Is a director or employee thinking of leaving your business to go into competition?

February 2012

This recent High Court case clarified the position where a director or senior employee without restrictive covenants in his contract is planning to leave his company and to set up or go to work for a competing business.

Background

Most contracts provide that the employee has a duty of fidelity to the company, and include a duty not to compete with the employer after the employment has ended. These can be enforceable by the company if they do not go beyond what the company is legitimately entitled to protect itself against, when balanced against the need for an employee to be able to get a job and to be able to use his ‘tools of trade’, such as specialist skills, to do so. This can be quite a hard balance to strike, particularly without the benefit of hindsight, and an employer has to be very careful with its drafting as the courts tend to veer on the side of the employee.

Restrictive covenants in other circumstances, such as when a business owner sells his business for a decent sum and agrees with the buyer that he will not compete with it, are much easier to enforce.

If an employee does not have restrictive covenants, the company can only rely on any fiduciary duties an employee may have. But fiduciary duties are only owed where there is a relationship of trust and confidence. This is automatically the case for directors (and there are a whole lot of statutory duties which a director also owes), and can be the case for senior employees who are very important to the business and who the employer relies on in a big way.

Customer Systems plc v Ranson

In this case a senior employee of CS set up his own company in competition. His contract did not have fidelity obligations/restrictive covenants. Before he left he approached CS’ customers, he emailed contact numbers for clients and various important documents from CS’ IT system to himself, and he discussed with other employees about them joining his new business.

The court held that he was entitled to set up his own business and not inform CS about this, but shouldn’t have done all these things while he was still an employee.

The best practical advice for an employer is to ensure there are well-worded restrictions in employees’ service contracts.

Question: what should you do if you are a shareholder and director in a joint venture company but you’re not happy and want to leave? There may be a shareholders agreement which includes restrictive covenants, as well as provisions relating to the other shareholders being able to buy the resigning shareholders’ shares and provisions requiring a departing shareholder to resign as a director. But quite often there is no shareholders agreement, and a minority shareholder walks away from the company but is left with shares in it. He is then in a quandary because if he doesn’t resign as a director he will continue to have all sorts of duties to the company, including a duty not to compete with the company (as well as duties which put him at risk of personal liability if the company later goes out of business). But on the other hand if he does not remain as a director he may find it very difficult to find out what is going on in the company and to protect the value of his remaining interest in the company.