If you are looking to set up a business in competition with an employer you have recently worked for, it is critical that this is well thought through. This is not only because careful strategy is required for any new start-up to be successful, but because setting up a competitor business can be particularly high risk. This area is heavily litigated and so the potential costs and practicalities need to be carefully considered; we have set out the main considerations below.
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What obligations do you have from your previous employment?
There may be explicit and implied contractual obligations that apply both during and after your relationship with your previous employer. These aim to reduce any action you might be able to take in setting up a competing business. Provided that you are not a director, LLP member or partner with fiduciary duties (meaning you must act in the best interests of the business at all times, even at the expense of your own interests) you may generally take ‘preparatory steps’ towards setting up a competing business without being in breach of your obligations. However, this will depend on your express and implied obligations to your previous employer. Express obligations may be found in a variety of documents, including employment contracts, shareholders’ agreements, membership or partnership agreements and long-term incentive plans, bonus, or other remuneration schemes.
Implied terms are not expressly set out in documents but may apply and have force in certain circumstances. As an employee, you owe an implied duty of fidelity to your employer whilst you are still employed and owe a duty of trust and confidence to your employer. Terms that would have previously been implied, such as the requirement to report your own and others’ wrongdoing or disclose information which if you do not could cause damage to the business, are more commonly being added to employment documents as explicit terms and these have generally been enforced by the courts. It’s therefore important to proceed with caution when preparing to leave your employer.
What confidentiality and IP considerations are there?
It’s very important to consider your obligations around handling confidential information and intellectual property as you prepare to leave your employment, as well as after you leave. This is because your former employer could take legal action against you if you breach terms and conditions relating to how your previous employer protects its confidential information and intellectual property.
In your current employment, you are likely to have access to some of your employer’s confidential information and trade secrets, at least until you return business property, hard and soft copies of documents, memory sticks and devices, and permanently delete documents on personal devices or email at the end of your employment. As there are only very few protections for businesses implied in the law, relating to confidentiality and keeping trade secrets once you leave the business, it is likely that there will be express contractual terms limiting your use of confidential information relating to that business both during and after your employment with it.
Confidentiality restrictions, unlike other post termination restrictions, may not be time limited, although the confidential information may only be relevant or become public after a period of time, after which point there will be no requirement to keep it confidential. Again, confidentiality restrictions are likely to be contained in your employment contract and other employment documents, and there may even be a separate confidentiality agreement which you signed when joining your employer.
Confidential information is often defined widely to include information relating to clients and potential clients, pricing, business strategies and technical know-how (eg algorithms and source code) and can generally be considered confidential if you know information to be commercially sensitive, particularly if this is marked ‘confidential’ and/or password protected and/or there are other security measures in place to prevent certain personnel or the public seeing the information. If you use this information in breach of your contract and this causes damage or might cause damage to the business you are leaving, it is likely that enforcement action will be taken against you personally and your new business, as set out below. As an extension of this, businesses are required to keep certain personal data protected and so any attempt to knowingly or recklessly obtain or disclose personal data without the consent of the data controller is a criminal offence under the Data Protection Act 2018, this might include personal data of customers and so care must be taken and legal advice sought, if further guidance is needed.
There may also be limitations on what intellectual property (IP) you are able to use when you leave a business to set up in competition. Generally, any inventions, works, designs, databases or names you have come up with during the course of working for a business and which is relevant to it cannot be used to set up a competing business, without prior authorisation, otherwise you are infringing your employer’s IP rights. Again, it’s important to check the terms of your contract of employment and any other documents you signed on commencement of employment that protect your employer’s intellectual property.
Notice periods and garden leave
Notice periods are usually set out in your contract of employment, and if your employer gives you notice it must be at least the minimum statutory notice period of one week per full year of service up to a maximum of 12 weeks. Whether you are serving out all or part of your notice period, you should continue to comply with the terms and conditions of your employment. For example, you should not download and make copies of any confidential information if to do so would mean you are in breach of your contract.
Employers often have discretion within your employment contract to place you on garden leave for the duration of your notice period, requiring you to stay away from the office not to contact colleagues or customers. During garden leave, all your other contractual obligations will continue to apply in full, including those relating to confidential information and competitive activities.
Garden leave is generally easier for employers to enforce than restrictive covenants and so is a useful tool for your employer to use to protect against the competitive threat you might pose as you transition out of the business. While you may think garden leave is a useful time to develop your new competing business, you are still restricted by the terms of your contract and your employer will be monitoring your activities carefully to ensure you do not breach those obligations (eg whether you are accessing, downloading or making copies of its confidential information such as customer lists and business strategies). If there is no contractual right to place you on garden leave, you may be able to argue that there has been a breach of contract and so the terms of your contract no longer bind you, but it is recommended you seek legal advice from an experienced employment solicitor first if you are hoping to run that argument.
During your notice period and garden leave, you are only able to make acceptable preparatory steps to compete. As long as there are no express obligations preventing you from doing so, you can purchase an off-the-shelf company, arrange business premises, meet investors and other potential business contacts, take professional advice and prepare a business plan, as long as this is done outside of your working hours whilst you are still employed and not using your current employer’s resources,contacts and confidential information.
Restrictive covenants
A key consideration for any employee considering competing with their previous employer is whether they are bound by restrictive covenants that restrict their ability to do so.
Restrictive covenants, or post-termination restraints are designed to protect an employer’s legitimate business interests by limiting activities by former directors, employees, partners, LLP members or shareholders to protect against competitive activities of a rival business. If you are subject to these types of restrictions, you may be limited in your ability to compete with your previous employer and you risk legal action being taken against you if you do so in breach of these restrictions.
To be enforceable against you, restrictive covenants must be limited in scope and must not go further than reasonably necessary to protect the employer’s legitimate business interests. Legitimate business interests can include protecting confidential information and trade secrets, client contacts, goodwill, relationships with suppliers and maintaining a stable workforce. How reasonable a restriction is will depend on what was reasonable at the point the restriction was agreed and must apply for a fixed period immediately after your relationship with the business ends. If the restrictions are unreasonably restrictive, they will be void for being in restraint of trade and will be unenforceable. Again, you should seek legal advice from an employment solicitor on any restrictions you are subject to before taking steps to compete with your employer.
Restrictive covenants are often reduced by the length of time an employee is on garden leave, and you should argue this if you have been placed on garden leave immediately before the end of your employment.
There are different types of restrictive covenants, and these may include restrictions on your ability to compete, solicit or deal with clients or prospective clients, poach employees and may also prevent you from interfering with business contacts like suppliers after you leave your employment. These restrictions will depend on your status within the business and what is reasonable for your particular role in your industry. For more information read our article ‘A guide to restrictive covenants in employment law’.
Team moves
If two or more people leave a business at the same time to join another competing business, this is a team move. Team moves are often high-stakes situations for businesses as they often involve groups of employees taking coordinated steps to compete with their previous employer and can destabilise the employer through loss of key skills and resources. Team moves often involve breaches of confidential terms and post-termination restrictions such as non-competes and restrictions on soliciting customers. They can also have implications for your new employer if the new employer has encouraged or facilitated a breach of your restrictions in any way. Consequently, team moves can result in legal action against you personally as well as your new employer.
If you are moving to a new competitive venture as part of a team, you should seek advice on your terms and conditions and whether there are risks of legal action being taken against you. If you are being recruited as a team to join a new employer, you should give your new employer copies of your existing terms and conditions, including post-termination restrictions, so that your new employer can understand whether you will be in breach of contract by joining them. Although it can be tempting not to discuss these matters with a new employer for fear of losing an offer of employment, the consequences from not disclosing your restrictions can be much more severe (eg resulting in protracted legal action against both you and your new employer).
Enforcement
If restrictions are reasonable and enforceable and you breach any restrictive covenants or confidentiality restrictions, or threaten to do so, and your employer can prove this, they could be entitled to terminate your employment contract without paying you for your notice period or any payment in lieu of notice (PILON). There will also be a loss of any bonus, commission or benefits from any incentive plan if you are still employed, and your employer may still take legal action against you (eg by getting an injunction) to stop you from competing and / or from misusing any confidential information.
If you are no longer employed and breach your post termination restrictions, your former employer could seek damages from the courts for loss suffered or profit made as a result of your breach. They may also apply for an injunction to prevent you from working for or dealing with a new employer. An interim injunction can be sought within a few days, pending a full hearing, to ask the court to enforce express restrictive covenants or order springboard relief to cancel out any unfair advantage from a departing individual because of the individual’s breach of obligations.
Employers often send departing employees letters before action as a precursor to obtaining injunctions and seeking damages in the courts. These are letters designed to informally resolve the dispute and often ask employees to give contractual undertakings, for example undertakings not to compete or misuse confidential information.
If you are sent a letter before action from your previous employer asking for undertakings, you should seek legal advice and inform anyone else involved in your new competitive venture. This is because any financial backers, as well as your new competing business, may be liable for knowing inducement of a breach of contract, causing loss by unlawful means, conspiracy, dishonest assistance in breach of fiduciary duty or misuse of confidential information. Undertakings may also severely restrict what you are able to do within the new competing venture for a period of time. You will want to seriously look at what undertakings you could give and remain focused on the interests of your competing business. This may mean avoiding expensive litigation and compromising on a solution, as the cost of defending such claims and potential risk for backers could result in the closure of your competing business.
Competing against your former employer brings significant risks and you should always seek specialist advice from an early stage. Our employment lawyers have extensive experience advising on strategies to mitigate risks and are on hand to support you.
