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UK decision on employees duty of loyalty may influence NZ courts

05 August 2012

This article was first published in the August edition of Boardroom magazine.​

It is how many businesses get started, particularly in New Zealand.  The would-be entrepreneur gets a job, learns the industry then strikes out on his or her own account. 

But what are the rules in the transition from employee to competitor?  To what extent can employees, while still on their employer’s time, prepare to compete against that employer?  The circumstances in these disputes are often complex, but the law just got a lot clearer thanks to a recent UK decision.

We expect that this judgment will be influential in the New Zealand courts for two reasons – it came from the UK Court of Appeal, and it provides a very clear enunciation of the legal position. 

An IT specialist looks ahead

Jeremy Ranson joined Customer Systems (CS), a UK-based IT consultancy, in 2001 and was promoted up the ranks to divisional manager.  Despite these promotions, he became disenchanted with his career prospects at CS and gave one month’s notice on 12 January 2009.  Two years previously, he had incorporated Praesto Consulting.

The issues at appeal revolved around his dealings with two men – Alex Clothier and David Boardman – with whom he had developed close working relationships while at CS and with whom he pursued work for Praesto both before and during his notice period.

Clothier had worked for a firm which was one of CS’s key clients but was moving to Diageo Great Britain Ltd and was asked by CS if there were any work opportunities for CS at Diageo.  Ranson and a CS director hosted a lunch for Clothier at which this was discussed and it was agreed that, after Clothier had been in the position four weeks, Ranson would contact him.

In fact a job suiting Ranson’s skills and experience arose immediately Clothier started at Diageo.  He recommended Ranson for the work to the project manager responsible for making the decision and introduced the two men.  Although still in CS’s employ, Ranson took the contract for himself without informing CS of the opportunity.

Two days before Ranson left CS he took David Boardman, the IT manager at AstraZeneca, another important CS client, out for a boozy dinner.  Ranson paid for the meal himself, and it was in his own time, but the purpose was to pave the way for Praesto to get future work offers. 

Ranson appealed the lower court’s findings that his conduct in relation to Clothier and Boardman was in breach of his contractual duty of good faith to CS, and the Court of Appeal found for him.  It said the lower court had drawn on cases involving company directors but Ranson was only an employee and the difference was “highly material” because employees do not owe fiduciary duties to their employer.

The “hallmark” of a fiduciary was “a single-minded duty of loyalty”.  The employee’s duty of loyalty, by contrast, was “one where each party must have regard to the interests of the other, but not that either must subjugate his interests to the other”.

Ranson’s obligations to CS were defined by his employment contract, and that contract had imposed no restraint of trade conditions on him after he left CS.  “This freedom to compete, once an employee has left, unrestrained by any enforceable covenant, carries with it a freedom to prepare for future activities, which the employee plans to undertake, once he has left”, the Court said.

This much more contractual approach could well be reflected in future by the New Zealand courts, and, if so, would represent a significant departure from previous practice as the leading New Zealand decision is still the Court of Appeal judgment in Schilling v Kidd Garrett Ltd, 1976. 

A chain saw expert looks ahead

Hans Schilling was employed in late 1970 by Kidd Garrett Ltd to establish an exclusive New Zealand agency for them with Husqvarna.  He concluded an agreement with Husqvarna in November 1970 and by 1973 had a new distribution network in place. 

But he had various grievances against his employer and in January 1974, Schilling decided to leave and to seek the Husqvarna franchise for himself.

Although his contract provided for one month’s notice, he insisted on leaving after only two weeks, one of which he took as annual leave.  He used this week to go to Husqvarna’s head office in Sweden to have the franchise transferred to H. Schilling Ltd, a company he had formed with his wife.  He kept this visit secret from Kidd Garrett.

The Court concluded:  “He (Schilling) evidently felt that he could secure a considerable advantage to himself, at the expense of his employer, by giving a short notice, concealing his intentions, and making the first personal contact with Husqvarna representatives in Sweden”.

It paid no regard to the specific terms of Schilling’s employment contract, instead working from the implied principle that an employee is “bound to serve his employer in good faith and fidelity” and applying an essentially moral test – whether Schilling’s behaviour “would be looked upon by a person of ordinary honesty as dishonest conduct toward the employer”.    

Take-outs

To protect against the risks exposed by the UK Appeal Court’s findings, businesses should ensure that employment agreements:

  • require employees to act faithfully and in the best interests of the company, including passing on all relevant business information and potential opportunities, and
  • are updated to reflect employee promotions, and any associated widening of expectations attaching to employees.

Marie Wisker is a senior associate at Chapman Tripp, specialising in employment law and commercial dispute resolution.

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