Overview of Non-Competition and Other Employment Restrictions

Overview of Non-Competition and Other Employment Restrictions

I. Common Law and Statutory Obligations

A. Introduction

Apart from any contractual obligations that may limit the manner in which an employee may act both during and after his employment by a company, there are also limitations that are imposed by the so called common law (long established judge-made principles) and by statute, of which the employee must be aware and with which he must comply.

B. Common Law Duties of Employees

The most important of the common law obligations which employees have is the duty of loyalty. The common law duty of loyalty prohibits an employee from actively competing with his or her employer during the employment relationship. The duty of loyalty also prohibits an employee from engaging in any activity that creates a conflict between the employee’s own self-interest and the interest of his employer. In addition, the duty of loyalty also requires that an employee exercise “due and ordinary skill in the employment of his art of business about it, or in other words, to perform in a workmanlike manner.”

An employee is free to search for another job prior to leaving his current employer. A group of employees may agree to leave together, such as when a partner in a law firm leaves with his associates. However, an employee may not systematically induce other employees to leave their jobs if the purpose of doing so is to destroy an integral part of his employer’s business. In other words, “an employee may discuss job offers with his circle of friends and the group may debate whether to leave together.” A breach of loyalty, however, may occur when an employee who is considering leaving targets employees outside his normal circle and uses his position to induce them to defect.

An employee is not precluded by the duty of loyalty from preparing to compete prior to the complete termination of the employment relationship. However, an employee may not solicit customers until after he has left his prior employer. Departing employees, for example, may purchase a rival business or equipment, obtain land, and secure financing for the prospective new business. However, the employee’s right to prepare to compete is not absolute and certain activities may constitute a breach of the employee’s duty of loyalty. These circumstances were discussed by the Court of Appeals of Maryland in Maryland Metals vs. Metzner, 282 Md. 31, 382 A.2d 564, 567 (1978):

“Thus, the privilege [to make preparations to compete] has not been applied to immunize employees from liability where the employee has committed some fraudulent, unfair or wrongful act in the course of preparing to compete in the future. Examples of misconduct which will defeat the privilege are: misappropriation of trade secrets, misuse of confidential information, solicitation of an employer’s customers prior to cessation of employment, conspiracy to bring about mass resignation of employer’s key employees [and] usurpation of employer’s business opportunity.”

Accordingly, an offer of employment in a new venture which is extended to another employee is ordinarily deemed a violation of the duty of loyalty if the offer is made while the employee is still employed; this is ordinarily not considered to be proper “preparation to compete”. The duty of loyalty also requires that an employee not take advantage of business opportunities which he knows may be of interest to his employer. This would include, for example, seeking to postpone commencement of work until the employee has had an opportunity to be a competitor.

Departing employees in Maryland also have a common law duty to return to their former employer files (including electronic files); records, documents, materials and equipment belonging to their former employer.

C. Trade Secrets and Confidentiality

The other significant area in which an employee or ex-employee may be held liable in the absence of a written agreement is in connection with the post-employment use of proprietary or other confidential information. As a general matter, this conduct which was previously based upon the common law, has been superseded in Maryland by the Maryland Trade Secrets Act. This statute prohibits the “misappropriation” of “trade secrets.”

The Maryland Uniform Trade Secrets Act (MUTSA) defines a “trade secret” to include information, including a formula, pattern, compilation, program, device, method, technique, or process that:

1. derives independent economic value or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and
2. is the subject of efforts that are reasonable under the circumstances to maintain its secrecy

   Md. Code Ann., Comm. Law II, § 11-1201(e)

In determining whether a trade secret exists, Maryland courts look to several factors including:

1. the extent to which information is known outside of the business;
2. the extent to which information is known by employees and by others involved in the business;
3. the extent of the measures taken to guard the secrecy of the information;
4. the amount of effort or money expended by the owner in developing the information; and
5. the ease or difficulty with which the information could be properly acquired or duplicated by others.

Specifically, under the MUTSA, “misappropriation” of a trade secret is defined by statute to mean:

1. the acquisition of a trade secret by a person who knows or has reason to know that the trade secret was acquired by improper means; or
2. the disclosure or use of a trade secret by another without express or implied consent by a person who:
   1. used improper means to acquire knowledge of the trade secret, or
   2. at the time of the disclosure or use, knew or had reason to know that the person’s knowledge of the trade secret was:
      1. derived from or through a person who had utilized improper means to acquire it;
      2. acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or
      3. derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use;
   3. before a material change of the person’s position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake.

In other words, in order to qualify as misappropriation under the statute, one must either acquire the trade secret by improper means or disclose the trade secret without express or implied consent.

II. Restrictive Agreements in General

By agreement, an employer may impose obligations which are broader than those imposed by the common law. These obligations typically exist in employment agreements. However, a particular restrictive covenant (such as a provision preventing or restricting competition, solicitation of customers, and/or solicitation of employees) is enforceable only if it is “reasonably necessary for the protection of the business of the employer.” Maryland courts, like courts in most jurisdictions, recognize the validity of a restrictive covenant to protect an employer’s interest generally in only three situations: (1) where the employee has access to legally protectable “trade secrets” or other confidential information of the employer which the employee, unless restricted, could give to a competitor to give that party a competitive advantage; (2) where the employee has had access to the employer’s confidential customer information or has developed a close relationship with the customers or clients of the employer; or (3) where the employer’s business is dependent in some way upon the special, or extraordinary services of the employee to the extent such that the employee’s employment by a competitor may cause the business from the former employer to be diverted.

If a particular business does not possess at least one of these three interests, then there is nothing to balance against the hardship to an employee who has a restrictive covenant. Accordingly, if there is not a recognizable employer interest on the part of the employer, a restraint may not be enforced, even though it may appear reasonable.

A. Types of Contractual Employment Restrictions

The term “non-compete” is often used generically to describe what are, in reality, generally four separate contractual employment restrictions that employers place on employees: (i) a true non-competition provision; (ii) a non-solicitation of customers (and potentially prospective customers); (iii) a non-solicitation of employees; and (iv) an obligation to maintain confidentiality. At times, and depending upon the circumstances, employers may add a fifth restriction concerning non-disparagement.

A non-competition clause directly prohibits competition (typically in a certain area, region, etc.). In order for a covenant not to compete to be enforceable the following elements must be satisfied: (i) the covenant must be supported by adequate consideration; (ii) the covenant must be ancillary to an employment contract; (iii) the covenant is confined within limits that are no wider as to area and duration than reasonably necessary for the protection of the employer; and (iv) the covenant must not impose undue hardship on the employee or disregard the interest of the public. As of October 1, 2019, employers are prohibited from entering non-competition and other types of non-competition arrangements with employees earning equal to or less than $15 per hour or $31,200 annually.

A non-solicitation of customers does not prohibit competition directly. Rather, it prohibits the employee from soliciting the former employer’s customers. Typically, courts will provide greater latitude in enforcing non-solicitation of customer clauses than non-competition clauses which restrict an employee from competing in any way with a former employer.

The third type of contractual employment restriction is the non-solicitation of employees. This restriction typically prevents employees from directly or indirectly encouraging, soliciting, or hiring the employees of their former employer.

The fourth common employment restriction is a obligation to maintain confidentiality of the former employer’s sensitive, proprietary, and financial information and documents. This contractual restriction often overlaps with, and is sometimes greater than, the common law duty that employees have.

B. Best Practices in Crafting Employment Restrictions

Particularly since courts increasingly are scrutinizing both the business need for contractual employment restrictions and the scope of such restrictions, it is important that employers do the following:

1. Carefully consider what it is they are seeking to protect;
2. If a company truly has “trade secrets”, it should take appropriate measures to ensure that they are protected (i.e., password protecting documents; limiting the access to individuals who can review certain documents, etc.);
3. Carefully tailor the employment restrictions and, in particular, a non-compete or non-solicitation clause, to the duties and responsibilities that the employee had;
4. Be careful in using “one hat size fits all” restrictions for employees at all levels as they may not be applicable in certain situations;
5. Be particularly careful about imposing post-employment restrictions on low wage earners. The Maryland legislature has explicitly prohibited non-compete and other types of non-competition agreements with low wage earners and (presently) remains silent about the validity of non-solicitation agreements imposed on low wage earners. However, the law does feature a carve out for confidentiality and non-disclosure agreements restricting the appropriation of client lists or other proprietary client related information;
6. Fully define “customers” in any non-solicitation of customer provision;
7. If the restriction is going to encompass “prospective customers”, be careful to draft the provision in a narrowly tailored manner;
8. Be mindful that state laws can vary greatly in terms of the enforceability of post-employment restrictions so that employers who have employees in multiple states need to be aware of laws in various jurisdictions;
9. Carefully consider whether enforcement of a non-compete makes legal, professional, business, and relationship sense; and
10. Carefully consider the precedent of aggressively enforcing employment restrictions (i.e., “what goes around comes around”).

C. Summary of Departing Employee Obligations

In light of the common-law and statutory obligations described above, there are several practical issues to keep in mind insofar as things that departing employees should and should not do:

1. Departing employees should not perform any work associated with the formation of a new company (i) during the normal workday or (ii) at the former employer’s offices.
2. Departing employees should not solicit any employees prior to the time that they leave their former employers.
3. Departing employees should not solicit any customers prior to leaving their former employer.
4. Departing employees should continue to work diligently at all times to maximize business opportunities for their former employer until the date of termination.
5. Departing employees should not attempt to divert any business opportunities from their former employer, including diverting opportunities to any newly formed company.
6. Departing employees should not attempt to delay or protract any business opportunities on the hope that the new entity might ultimately attempt to solicit this business once it is formed.
7. Departing employees should not use computers belonging to their former employer to do any work associated with the new company.
8. Departing employees should not send emails or mail documents from their former employer’s offices which relate in any way to the formation of a new company.
9. Departing employees should not take, copy, or download, any information or documents, which belong to their former employer.
10. Departing employees must return all documents, records, data former employer and files (including all client documents, records, and plans) to their former employer immediately upon the termination of their employment.

Marc Engel is an employment attorney experienced in providing successful strategies for managing employees and preventing employment claims. For more information, contact Marc at 301-657-0184 or [email protected].