Diversion of business – when your employees become competitors

What should you do if senior employees have assisted your business competitors or become competitors themselves? Patrick Selley examines the remedies available.

Competition is in the very nature of business and is something that free markets pride themselves upon. However, what should you do if you discover that others with knowledge of your business, such as senior employees, have assisted your business competitors or become competitors themselves?

Typically, the first action businesses take is to gather as much evidence as possible and then to dismiss the employee for gross misconduct or to suspend them (assuming of course it is detected during their employment). This may well stop the situation from getting any worse, but what about the lost opportunity and thus lost profits that your business has suffered? Does the law provide for compensation to be paid to you and by whom?

Patrick Selley examines the remedies available to you against both the (by now) former or suspended employee and the competitor and examines whether senior employees, in addition to their contractual duties and duties of good faith, can owe fiduciary duties to your business and the remedies that flow from breach of such duties. The position where the employee is a director has recently been codified and is summarised in another Keynotes publication entitled “Directors’ Duties” and thus is not dealt with here.

What are fiduciary duties?

Certain employees are fiduciaries which means that they owe a duty to act “bona fide” in what they consider to be the best interests of the business that employs them. Two rules emerge from this general principle: a fiduciary should not put himself in a position where his fiduciary duty and his personal interests conflict (the no conflict rule) and no fiduciary should make a secret, or undeclared, profit from his fiduciary position (the no profit rule).

The no conflict and no profit rules impose a higher standard of loyalty than is owed by mere employees. Accordingly, businesses want to be in a position to argue that the competing employee is an employee who owed fiduciary duties.

When does an employee owe fiduciary duties?

Not all employees owe fiduciary duties to their employers and even those who do owe fiduciary duties only do so in certain respects. The starting point is the employee’s role and his or her employment contract. The relationship created by an employment contract is not generally of a fiduciary nature. The leading authority on the relationship between the contract of employment and fiduciary duties is the decision in University of Nottingham v Fishel [2000] ICR 1462 which states that “the essence of the employment relationship is not typically fiduciary at all”. Rather the employment relationship allows the employer to avoid a position of conflict arising by giving the employer “the opportunity to exercise considerable control over the employee’s decision making powers”. The simplest example of this is the common prohibition in the employment contract preventing the employee from working for any third party.

University of Nottingham v Fishel then sets out the current legal test of whether a fiduciary relationship has arisen as follows: “in determining whether a fiduciary relationship arises in the context of an employment relationship, it is necessary to identify with care the particular duties undertaken by the employee, and to ask whether in all the circumstances he has placed himself in a position where he must act solely in the interests of his employer”. The duties of the employee are therefore key. The role of company director is a fiduciary role in the widest sense. It follows therefore that the closer the role of the employee is to that of a director, for example where the employee describes himself as a ‘director’, where he is not, or acts as if he is a director, then this will usually be sufficient to mean his role was akin to that of a director and therefore that fiduciary duties apply to all employees in such a role.By the same analysis the extent to which an employee is part of the corporate governing structure, or is part of the senior management inner circle and is given senior tasks, will also be relevant in assessing whether fiduciary duties are owed.

In the case of QBE Management Services (UK) Limited [2012] EWHC 80 (QB) the court considered the question of whether a Mr Dymoke, a senior insurance underwriter, owed fiduciary duties as a result of his contract of employment.

Mr Dymoke held a senior and important position. He played a pivotal role in the marine division of QBE and supervised a large team of underwriters and enjoyed a position of trust as well as access to sensitive business information, quarterly accounts, financial performance information, claims data and information relating to broker relationships and performance against targets. He was also involved in developing and implementing strategic business plans. Unsurprisingly, from such an analysis of his contractual obligations, the court held Mr Dymoke to be a fiduciary.

The position with junior employees is narrower and more complex. It is likely that their role will contain a suite of duties. The same tests though will apply in relation to each of his duties. Where a junior employee places himself in a position in relation to certain contractual duties to act solely in the interests of the employer he may well be a fiduciary in respect of those duties. For example, consider the situation where the employee has custody of company property, whether that be a real item such as a company van, or an intangible item such as know-how or information, the only purpose for which the employee may use such property is bona fide for the benefit of the employing business.

So, given that the role of the employee is key, it will consequently be important to establish what the role of the employee was. The simplest and most effective way of doing this is to refer to the employee’s signed contract of employment, and for this reason all employees should have an up-to-date employment contract.

Consequences of a breach of a fiduciary duty

The advantages of successfully characterising your senior employee’s breaches of duty as breaches of his fiduciary duties are various. First, there are a number of actions that will constitute a breach of fiduciary duty that do not necessarily constitute a breach of employment obligations. Second, the remedies available following a breach are far wider and include compensation.

Wrongful acts

Where, during employment, the fiduciary takes steps in relation to a maturing business opportunity for the benefit of himself it will be much easier to establish that such pre-termination acts are wrongful as they will invariably constitute a breach of the no conflict rule.

Another important aspect of the no conflict rule is the positive duty on fiduciaries to disclose their own wrongful activity and the wrongful activity of others. In general, an employee can look for work elsewhere and set up a new business or join a rival. However, if the employee is also a fiduciary and plans to go to a new venture or business and fails to tell the employer of his or her intention then such action could be construed as causing a conflict of interest.

Remedies against the fiduciary

In addition to damages, an important consequence of a breach of duty by a fiduciary is that the fiduciary is obliged to account for all profits as a result of the breach of duty. The fiduciary is precluded from retaining any property he acquired on his principal’s (i.e. employer’s) behalf, or from obtaining for himself any property or business advantage belonging to his principal, or for which his principal was negotiating during the subsistence of the fiduciary relationship, even after it has ended. The fiduciary is thereby forced to give up all benefit he has obtained regardless of any proof of loss by the employer. An account of profits is not a compensatory remedy, in the sense that the victim need not demonstrate that he would have made the relevant profits had the breach not occurred. The purpose is to remove any benefit of the breach from the party in breach. In this context, and as set out in Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244, the additional obligation of a fiduciary to disclose his own wrongdoing “makes the remedy [for a fiduciary] to account for secret profits and for the diversion of corporate opportunities more effective”.

Remedies against your competitor

Where third parties encourage or induce the fiduciary to act in breach of duty, the third party may be liable for knowing assistance of a breach of fiduciary duty. For example, the employer who encourages a director of a rival company to act as a recruiting sergeant of employees of the rival who may be approached to join the new employer would knowingly assist a breach of fiduciary duty.

The advantages of a cause of action based on knowing assistance is that the third party would then be susceptible to the full range of equitable remedies, including the remedy of an account of profits. In addition, the competitor may be better able to pay damages than the former employee.

Regardless of whether your employee was also a fiduciary, if your employee has breached restrictions in his contract of employment, you may well also have a claim against your competitor for inducing such breach of contract. It is only necessary to establish that the competitor knew of (or indeed turned a blind eye to the possible existence of) restrictive clauses in the employment contract and that it did realise the conduct being induced would result in a breach of such clauses.

Remedies against both your former employee and your competitor Conspiracy to injure

A conspiracy to injure (which refers to pecuniary injury) by unlawful means is actionable where you can prove that you have suffered loss or damage as a result of the unlawful action of your employee (whether or not a fiduciary) and your competitor, whether or not it is the predominant purpose of the former employee or competitor to do so.

Springboard injunction

If one or more employees leave to set up in competition, you may be able to enforce restrictive covenants in the employees’ contracts and restrain their use of confidential information by applying for an injunction. However, in many cases this is inadequate to protect your business and this has led to the development of the ‘springboard injunction’.

A springboard injunction prevents an employee or their new employer (i.e. the competitor) from making use of their wrongdoing to gain a head start in competition with the former employer. For example, in Roger Bullivant v Ellis [1987] ICR 464 the employee was restrained for a period from doing business with any of the customers on a list of contact details which he had stolen from his employer before leaving to set up in competition. The injunction was granted despite many of the customers’ names and addresses being in the public domain and therefore legitimately accessible.In the case of UBS Wealth Management v Vestra Wealth [2008] IRLR 965 senior managers’ failure to disclose their knowledge (for reasons of personal involvement) in planned poaching raids on the company’s staff and client base supported the making of springboard injunctions precluding them from dealing with the client base pending speedy trial.

Conclusion

The courts have shown themselves willing on many occasions to protect businesses from the unlawful actions of their former employees and those with whom they are working in concert. In particular, a wide range of options are available to businesses in such cases that may put the business back into the position as if the unlawful action and not taken place, or, in certain cases, put the business in a better position.