United States: Employee Exits: Preparations To Compete Despite Fiduciary Duties

Introduction

The dissolution of an employment relationship can provoke conflict, uncertainty, and stress. The stress can be heightened when the departing employee is likely to compete with the former employer, using knowledge and skill learned during the employment. This article addresses the legal framework that applies when at-will employees who are not subject to contractual restrictions exit an employment relationship and compete with their former employer.

Legal Duties of Employees: Agents as Fiduciaries

Employees owe legal duties to their employers. Kinzbach Tool Co. v. Corbett-Wallace Corp., 160 S.W.2d 509 (Tex. 1942). These duties result from the principal-agent relationship and arise from the law of agency. Id. This relationship imbues on the employee a duty to act primarily for the benefit of the employer in matters related to the agency. Johnson v. Brewer Pritchard, P.C., 73 S.W.3d 193, 200 (Tex. 2000). Essentially, within the scope of an employee's agency relationship, an employee owes fiduciary duties to an employer. Abetter Trucking Co. v. Arizpe, 113 S.W.3d 503, 509 (Tex.App.-Houston [1st Dist.] 2003, no pet.) (citing Johnson at 200 (Tex. 2000)).

However, these duties generally do not survive termination of the employment relationship. "An employee may use his general knowledge, skill, and experience acquired in the former employment to compete." Arizpe, 113 S.W.3d at 512 (citing Johnston v. American Speedreading Acad., Inc., 526 S.W.2d 163, 166 (Tex.Civ.App.-Dallas 1975, no writ)); see also Sands v. Estate of Buys, 160 S.W.3d 684, 687 (Tex.App.-Fort Worth 2005, no pet.); Rugen v. Interactive Bus. Sys., Inc., 864 S.W.2d 548, 551 (Tex.App.-Dallas 1993, no writ); Am. Derringer Corp. v. Bond, 924 S.W.2d 773, 777 (Tex.App.-Waco 1996, no writ). Consequently, employees are entitled to compete with their former employers unless the employer and employee restrict the employee's future conduct by way of a covenant not to compete. Texas courts have described this right to resign and compete against a former employer as a constitutional right. See Ledel v. Bill Hames Shows, Inc., 367 S.W.2d 182, 184 (Tex.Civ.App.-Fort Worth 1963, no writ).

Notwithstanding the right to compete and the termination of agency duties with the employment relationship, when the post-employment competitive activity is linked to the breach of a fiduciary duty that existed during the employment relationship, former employers can seek legal redress. Companies have successfully sued former employees for various disloyal activities during their employment including the following conduct:

• Soliciting business from customers while still employed;
• Soliciting the departure of other employees while still employed;
• Using trade secrets or confidential or proprietary information in a manner adverse to the employer;
• Carrying away trade secrets or confidential information such as customer lists;
• Having an undisclosed financial incentive in an employer transaction;
• Appropriating trade secrets or confidential or proprietary information;
• Appropriating business opportunities of the employer; and
• Appropriating resources of the employer to an extent that leaves it unable to operate.

However, courts must balance an employer's right to loyalty with other interests, including society's legitimate interest in competition. Arizpe, 113 S.W.3d at 510 (citing Johnson, 73 S.W.3d at 201). Accordingly, courts have avoided an all-encompassing employee fiduciary duty by being careful in "defining the scope of the fiduciary obligations an employee owes when acting as the employer's agent in the pursuit of business opportunities [...]" Id. This balance reflects a tension in judicial decision-making that arises from two conflicting public policies: protecting business from unfair competition and fostering a free market. Arizpe, 113 S.W.3d, 510-511 (citing Metal Lubricants Co. v. Engineered Lubricants Co., 411 F.2d 426, 429 (8th Cir. 1969)). As eloquently stated by the Missouri Supreme Court and echoed by the Eight Circuit in Metal Lubricants Co. and the Texas First Court of Appeals in Arzipe, if protection from potentially unfair competition were taken to its extreme, "it would deprive a man of his right to earn a living[.]" Arizpe, 113 S.W.3d, 510-511; Metal Lubricants Co., 411 F.2d 426, 429 (8th Cir. 1969). And, conversely, if free market concerns were allowed to prevail unchecked, they "would probably make a mockery of the fiduciary concept, with its concomitants of loyalty and fair play." Id. For these reasons, exiting employees would be ill advised to disregard the legitimate interests of their employers—but there are pre-exit activities for which courts should not subject employees to liability.

Thus, despite having fiduciary duties, employees are not prevented by law from taking steps to prepare for a future competing business venture. Texas courts have expressly held that there is "nothing legally wrong in engaging in such competition or in preparing to compete before the employment terminates." Arizpe, 113 S.W.3d 510 (citing M P I Inc. v. Dupre, 596 S.W.2d 251, 254 (Tex.Civ.App.-Fort Worth 1980, writ refd n.r.e.). For instance, Texas courts have held that existing employees may lawfully take the following preparatory conduct (in the absence of a countervailing contractual commitment):

• Planning to compete with the employer with no obligation to disclose the plans to the employer;
• Vaguely or hypothetically discussing the potential of doing business with a customer of the employer (as long as the finder-of-fact believes the employee acted in employers' best interest in dealing with the customer, that the employee did not solicit the customer, and that the employee disclosed sufficient information);
• Establishing a business entity for the purpose of competing; and
• Obtaining permits and insurance policies.

Notwithstanding the "right to prepare to compete," if preparatory conduct is "too significant," it may give rise to a cause of action for breach of fiduciary duty. Arizpe, 113 S.W.3d at 510 (citing Herider Farms-El Paso, Inc. v. Criswell, 519 S.W.2d 473, 476 (Tex.Civ.App.-El Paso 1975, writ ref'd n.r.e.); Augat, Inc. v. Aegis, Inc., 565 N.E.2d 415, 419 (Mass. 1991)).

It is relatively easy to imagine hypothetical situations in which employers could exert pressure on departing, competing employees by creatively pleading that a departing employee's permissible preparatory conduct became "too significant" and crossed a line into breach territory. Similarly, exiting employees can minimize conduct that breached a fiduciary duty characterizing the activity as merely preparatory. Certain preparations will be clearly within a range of permissible or impermissible conduct. Many other actions will fall within a grey area.

On that basis, judicially determining whether any specific conduct in preparation to compete constitutes the breach of a fiduciary duty involves a framework requiring ad hoc decision-making. In sum, existing background law protects a wide array of conduct in preparation to compete upon leaving an employment, but the lack of legal certainty on "grey area conduct" may favor parties who are willing and able to use litigation with a former employee (or employer) as part of their competitive strategy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.