Employment Law: Can You Stop Employees ‘preparing’ To Compete?

The relationship between employer and employee is founded on a continuing bond of trust and confidence. In relation to this, the terms ‘duty of fidelity’ and ‘fiduciary duties’ have arisen in relation to employees and directors respectively. These terms have been around for many years but defining the extent of these duties remains a challenge.

All employees owe a ‘duty of fidelity’ to their employer, requiring them to act in good faith when executing their contractual duties. In addition, directors owe ‘fiduciary duties’, requiring them to positively act in the best interests of the company and, unlike ordinary employees, even disclose their own misdeeds. Directors’ fiduciary duties are distinct from, and go beyond, the duty of fidelity owed by all employees.

In an interesting recent development, two similar cases have provided useful guidance on the scope of these implied duties and the degree to which they may restrict an employee who is preparing to go into competition with his or her employer. The judgments, whilst reaching opposite conclusions on their facts, provide a useful insight into this area of law.

The Sliding Scale

In Shepherds Investments Ltd v Walters, the Court of Appeal indicated that there was sliding scale of behaviour in respect of an employee’s preparations to establish a competing business. The precise point at which such actions become unlawful (i.e. breach the duty of fidelity or a fiduciary duty) will turn on the facts of the particular case. At one end of the scale “merely making a decision to set up a competing business at some point in the future and discussing it with friends and family’ would not constitute a breach. At the other end of the spectrum, “soliciting customers of the company…or the actual carrying on of trade by a competing business’ would be a clear breach of duty. The area in between was left open for future judicial interpretation.

On the facts of this case, directors and senior employees were held to be in breach of their fiduciary duties and obligations of fidelity by promoting their own competing business whilst still employed. Interestingly, the Court was quite prepared to extend the scope of ‘fiduciary duties’ to senior employees who were not formally directors (i.e. employees parading as ‘sales director’ or ‘marketing director’ etc, but who are not registered office holders). It might come as surprise to those concerned that the designation of such a title carries with it the more stringent duties a fiduciary.

The Importance of Drafting

In Helmet Integrated Systems Ltd v Tunnard, the Court of Appeal went one step further, describing a “middle-ranking” senior salesman as a fiduciary on the basis of his activities – it being part of his duties to advise on competition with the employer’s business and the employer being dependent upon him to pass on such information. In essence, therefore, the test for a ‘fiduciary’ is one of function rather than status.

In this case, the employee had taken preparatory steps whilst remaining employed, to market his own safety helmet in competition with his employer. However, despite ruling that the employee owed fiduciary duties, the Court did not accept that these preparatory steps were sufficient to constitute a breach of those duties. According to the Court: “Clear words are needed to restrict the ordinary freedom of an employee who is considering setting up in competition to his former employer” and wish “to assess the viability of the concept”.

Comment

These cases will be welcomed by employers for extending the coverage of fiduciary duties to a broader range of employees. However, the cases also emphasise the importance of clear contractual drafting. Whilst many employers include post-termination restrictive covenant in their standard contracts of employment, a restriction on ‘preparatory acts’ whilst still in employment is far less common.

Should you require assistance in drafting or implementing such restrictions, the Michelmores’ Employment Team will be happy to help.

AND IN OTHER NEWS:

Legislation coming into force in April 2007…

From 1 April:

The basic rate of maternity pay, paternity pay and adoption pay increases to £112.75.

From 6 April:

Statutory sick pay increases to £72.55

The Sex Discrimination Act 1975 is amended to place a statutory duty on all public authorities to eliminate unlawful discrimination and harassment and promote equality of opportunity between men and women.

The Information and Consultation Regulations are extended to cover employers with 100 or more employees

The Flexible Working Regulations are extended to include carers of adults.

And on the horizon…

The Employment Retention Bill had its first reading in the House of Commons on 13th March 2007 and is due to have its second reading on 18th May 2007. The Bill makes provision for a statutory right to rehabilitation leave (disability leave) for newly disabled people and for people whose existing impairments change.

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