Einstein formulated his theories of modern physics while working as a clerk in the patent office in Bern, Switzerland. Jeff Bezos worked on Wall Street before launching Amazon. Chances are your humble beginning will tell a similar story, working as an employee before you leave to launch your dream. With the markets at historically high levels, more people are self-directing their retirement accounts, according to the Retirement Industry Trust Association, and are tapping home equity to finance a new business opportunity. In fact, over its last fiscal year, the Arizona Corporation Commission processed the formation of 5,545 limited liability companies per month, a 15% increase over fiscal year 2016.
Before you act to build your company, you should understand your legal obligations to your current employer.
First, take stock of your existing agreements. Review your employment agreement. Certain promises may extend beyond your resignation, such as obligations for non-disclosure, non-competition, and non-solicitation. It is wise to have an attorney help you determine whether those restrictions are enforceable and whether they would interfere with your new venture. Additionally, locate any ancillary agreements you signed, such as an intellectual property assignment, to evaluate whether those ideas you developed while an employee belong to you — or your employer.
Further, beyond written contracts, employees owe their employer certain common law fiduciary duties during their employment.
Generally, in Arizona, employees owe duties of good faith and loyalty. And employers can assert legal claims for damages arising from a breach of those duties. A body of common law has developed, defining what acts may violate “good faith” and “loyalty” to an employer, distinguishing between an employee’s direct competition, on one hand, and permitted preparation on the other, and these cases declare certain behavior as clearly out-of-bounds, like wrongful use of company property or confidential information.
Competition or Preparation?
An employee is precluded from actively competing with his or her employer during the period of employment. Following the termination of the employment relationship, however, in the absence of an enforceable non-compete agreement, a former employee is free to compete.
Arizona law gives employees wide latitude in making lawful preparation to compete with the employer. But preparation cannot take the form of “acts in direct competition with the employer’s business.” And so, our challenge is to find the line between “preparation” and “competition.” Each situation is different, and the law applies on a case-by-case basis, where certain acts may or may not be wrongful, based upon the surrounding circumstances.
For example, certain Arizona cases have found business and legal planning to be allowable preparation. An employee may even acquire a rival business during employment, such as the purchase of a franchise, to later compete with the employer. Also, certain research and development may be legally allowable.
Additional Restrictions: Business Opportunities, Solicitation of Co-Workers
On the other hand, employees are prohibited from taking business opportunities from their employers. Additionally, employees are not entitled to solicit customers or co-workers for their competing businesses before the end of their employment. Particularly, solicitation of a co-worker might be found from a simple discussion of any benefits promised or inducements made to obtain their services for the competing company — something much less than a formal job offer. Rather, employees are generally permitted only to advise current customers and co-workers of the fact that he or she is leaving their employer.
Further, the nature of an employee’s preparation while employed has limits — and may not involve use of company property or disclosure of the employer’s confidential information. In that case, an employee’s duty to maintain confidentiality extends beyond their last day of work, but it does not include any restriction on general knowledge and skills acquired during their tenure. Finally, upon departure, be sure to return all documents, property, materials, and information that belong to your employer.
Overall, timing is the dispositive factor in determining whether an act is lawful (preparatory) or unlawful (a solicitation). So be careful and well-advised in your transition. Litigation in the early life of new companies tends to be ruinously disruptive.
The law of business organizations has continually modernized, providing us with accessible tools to limit personal liability. But, whether your company is in real estate or technology, building upon the right legal structure is critical to its long-term success. If you or someone you know has questions about how to structure their business or investments, please call our office today to schedule a consultation with Andy Anderson.