OBLIGATIONS AND RIGHTS OF AN INDIVIDUAL
COMPETING WITH AN EX-EMPLOYER

by
Sheldon Mak Rose & Anderson

INTRODUCTION Several different issues regarding the rights of an individual and the rights of an ex-employer arise when that individual changes from an employee to a competitor. Generally speaking, an individual cannot be restricted from practicing his profession or utilizing his expertise in his field of endeavor. On the other hand, an ex-employer has a right to protect his trade secrets and to restrain that ex-employee from using those trade secrets in any manner not approved by or consented to by the ex-employer. The key issues revolve around whether or not the ex-employer's "trade secrets" are in fact secret and subject to protection or whether the ex-employee, as a result of a special relationship with his employer, may be restricted from practicing his profession in a certain area or with certain customers or whether the expertise of the individual is in fact the protectable trade secret of the ex-employer. COVENANTS NOT TO COMPETE The Business and Professions Code  16600 states that "every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void" unless that covenant falls within a specified statutory exception. These exemptions include: a sale of goodwill of a business by a person who agrees not to compete, a sale or other disposition of the party's shares in a corporation, the sale of all or substantially all of the operating assets and goodwill of a corporation, the dissolution of a partnership. In such case, a covenant not to compete in areas where the prior business is carried on is permitted. However, the California courts do not look favorably on covenants not to compete and the court will strictly construe the covenants against the employer and in favor of the ex-employee. TRADE SECRETS Misappropriation of trade secrets or the unauthorized use of a trade secret is a criminal act under the California Penal Code. Further, any party inducing, bribing or rewarding ex agents, employees or servants of a trade secret holder to turn over or reveal those trade secrets is subject to criminal sanctions. Elements of a Trade Secret The definition of a trade secret is set forth in  3426.1(d) of the California Commercial Code. "A trade secret is information, including a formula, pattern, compilation, program, device, method, technique, or process, that: Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy." A trade secret may therefore be any of a long listing of information which is critical to the trade secret owner in maintaining or improving his position in the marketplace. It may include: technical information, drawings, procedures and processing details necessary to prepare a product, purchasing information critical to the manufacturing, function or cost of a product, testing parameters which allow the owner to assure that his product is better than or functions differently from his competition, sales information regarding customers and the customers' desires, preferences, purchasing volumes and like information, marketing plans for introduction of new products, entry into new marketplaces, or proposed new uses, personnel data regarding key or unique capabilities of specific individuals necessary or critical to the operation of the company, or a broad range of other factors which allow one company in the marketplace to distinguish its products or services from those of its competition. It is critical, however, that this information believed and represented to be a secret is in fact kept secret and that reasonable procedures be implemented and enforced to maintain the information as a secret. Formulas or procedures published in journal articles or patents, manufacturing processes well known to the industry, readily determinable by anyone competing in the industry or shown to parties freely without the benefit of a confidentiality agreement, marketing plans or sales records which are not safe guarded or customer lists which can be readily ascertained and generated from public records can be used by any party including ex-employees. In a nut shell, if the information is not kept secret or it is in the public domain by the acts of other parties, it is not protectable as a trade secret and the ex-employee would be free to use the public domain information. UNFAIR COMPETITION Even though the covenant not to compete may be void, some other restrictions placed on an ex-employee may be enforceable. Particular care must be taken not to breach a confidential relationship previously established, to violate a fiduciary duty to the prior employer or to interfere with prospective economic advantage or business or contractual relationships. For example, while a covenant not to compete may not be enforceable, solicitation of prior customers along with other acts of "unfair competition" may be actionable. Merely informing customers of a change in employment does not constitute solicitation and an ex-employee is free to discuss business at the invitation of that customer. The general rule in the absence of a prior valid non-solicitation agreement is that contact with a former employer's customers is not unfair competition if it is conducted fairly and legally. However, if the contact is made easier and more effective by the use of that prior employer's customer list and it can be shown that that customer list has been properly protected as a trade secret, then there is impropriety in that solicitation. On the other hand, if that customer list is not a trade secret or the list of customers is readily derived from the public records, then nothing improper would appear to exist. Questions of unfair competition can be very fact specific and should be carefully reviewed as there can be a broad gray area between proper and improper conduct. The use of a customer list which is a trade secret may be enjoined even if it results in a restraint on competition. On the other hand, if there is nothing confidential about the customer list, a covenant not to solicit these customers will be held to be invalid. In between these extremes, there is a gray area where the court may find that some information is not a trade secret but is confidential and some reasonable restraint may be placed on the ex-employer from using that confidential information. COMPETITIVE EMPLOYMENT Threats Of Ex-Employer A former employer may not prevent or threaten to prevent an ex-employee from accepting employment with a competitor. The "interests of the employee in his own mobility and betterment are indeed paramount to the competitive business interests of the employers." (Diodes, Inc. v. Frazen, 260 CA2d 244 (1981). The mere employment of an ex-employee by a competitor does not mean that the employee will violate any agreements or obligations regarding the confidentiality of trade secrets and the courts will not prevent that individual from obtaining a position where he can utilize his training and expertise. Additionally, unless unfair and deceptive business practices are utilized and there is a clear intent on the part of the ne employer to "destroy" the competitor rather than to hire effective employees, that the employer is free to solicit competitor's employees. Again, a gray area exists if an employer hires a significant number of a competitor's employees and these employees leave in mass, the intention being to render the competitor incapable of functioning, liability from unfair competition may result. Actions Prior To Leaving Employer Certain actions which an employee may take prior to leaving employment may expose that individual to claim of unfair competition. These actions can be considered a breach of an implied obligation or fiduciary duty to the first employer. An individual while still employed by his first employer, should not solicit fellow employees to leave that company and join the competitor along with him. Also, for example, it would be improper for the individual to set up and operate a competing business while still employed; however, an employee may be allowed within limits to take steps to set up the competing business prior to termination of employment. For example, that employee may set up a business to become effective upon termination but he should not solicit customers or fellow employees prior to termination. Acceptable actions have included preparing written announcements, leasing premises or forming a corporation. However, on the other hand, an employee was found to have breached his duty of loyalty to his employer by assisting third parties in obtaining financing for a corporation which the employee intended to join upon resignation. Corporate owners or partners in a partnership can be held to a higher standard in that preparation and concealment of competitive plans may be an actual breach of their fiduciary duty to the corporation or partnership. There is an implied covenant of good faith and fair dealing which requires fiduciaries to deal fairly with one another and to refrain from conduct which will injure the rights of other parties involved in the business organization. Broadly speaking, an employee cannot compete with his employer while still employed but he can take steps preparatory to competing with the employer. Further, he can discuss his plans with customers and co-employees but he cannot solicit employees or customers while still employed. However, one must recognize that it may be difficult to distinguish between "discussion" and "solicitation" or "preparation" and "competition." As the court in Bankcroft-Whitney Co. stated who "no ironclad rules as to the type of conduct which is permissible can be stated since the spectrum of activities in this regard is as broad as the ingenuity of man itself." The specific facts of the situation will definitely affect the outcome of any litigation regarding these matters and the courts may very well be swayed by the specific actions and demeanor of all the parties involved. KNOWLEDGE OF THE INDIVIDUAL Labor Code  2860 states that "everything which an employee acquires by virtue of its employment, except the compensation which is due to him from his employer belongs to the employer whether acquired lawfully or unlawfully or during or after the expiration of the term of his employment." While this language appears to be quite broad courts have found that this language applies only to property belonging to the employer. Special skills and knowledge (which is not a trade secret of the employer) acquired by the employee during the course of employment is not property and does not belong to the employer and the employer cannot prevent the employee from using these acquired skills later when employed by another. CONCLUSION An individual is free to change employment and to work for competitors or to start a business directly in competition with his previous employer. However, no use should be made of the previous employer's trade secrets. Additionally, extreme care should be taken regarding preparations to compete which are undertaken while still employed by the former employer.