FOUNDER OBLIGATIONS TO PAST/PRESENT EMPLOYERS*
Guiding Principles for Managing Founder Obligations to Past/Present Employers*
When launching a startup, founders must be careful not to breach legal obligations owed to any past or present employer. A breach may limit a founder’s ability to contribute to the startup and can, in some cases, compromise the future of the new venture. While founders may owe legal obligations to other parties than merely employers, this article is limited in focus to the employment context.A good general principle to bear in mind regarding founders and existing or previous employment is the notion of stickiness. Essentially, employers’ resources, such as (i) employee working time, (ii) company intellectual property (“IP”), (iii) company confidential information, and (iv) company equipment (collectively “Employer Resources”) are all sticky. Thus, if a founder uses any of these Employer Resources for purposes unrelated to employer interests (such as for the founder’s startup company), the employer may have rights that stick to the situation allowing the employer to terminate the founder’s employment and/or to take legal action against the founder or startup for damages caused by the activity and even to seek a court order (known as an injunction) for the founder or company to stop using the employer’s property or rights. This can be a major blow to the startup if an injunction is imposed on a critical aspect of the startup.
So, assuming a founder is not using any such Employer Resources (i.e. time, IP, confidential information, and/or equipment), there still may be other restrictions stipulated in the founder’s existing or past employment agreements that must be honored.
There are four main areas where founders can run afoul of existing obligations to present or past employers. These contexts are:
1. Moonlighting
2. Competition
3. Solicitation
4. Confidential or Proprietary Information
Before delving into the details of these four scenarios, always bear in mind employment agreements can contain (whether intentional or not) unenforceable restrictions. Local law may prohibit restrictions altogether or require certain formalities (such as additional payment and reasonableness of scope, time, etc.) to be present for such restrictions to be enforceable. Conversely, there are scenarios where the employment agreement may be silent on restrictions but local law implies restrictions based upon the type of employee in question (e.g. if a key employee or a skilled employee as opposed to a lower-level unskilled employee that may not have a position of trust and therefore not have access to sensitive company information). In some jurisdictions, even unskilled employees owe a duty of loyalty to employers. Finally, some employees may be shareholders of their employer and shareholder agreements may include various provisions restricting shareholders from, e.g. engaging in any competitive activity while a shareholder. This article does not address such shareholder implications.
UNCERTAINTY
Given this overall uncertainty and the importance of getting a startup off to a strong start, if you are an existing or departing employee and will be founding a new company—it is best to retain a local qualified attorney to identify any constraints on your freedom to operate.
1. Moonlighting
As noted earlier, employee working time is an employer resource and therefore working time is typically limited to doing work for the employer. Generally, an employee can perform work unrelated to the employer during non-working time (this is known as “moonlighting”). If, however, the employment agreement includes a “no moonlighting clause,” the employee may be required to devote all working time to the employer and to refrain from all other work, board assignments or even charitable support to a business without employer approval.
If a valid no moonlighting clause is breached, the employer may assert an ownership claim to the results of such work and can seek termination of the employment agreement.
2. Competition
There are two scenarios here. An employment agreement can be silent on this subject or may include a covenant not to compete.
(i) Silent on the issue of competition:
If the agreement does not include express prohibitions against competition or moonlighting and the employee uses no Employer Resources, can the employee be prevented from working competitively during or after the employment?
Here is an example of when implied law may impose a duty on a key or skilled employee, i.e. that such employee has an implied duty of loyalty (i.e. not to use confidential information or to assist a competitor) while being employed by employer. The issue of any such implied obligations and whether they exist only during the employment or for some time thereafter is an issue of local employment law.
An example of this can arise when an employee sees an incoming employer opportunity but actively diverts such opportunity to the employee’s new venture. Even if there is no contractual provision prohibiting this activity, this may constitute a breach of the duty of loyalty owed to the employer. This situation, where it is legally recognized, is sometimes referred to as “intentional interference of implied economic opportunity.”
(ii) Covenant not to compete
If the employment agreement contains a covenant not to compete, first determine whether non-competition clauses are legally enforceable on employees in your jurisdiction. This is not always the case. For example, in Sweden and the State of California, non-compete restrictions on employees are generally prohibited. If enforceable in your jurisdiction, your next question is whether the specific terms of the non-compete restriction are enforceable. To be enforceable, many jurisdictions require a reasonable duration (e.g. not to exceed 1 year post employment) and a reasonable field of activities (i.e. directly competitive and there is a definition of what types of activities are indeed competitive). Further, separate payment (known as “consideration”) may be required for the employer to be able to invoke the restriction after termination of the employment. If the clause is enforceable in its specific, written form in your jurisdiction, ensure you have a crystal clear understanding of the time and breadth of the restriction and act accordingly unless you've received a legal waiver from the employer stating the employer will forfeit (i.e. waive) the employer's rights under the employment agreement.
3. Solicitation
An employment agreement can include a clause stating a departing employee is prohibited from recruiting over (known as soliciting or poaching) coworkers from the employer for a certain period of time. If this clause exists and is enforceable, it should be respected.
The more common issue, in the departing employee context, is whether poaching of coworkers may expose the departing employee or his/her new startup venture to liability for such conduct even if there is no clause prohibiting such solicitation in the employment agreement. In many states of the U.S., for instance, if a departing employee induces a coworker to leave his/her employment prematurely (i.e. in breach of some employment term commitment), the employer may have a claim against both the departing employee and his/her new startup venture. This type of claim is known as “Intentional Interference with Contract.” Even if employees have not committed to a specific contract term with an employer, a departing employee and his/her venture may be subject to claims if recruiting multiple coworkers which causes a material disruption to the employer’s business or, naturally, if any of such coworkers violate any non-compete clause or misappropriate any of the employer’s confidential or proprietary information.
4. Confidential and Proprietary Information
As explained previously, there is stickiness with regard to employer’s confidential information and IP (a.k.a. proprietary information). As such, if a founder uses either of these during or after his/her employment without receiving the employer’s consent, the employer may take legal action against the individual and/or the startup venture in question. Again, legal action can include claims for damages but also demands not to use the misappropriated materials or any results thereof—and, in some cases, this can fatally compromise the future of the startup venture.
Prohibitions from using confidential information for purposes outside of the scope of the employment are generally recognized post employment even in jurisdictions that do not recognize non-competition covenants (such as, California).
As a final note, some departing employees may claim they are the ones that created the IP in question while employed and therefore should be entitled to use the same in a new venture in the future. The problem with this reasoning is that all intellectual property rights subsisting in employee work product is generally (be operation of law) assigned, immediately upon creation, to an employer- if connected to Employer Resources (time, IP, confidential information or equipment) or if created otherwise by the founder but within the scope of the founder having a valid no moonlighting clause or non-competition covenant in place.
All the best with your venture!
*This article is not legal advice and is provided for informational purposes only.