We are all faced at one time in our business life when our key employee says "I'm leaving to work for a competitor" or "I'm opening up a similar business on the same street and I am taking your major client." To help employers deal with these situations, Massachusetts courts hold that a key employee owes their former employer what is known as the "duty of loyalty." The courts define "key employee" as an employee occupying a position of trust and confidence. This would seem to include, at a minimum, managers, department heads, decisionmakers and supervisory employees. To counterbalance this burden to key employees, the courts have developed a policy of promoting competition, even if it is by key employees against their former employers. Courts feel that if an employer wishes to restrict post-employment competition of a key employee, it should seek that goal through a non-competition agreement.
Despite the existence of non-competition agreements, in many instances the employer has either not had their key employees sign non-competition agreements, or, because of the circumstances involved, the non-competition agreements are not fully enforceable. In such cases though, an employee's right to compete is not unlimited. The "duty of loyalty" prohibits a key employee from taking a business opportunity of their employer for the employee's own personal gain. While this duty does not necessarily prohibit an employee from taking part in a business opportunity, it does prohibit an employee from appropriating trade secrets of their employer, soliciting their employer's customers while still employed, and using an employer's resources in the pursuit of a competitive opportunity (i.e., using an employer's assets in pursuit of the opportunity (telephone, computers, etc.) or pursuing the opportunity during hours of employment).
What is not clear is how far in advance an employee can plan to take competitive steps and what steps can be taken. The current case law appears to permit an employee to take competitive steps, but cautions an employee from going too far in its actions as it may be breaching its "duty of loyalty" owed to its employer. As to what specific actions and the timing of such actions a court is likely to consider a breach of this duty, it largely depends on the facts and circumstances of each individual case.
If an employee learns of a business opportunity during employment, the safest path for the employee is to inform their employer of the opportunity prior to acting upon it. An employer would then have the right to accept or reject the opportunity. If the employer did not have the wherewithal or inclination to undertake the opportunity themselves, the employee would be free to pursue the opportunity themselves. Such an opportunity includes the purchasing of a competitor's business. If an employee does not inform his employer of this opportunity prior to the employee taking the opportunity for his/her own personal gain, the employer may have a valid claim for breach of the "duty of loyalty" for what the law refers to as an employee "usurping a corporate opportunity."
Massachusetts courts have yet to develop a litmus test as to which actions by an employee are considered "usurping of a corporate opportunity." Courts though have developed several factors which they consider. These factors include an employer's ability to undertake the opportunity, whether an employer rejected a similar opportunity previously, if the employee is an at-will employee, and whether the opportunity is in the same line of business as the employer is currently in. A recent case also added the additional factor of whether the key employee had recruited fellow employees while still employed by their employer to take with him in his competitive business. This was referred to by the court as the "pied piper" effect. Courts look negatively at this conduct because it may leave the employer without anyone qualified to operate a phase of its business and because the conduct may be designed to hurt the employer. Therefore, should an employee leave an employer without other key employees, the employer may have a strong claim that the key employee has breached its "duty of loyalty."
Even if an employee informs his employer of the business opportunity and the employer does not undertake the opportunity, the employee is not out of the woods. An employee may be breaching the "duty of loyalty" if it is determined by a court that while still employed with its employer the employee materially completed a deal to compete against the employer. As to how far an employee may go in its negotiation of the deal, that appears to be based upon the circumstances of each individual situation. Every employee wants to bake his cake and eat it too. He does not want to quit his current job until he has a new deal wrapped up. As a general rule though, the later in the acquisition process an employee waits to terminate his employment, the more likely the employee will have breached the "duty of loyalty."
Key employees are not the only people involved with a corporation who owe the corporation a "duty of loyalty." Massachusetts courts have held that stockholders in closely-held corporations also owe a duty of "utmost good faith and loyalty" to the corporation in which they own shares. The courts define a closely-held corporation as a corporation with a small number of stockholders, no ready market for the corporate stock and where the substantial majority stockholder(s) participate in the management, direction and operation of the corporation. Since stockholders in closely-held corporations are often also employees of that corporation, this results in them being held to the duties of both employees and stockholders. The courts hold stockholders in closely-held corporations to this duty of the "utmost good faith and loyalty" because they deem these relationships to be substantially equivalent to a partner's relationship in a partnership. While this standard of the "utmost good faith and loyalty" has yet to be fully defined in the area of competition between stockholders and the corporation they own stock in, the case law to date in Massachusetts appears to hold that a shareholder cannot lawfully perform activities which are detrimental to the corporation. Detrimental activities would appear to include competing against the corporation.
In conclusion, while Massachusetts courts have yet to set hard-and-fast rules with regard to how far an employee can go in competing with their employer or how far stockholders can go in competing with the corporation they own stock in, it is clear that employees/stockholders must proceed carefully or they may overstep their bounds and be guilty of breaching the "duty of loyalty."