Monday, May 24, 2010

What Are the Limits on "Preparing to Compete"?

Most jurisdictions recognize that employees are able to plan, outfit and form a competitor prior to the time they quit without running afoul of their fiduciary duty of loyalty. The law concerning fiduciary duties is best understood as a gap-filler that will prohibit unfair competition, particularly when a non-compete agreement is absent or unenforceable.

This doctrine - allowing an employee to prepare to compete - has its limits, of course, and like much of the law concerning unfair competition, a lot has to do with the equities.

What is permissible? Again, that all depends, but here is a basic list of permissible preparatory activities:

1. Incorporating or organizing a business entity
2. Developing a business plan
3. Negotiating an office lease
4. Establishing a bank account
5. Raising capital
6. Purchasing a competing business (if those intentions are disclosed prior to closing)
7. Identifying potential clients or sources of supply

What is prohibited? The touchstone inquiry will be demonstrable, actual competition, not preliminary steps to compete. Another non-exhaustive list:

1. Using employer information to develop account lists
2. Selling or making sales proposals to customers prior to resignation
3. Downloading ex-employer confidential information for use in the new venture
4. Failing to follow through on sales leads in the hopes of saving that account for future competitive activity
5. Taking a corporate opportunity and failing to tender it to the employer

An employee can certainly plan a competing venture so that on the day following resignation, she is able to start contacting customers and generating sales. Most courts will look at how active an employee was in actually competing - not just preparing to compete - in assessing whether the employee has violated a common law fiduciary duty of loyalty.

Remember: this body of law tends to place limits on competition in the absence of a non-compete. Just because an employee has no post-employment non-compete agreement in place does not mean the preparing to compete doctrine can somehow be extended or rendered inapplicable.

Recently, I have seen a number of employee non-compete agreements that contain not only customer covenants, but also prohibit an employee by contract from preparing to compete. It is not clear to me that this type of restriction has any real teeth, or how a court would analyze such a restriction in light of the common law preparing to compete doctrine. In fact, it is difficult to assess what the remedy would be for such a breach as long as there is no actual competition prior to resignation.

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