon which your competitor can base a potential lawsuit.
1) Breach of a Written Covenant
When your organization hires one of your competitor’s employees, it can be sued by that competitor if the competitor had a restrictive covenant with its former employee prohibiting that employee from either (i) engaging in competitive work; or (ii) soliciting its own former clients; or (iii) disclosing any allegedly confidential information to competitors.
If such covenants exist, then both you and your new employee may be held jointly liable for any resulting damages suffered by your competitor in the event that these clauses are breached. In the event of such a breach, your competitor could also be successful in obtaining an interim injunction preventing you from using its former employee in a way that is useful to your company. As a result, you could find yourself not only having to pay a large sum of money in damages and legal fees, but also with a new employee who is effectively unable to perform the job that you hired them to do.
Not all restrictive covenants are legally binding. If a court can be persuaded that the restrictive covenant is “unreasonable,” in that it goes further than what is strictly necessary to protect your competitor’s legitimate proprietary rights, the court will refuse to enforce the covenant.
Due to the reluctance of courts to restrict an individual’s ability to earn a living, restrictive covenants are presumptively unenforceable. For that presumption to be rebutted, a court must be persuaded that the restrictive covenant is the least restrictive means of protecting the competitor’s essential proprietary interests. For example, in assessing whether a 12-month non-competition covenant is enforceable, a court will consider whether a shorter non-competition covenant, of only 6-months duration, or a less restrictive covenant merely prohibiting solicitation of clients, would have been sufficient to protect the former employer’s proprietary interests.
If the court determines that such lesser restrictions would have been sufficient, it will not simply reduce the duration of the restriction from 12 to 6 months. Rather it will invalidate the entire covenant, thereby leaving the employee completely free to compete against their former employer.
The question of whether a particular restrictive covenant is so “unreasonable” as to be legally invalid is not easily answered. A court will look at the wording and scope of the covenant and the nature of your competitor’s proprietary interest before jumping to the conclusion that the covenant is invalid and thereby excusing your company’s defiance of the covenant.
A serious error frequently made by employers is to assume that the restrictive covenant, in the employment contract of a prospective employee, is “unreasonable”, and therefore unenforceable, simply because it prohibits that former employee from competing in a large geographic area for several years. In many cases, the “unreasonable” nature of the covenant depends less on its geographic scope or duration than on the nature of the former employer’s business. For example, in the case of IRIS The Visual Group Western Canada Inc. v Park the court took no issue with a relatively long, 3 year, prohibition against competing within a wide radius of the former employer’s place of business. The Court nonetheless struck down the restrictive covenant as “unreasonable” because the activities that it prohibited went well beyond what was necessary for the protection of the former employer’s proprietary interests. The Court found that the covenant was legally unenforceable because it purported to prohibit the employee from performing services that she had never, in fact, ever performed for her employer.
2) Breach of Fiduciary Duty
Former employees who have a fiduciary relationship with their former employer are prohibited from unfairly competing against that former employer after they leave their employment, even in the absence of a valid restrictive covenant. Employees who have a fiduciary relationship with their former employer are prohibited from (i) unfairly competing against their former employer, (ii) soliciting the former employer’s customers, (iii) disclosing their former employer’s confidential information, and (iv) taking advantage of any “ripening business opportunity” which they may have learned about while working with their former employer.
Accordingly, fiduciary employees who resign for the purpose of joining a competitor, and competing against their former employer, may be found to be in breach of their fiduciary duties owed to that employer. If so, both the employee and the new employer who just hired them may be liable to the former employer for any resulting damages.
Managerial employees, directors and officers are considered fiduciaries who continue to owe special duties to their employers, often long after their employment has ended. Put another way, these key fiduciary employees are those whose future competition could seriously damage the employer’s business.
In attempting to ascertain whether prospective employees are fiduciaries of their former employer, whose hiring may make your company a party to a breach of fiduciary duty, courts will look not so much at the official description or title of their former position as at their job duties and responsibilities. All too often, companies fall into the trap of assuming that simply because a prospective employee holds a junior position with a competitor, they cannot be a fiduciary. On the contrary, courts have held that even junior salespeople, who exercise no managerial functions, can be fiduciaries, and have severely penalized their new employers for breaching the fiduciary duties owed to their former employer.
Courts throughout Canada have held that very low-ranking employees who exercise a certain degree of independent discretion and autonomy in their day-to-day dealings with their employer’s customers, and who develop a close relationship with those customers, may in fact be bound by a fiduciary duty not to solicit those customers. In addition, even where junior employees are not themselves fiduciaries, a court may nevertheless impose fiduciary duties on them if the court finds that they are competing against their former employer in concert with another former employee, who is senior to them, and who is a fiduciary.
3) Breach of Confidentiality
Even where employees have not signed a valid restrictive covenant, and were not in a fiduciary relationship to their former employer, they may still be found liable to their former employer if, when they left their former position, they took with them confidential information which they then use in their new role with your company. If this happens, your company will become jointly liable in damages to the employee’s former employer for damages it may have suffered as a result of your use of such confidential information.
As a general rule, employees will be found guilty of breaching their duty of confidentiality if they divulge trade secrets or copy client lists, but not where they use the skills and general knowledge that they have acquired over the course of their former employment, even for the purpose of competing with their former employer. Courts have ruled that even where the employees do not take any written corporate document but instead deliberately memorize it prior to leaving, they are still in breach of their duty of confidentiality. Courts have also ruled that employees may be in breach of that duty of confidentiality where they gain knowledge about technical production processes which they then use in their new employment with your company.
Some courts now distinguish between (i) specific trade secrets and (ii) information, which although originally confidential when it was imparted to the employees by their former employer, cannot easily be separated from the knowledge that they acquired during the course of their employment with their former employer. Courts will generally be reluctant to grant an injunction to prevent disclosure of this latter category unless the employee has signed a restrictive covenant acknowledging that the information was confidential and promising not to divulge it to any future employer.
The law of restrictive covenants, fiduciary duties and confidentiality is complex and, on some issues, still obscure. It is never possible to entirely eliminate the risk of a successful lawsuit against your company by a competitor on any of these three grounds.
Before hiring new employees from a competitor, you may wish to take the following precautions, aimed at reducing the risk of a successful lawsuit against your company:
- Ask the prospective employees whether they are subject to any restrictive covenants with their former employer (and if so to produce those covenants for your careful review);
- Instruct the prospective employees to return, prior to resigning, all documents and client lists, belonging to their former employer;
- Ensure that your own employment contract with prospective employees provides you with the right to terminate their employment if ever they are later found to have breached any restrictive covenants or fiduciary duties owing to their former employer;
- Ensure that no prospective employee resigns in concert with other employees for the purpose of joining your company; and
- In appropriate cases, ask the prospective employees to secure their former employer’s written consent that their new position with your company would not breach any of their ongoing legal obligations to that former employer.
If your company is considering hiring an employee away from a competitor, whom you fear might owe ongoing legal duties to that competitor, you may wish to contact the employment lawyers at Soloway Wright LLP to ensure that you are not inadvertently courting an expensive lawsuit by breaching a legal obligation that your newly hired employee owes to their former employer.