Setting up a business which competes with your previous employer

Entrepreneurs often leave employment to start up a business in the same industry, using the benefit of experience gained while working for a previous employer.

This note is intended to highlight a few key considerations for entrepreneurs who are setting up their own business in a similar field so they know what kinds of restrictions they should be aware of.

We will consider the implication of restrictive covenants, confidentiality, and IP ownership.

General

In an employment context, restrictive covenants are the terms in a contract which limit an individual's freedom to work for others or carry out his/her/their trade or business. Restrictive covenants should meet some general criteria in order to be enforceable. These are as follows:

• Reasonableness: post-termination restraints must be reasonable; having regard to the interests of the parties and the public interest
• Legitimate interest: a restrictive covenant must be designed to protect a legitimate proprietary interest of the employer. This includes an employer's trade connections with customers or suppliers, confidential information and maintaining the stability of the workforce
• Preventing competition: this must be with a view to protecting the employer's confidential information, trade secrets or customer connections, and preventing the employee from obtaining an unfair advantage by exploiting these
• Restrictions must be no wider than necessary

If covenants go further than this then they can be struck out by the Courts and rendered unenforceable. However, we have noticed some legal myths starting to develop in relation to restrictive covenants. In particular some people seem to believe either that 'covenants are never enforceable' or that 'no-one ever enforces covenants'; both of these assumptions are wrong and you should read the specific text of any non-compete covenants which apply.

One principle which it is worth bearing in mind is that the specific language is important, if a covenant is ambiguous then the clause will be construed where possible in favour of the employee (although at the same time Courts will sometimes stretch to enforce a covenant on the basis that the parties must have intended covenants to be valid).

The Courts do have the power to strike out unenforceable parts of restrictive covenants; however, recent case law has highlighted a tendency for the Courts to be more inclined to enforce covenants where possible. This has included Courts seeking an alternative realistic interpretation of a clause. For this reason, you should approach restrictive covenants with caution.

As an exiting employee, you may be bound by a non-competition covenant. A non-competition covenant seeks to prevent a previous employee from engaging in business or trade with competes with that of the previous employer. It might use terms such "directly or indirectly", "engaged", "concerned" or "interested in". 

In a leading recent case Tillman v Egon Zehnder Ltd it was found that while a restriction against being 'interested in' a competitor was too broad to be enforceable (as it could for instance mean a passive shareholding in a competitor without any active role), the Supreme Court removed that wording and upheld the remaining covenant.

As a non-competition clause is particularly restrictive, it should be time limited (usually to three, six, or twelve months). It may also be narrowed to a certain geographical area and/or an area of the employers business in which you have been working in prior to leaving.

The effect of this is to delay you joining a competitor or setting up your own business which will compete with that of your previous employer.

If you are setting up a new business, you will probably need employees (or business partners or consultants), and will certainly need clients. Again, your previous employer will probably have contractual measurers in place to protect their interests in this regard. 

• Non-solicitation covenants:

There refer to a previous employee's positive act in contacting a former customer, contractor, supplier or trading partner of the former employer. This includes any approach made with a view to obtaining business. You may be able to inform clients and customers that you are leaving, and even include a contact address, though caution is necessary. You should not point to the forwarding address or be seen to encourage contact of any nature.

Usually these covenants will be limited to those business contacts you worked with. Where the covenant is broader and intends to protect the general customer base or goodwill of the employer, there should be a time limit to the restriction. 

• Non-dealing covenants

A non-dealing covenant is broader. If included in your employment contract, it prevents you having any dealings with previous business contacts. This will include where the contact makes an approach to you, rather than the other way around.

As this is much more restrictive, they will usually have limits. This may include length of time, personal relationship, area of industry and so on.

• Non-poaching covenants

Non-poaching covenants may also be called "non-employment covenants". These prevent you encouraging others to leave the employer (either simultaneously or subsequently).

Where the previous employer is a small business, the limit can extend to all employees. Where the employer is larger, it may be more appropriate to identify the types of employees that the ex-employee cannot poach (such as senior management). A time restriction is also usually attached to these.

Restrictions may also arise in your use of information that you became aware of as a result of your previous employment. Your employment contract will probably include explicit provisions regulating your use of information both during and following your employment. This will typically include the return of devices and documents and the deletion of information held digitally, as well as an undertaking not to make copies.

In addition to any contractual obligations, as an employee you will have an implied duty of confidentiality. If you were a director of the previous business, you will also owe a fiduciary duty to the company.

Trade secrets are information which is highly confidential, and may include chemical formulae, designs or special methods of production. The courts will imply terms to protect this against misuse or disclosure post-employment.

Where you have been told that information is confidential, or, it is obvious that it should be treated as such, you should not make copies or deliberately copy or use it. However, to the extent that this information incidentally remains in your head or becomes part of your knowledge and skillset, you may use it going forwards.

If you have developed intellectual property during the course of your employment, it is likely that your employment contract will state that this belongs to the employer. Provisions stating that you have waived your moral rights (e.g. your right to be identified as the author of a work) and agree to disclose inventions to your employer are also very common.

Even where this might not be expressed in your employment contract, British legislation (Patents Act 1977, Copyright, Designs and Patents Act 1988, Registered Designs Act 1949, and the Copyright and Rights in Databases Regulations 1997) give employers automatic ownership of patents, copyright, database rights, unregistered designs and registered designs in works created by its employees in the course of their employment.

It is possible to "contract out" of this by entering into a separate signed agreement with your previous employer. If there is certain IP that you created which is vital to your new business, you may decide to approach your previous employer with a view to purchasing it. 

As a general guideline, employers who act reasonably and who have imposed reasonable covenants may have a right to enforce their restrictive covenants against leaving employees. Therefore, if you are setting up a new business in an area which competes with that of your previous employer, you should be conscious of these restrictive covenants. You may need to delay setting up the business and your approach to various staff and clients as appropriate,

You should also be wary of obligations regarding confidentiality and the ownership of IP. Here, your contractual restrictions are in addition to the common law and statute provisions so they should be considered as a whole.

If you would like advice regarding setting up a new business and any restrictions which may apply, please do get in touch and we would be happy to assist.