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Potential Issues When Hiring Employees from Competitors in the United States

Article

The German Practice Alert

August 2014

By: Peter FlägelMitchell Boyarsky

German companies that intend to start-up or grow their U.S. business operations may choose to do so by hiring qualified and successful sales, management or marketing people from other businesses in the same or a similar market, who may have excellent relationships in the relevant industry. Such hiring decisions are often made quickly with the expectation of a short-term investment return. However, the best available and most highly paid sales, management and marketing employees often may have contractual non-competition, non-solicitation and confidentiality obligations following termination of their employment. A violation of these agreements may not only expose the employee, but also the new employer, to severe liabilities and restraints. Following are some aspects that should be considered before making any hiring decisions that may later turn out to be regrettable.

Scope of Restrictions

Typically, there are three possible post-employment restrictions: (i) obligations not to compete with the business of the former employer, (ii) obligations not to solicit customers and employees of the former employer and (iii) obligations to keep proprietary information or trade secrets confidential. While reasonable confidentiality obligations are almost always enforceable, the enforceability of non-compete and non-solicitation obligations, even in writing, is dependent on which state law applies and the nature and scope of the restrictions as well as other factors, such as the business level or role of the employee and the public interest. Under some state laws (such as New York) such prohibitions may be enforced (within certain limitations), while other state laws construe the agreements narrowly and limit their application. California law, for example, generally does not allow post-employment non-competition and non-solicitation agreements for employees.1

Additionally, even if no express confidentiality obligations are set forth in an employee’s offer letter, restrictive covenant agreement or employment agreement, an employee may generally not disclose his former employer’s trade secrets to a new employer under applicable state law. The Uniform Trade Secrets Act (UTSA) § 1.2 prohibits the unauthorized disclosure of trade secrets and UTSA2 § 1.4 defines a trade secret as any “information […] that: (i) derives independent economic value, actual 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 (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

Protective Measures

If it is determined that the prospective new employee is subject to one or more of the above described restrictive covenants, the new employee should consider whether the new employment may trigger a violation of such restrictions. For example, just because the former and potential new employer manufacture and distribute the same or similar products, the new employment would not necessarily violate a non-compete obligation. If the former employer sold the product only in a specific industry, which is unrelated to the customer base of the new employer, or if the former employer was in the wholesale business, while the new employer is in the retail business, good arguments can be made that the non-compete would not be violated. In these situations, the analysis often comes down to the question of what the former employer’s scope of “business” was, against which the former employer seeks to prevent the employee from competing.

The new employer should make sure to memorialize that it expects the new employee not to violate any non-solicitation or non-compete obligations and not to disclose any trade secrets. Accordingly, the offer letter should include express representations from the employee that he or she will not perform certain activities (such as soliciting former colleagues or customers) as long as a restrictive covenant remains in effect. The offer letter should also direct the employee not to bring any documents containing trade secrets or confidential information to the new employment. Should a lawsuit arise in the future (which, as explained below, may also be targeted against the new employer), such an offer letter can be very helpful for the employer’s defense.

Risks for the New Employer

If the new employee’s hiring or his actions at the new employer might be prohibited by his post-employment covenants, the new employer is subject to three risks.

First, the former employer may sue the employee and request the court to grant temporary restraints prohibiting the employee (and any colleagues he may have solicited to join him at the new employer) from working for the new employer. At that point, the employee may become (at least temporarily) useless for the new employer.

Second, the former employer may sue the new employer directly. Such a lawsuit may assert a violation of the applicable state statute or case law for the protection of trade secrets, with the argument that the new employer misappropriated the former employer’s trade secrets using improper means. Another cause of action may be a claim for tortious interference with a contractual relationship or prospective economic advantage. The employee and the former employer continue to have a contractual relation for the duration of any post-employment covenant. If the new employer knows about the agreement and hires the employee with a reasonable expectation that the employment would violate such restrictive covenants, U.S. law may allow the former employer to proceed directly against the new employer for damages or injunctive relief (prohibition to employ). To avoid such direct actions against the new employer, the above described protective measures can be of utmost importance.

Third, even where the employee and the new employer believe, in good faith, that there is no violation of any obligation to the former employer and even in the absence of such an obligation, the former employer may sue the employee and the new employer in an attempt to lessen the competitive impact of the new employer’s hiring. In our system, where each party usually pays its own attorney’s fees, irrespective of the outcome of the litigation, such strategic steps by the former employer cannot be discounted.

Conclusion

German employers interested in hiring valuable management, sales or marketing people for their U.S. operations, should determine whether such employees are subject to post-employment restrictions, analyze carefully whether those covenants are enforceable and if they are, take protective measures to avoid a violation. Not doing so, can subject the employee and employer to unnecessary litigation risks in the United States. Finally, where the analysis is done through counsel, and a strategy is devised by counsel, the new employer stands a better chance of asserting applicable discovery privileges over related internal communications.


1 To avoid any confusion, the above enforceability limitations only relate to restrictive covenants in employment situations. Non-compete and non-solicitation covenants entered into in connection with the sale of a business, are construed much more liberally, including in California, and often are enforceable particularly to protect the assets conveyed in the deal.

2 The UTSA is a form of proposed legislation that, as of 2014, has been adopted by almost all U.S. states, except for New York and Massachusetts. Here, trade secrets are governed by case law following the Restatement of Torts, in particular Restatement (First) of Torts, § 757, cmt. b. However, in general, a trade secret under the UTSA would also be considered a trade secret in application of the Restatement of Torts.