Part 3 – Fair Competition Series

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Protect the Knowledge of Key Personnel

Reprinted with permission of Upstate Business Journal

In parts one and two of this series, we discussed the typical issues arising with employees who compete with former employers. Greenville’s growing reputation in the “knowledge economy” also has resulted in the growth of another type of dispute. A company’s true value may not be based as much on a brand or capital equipment as it is on the knowledge of key personnel. Their departure or efforts to work outside the organization raise additional legal questions.

Fiduciary duty and owner/equity issues

Greenville is home to many startups and spinoff companies. As such, it also is becoming the center of substantial litigation over what key persons may do when striking out on their own. Greenville was one of the first counties in South Carolina to have a special Business Court, which regularly deals with such issues.

When the person departing a business is an owner, officer or director of the company, a number of additional issues can arise. First, equity owners often have signed some form of operating agreement or shareholder agreement. Many of these contain restrictive covenants or provisions that affect his or her ability to compete.

Second, such individuals also may have additional duties if they are deemed to be fiduciaries of the business. Whether someone is a fiduciary is often a contested and complex issue. An individual may be a fiduciary for some purposes (e.g., handling money), but not for all purposes. The level of duty owed also may vary depending on the status of the organization. Fiduciary duties are powerful, however, because they not only govern actions, they also create obligations to disclose material information, including business opportunities.

Third, South Carolina law also imposes duties by statute on key people. The South Carolina Corporations Act, for example, requires that officers and directors discharge their duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner he reasonably believes to be in the best interests of the corporation and its shareholders. In limited liability companies (LLCs), the duty a member owes differs depending on whether the company is member-managed or manager-managed. In a member-managed company, the duties are more limited than in a corporation, but they do include the duty to refrain from competing with the company in the conduct of the company’s business.

When an owner engages in transactions that benefit him or her in a manner more favorable than other owners, it often raises an issue of “self dealing.” Departing fiduciaries who compete may face claims of “usurping a corporate opportunity.” This claim requires a company to show that an actual opportunity for the organization existed that is within its line of business and that the business could have undertaken, but the individual improperly took the opportunity for himself or herself. Both of these claims also implicate the related fiduciary duty to disclose material information.

Practical steps and avoiding common mistakes

After the employer or employee understands the basic legal issues involved in anticipated or actual competition, the second practical step is to plan carefully. From the employer perspective, it is important to know how to prevent improper competition or to stop it if it already has occurred. The employee needs a plan to transition to a new business or employer while limiting exposure.

Although every situation is unique, some recurring issues discussed in this three-part series can provide general guidance for both employers and employees concerned about potential or actual competitive disputes:

For the Employer:

• Have clear policies regarding outside employment and restricting competition while employed.
• Carefully craft any restrictive covenants to comply with the latest developments in South Carolina law.
• Limit restrictive covenants and trade secret agreements to areas, activities, and information that are essential to protecting legitimate business interests.
• Make sure reasonable steps are employed to protect trade secrets, including the review of new technology usage that might eliminate earlier efforts put in place to protect data.

For the Employee: 

• Make sure you retain (outside of work) actual copies of all agreements you have signed with the employer.
• Know the line between preparing to compete and actually competing and realize that any litigation between you and your employer is likely to turn up all communications you had before departure.
• Make sure any new employer is aware of any restrictive covenants and is willing and able to assume any risk to which it might expose you in your new position or, if you are starting your own business, make sure you understand the  possible costs of defending a lawsuit even if you believe you are acting within your rights.
• Keep good records of how you obtained and constructed new lists and information about or from customers; these will be very important in showing that the information was not taken from prior employment.

Conclusion

Battles once waged in the market place in the days of Edison and Tesla are now fought in courtrooms. Taking practical precautions before a dispute ripens, or carefully considering strategy after one does, not only enhances the party’s ability to ultimately protect its interests, it can greatly reduce the cost and burden of any resulting litigation.

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