Part 1 – Fair Competition Series

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Branching out on your own? Consider your legal duty to loyalty first.

Reprinted with permission of Upstate Business Journal

In the 1880s, Thomas Edison hired a young Serbian, Nikola Tesla. Edison was developing his direct current (DC) system for power distribution, a revolutionary concept that allowed high voltages of electricity to be transmitted from the generation source to distant communities. Tesla believed he could develop a better method known as alternating current (AC).

While employed by Edison, Tesla developed the AC technology and, after a falling out with Edison, took the technology with him, sold it for $1,000,000 to George Westinghouse, and assisted Westinghouse in competing with Edison in the market for power distribution. Tesla and Westinghouse won, and AC has supplied power to homes and businesses for well over a century.

A Tesla-like success story would never happen today. In order to be hired, Tesla would have to agree to sign voluminous invention, trade secret agreements and restrictive covenants. As soon as Tesla’s employment ended, his employer would threaten to sue him if he violated the boilerplate (and often vague) agreements. If Tesla competed, he and his employer would become embroiled in costly and lengthy litigation.

Protecting rights on both sides

The legal issues related to employees competing with current and former employers are multifaceted. The law attempts to balance the legitimate rights of each party, but it rarely resolves cases quickly or provides parties with clear guidance at the outset. Employers certainly have a reasonable expectation that their legitimate trade secrets will not be stolen, or that employees will not undermine them while employed. Employees, on the other hand, have a legitimate right to pursue their chosen profession or trade. These interests often are difficult for courts to balance and ensuing litigation can be expensive and draining for all parties involved.

This three-part series will explore the basic legal principles involved in employee competition in South Carolina. It will provide practical steps both business owners and employees can take to protect their respective interests and improve their ability to prevail in court, if necessary. In this segment, we will explore the common-law duty of loyalty that governs what employees may and may not do while still employed.

No clear lines of competition

South Carolina law recognizes that, while employed, an employee owes his employer a duty of loyalty. The main cases defining this duty arise in the context of an employee competing directly while employed. In simple terms, the duty of loyalty prevents an employee from engaging in actual competition with his or her current employer.

During employment, employees may take certain preparatory steps to start a new business without breaching the duty of loyalty. The courts have recognized such steps to include forming a new entity, leasing space, and obtaining letterhead and cards. The key is that they may not actually compete. This would include, for example, intimating to a customer that the employee will get it a better deal if it can just “wait a couple weeks until I make my move.”

Context matters greatly in these cases and what may be permissible in one case can still bog litigants down in factual disputes. For example, some courts have stated that it is not a breach of the duty of loyalty for an employee to merely notify customers that he is leaving employment and relate his future whereabouts. However, soliciting business for a future employer, while still employed, is a breach.

The lines are rarely clear and while an employee may argue that no real solicitation occurred during a certain conversation, an angry employer is unlikely to accept that assertion at face value. At times, the only way to resolve such disputes is to involve the customer, and customers often hate to be dragged into such disputes.

Intent matters

A judge will sometimes view the scope of the duty of loyalty differently depending on the employee involved. An hourly employee looking to ply his trade, for example, is likely to be viewed very differently from a high-ranking manager. This is simply a practical application of the principle that individuals higher up in the ranks have a greater opportunity to cause real harm than do, for example, tradespeople simply seeking a better wage.

As a practical matter, courts also look at the employee’s actions during employment, as well as actions taken after employment ended, to ascertain intent. Many judges seek to determine whether the departing employee’s actions were calculated to harm the employer, or whether the departing employee was merely exercising his right to work in a chosen field.

The duty of loyalty ends when employment terminates. After the employee and employer part ways, the employee is generally free to compete directly with the employer. There are two common restrictions on this right. The first is contractual restrictive covenants (commonly referred to as “covenants not to compete” and “non-solicit agreements”). The second is the protection the law provides for trade secrets even in the absence of a written agreement. Both of these topics will be discussed in our next segment.

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