A recent report called The Walker Loyalty Report for Loyalty in the Workplace, released in September 2007, noted more than 35% of employees are likely to leave an employer within the first two years of employment. Yet, employers’ investments in training, recruiting, and compensation continue to rise. Turnover is even more damaging when employees take clients, employees and trade secrets with them. Do employers have the legal right to expect their employees’ loyalty? And what can an employer do to protect itself from competitive conduct by employees during employment?

Employees Owe a Duty of Loyalty to Their Employers

Employees’ duty of loyalty to their employers finds its source in the common law. An employee has a duty to act solely for the benefit of the employer when engaging in any conduct that relates to the employment. California has codified the “duty of loyalty” in Labor Code sections 2860 and 2863. An employee is obligated to give preference to the business of the employer when conducting any business on his or her own that is similar to the employer’s business. Likewise, everything the employee acquires from the employer by virtue of his or her employment (except compensation) belongs to the employer, whether acquired during or after the term of employment. Thus, an employee who improperly competes with his employer, assists a competitor during the course of employment, or makes use of the employer’s confidential information to compete with the employer after termination may have breached the duty of loyalty.

These principles potentially are inconsistent with the public policies favoring competition for employees’ services and employees’ rights to seek employment with whom they wish. The case law in this area recognizes that employers’ have little right to restrict employees’ post-employment activities, whether competitive or not. Employees even have some latitude to prepare to compete while still employed.

Beyond the Employment Relationship

The employee’s legally recognized fidelity to his or her employer largely ends when the employment ends. With some exceptions, an employer may not attempt to force employees to refrain from acts in conflict with the employer’s interests beyond the employment relationship. The non-compete agreement is one example of an impermissible attempt to control employees’ post-termination activities. These agreements prohibit an employee from accepting employment with competitors after employment ends. Valid in many states to one degree or another, they are illegal under California law except in narrow circumstances, such as in connection with the sale of a business and its goodwill. An ex-employee, therefore, is free to apply his or her skills on behalf of the new employer, and in fact owes that new employer a statutory duty of loyalty.

While the duty of loyalty does not apply to post-termination activities, employees may not engage in “unfair competition.” The primary restriction is that employees may not steal the former employer’s trade secrets or other property to gain an advantage in competition. The employee also may not injure the former employer by unfair means such as by “raiding” the former employer’s staff with the intention of harming its ability to compete.

Duty of Loyalty During the Employment Relationship

There are a number of ways an employee may breach the duty of loyalty while still in the employment relationship. An employee who has access to trade secrets (e.g., valuable, confidential information that would give the employer’s competitors a competitive edge), and takes or uses such information for that purpose has violated the employee’s duty of loyalty. This includes using an employer’s confidential customer list, or soliciting its employees or customers to further a competitive business.

In Huong Que, Inc. v. Mui Luu, for instance, the Court of Appeal found that current employees’ use of their employer’s customer list to help a competitor solicit the employer’s customers breached the employees’ duty of loyalty. In that case, the former owners of a calendar company remained employed by the new owners. At the same time, they appropriated the customer list, met with competitors to plan the formation of a competing business and steered plaintiff’s customers to the competing business. The court held the defendants clearly breached their duty of loyalty by attempting to divert customers to the competitor while still employed.

Divided loyalties often arise when employees prepare to leave their current employers. The California Supreme Court recognized in Bancroft-Whitney v. Glen, that some efforts to start a competing venture during employment do not always amount to a breach of loyalty. While still an employee, the defendant in that case assisted a competitor by disclosing employee salary information and soliciting his co-workers for positions with the competition. The employee misled his current employer about the possibility of an employee raid and discouraged the employer from granting salary raises to any of its employees. The court noted that the employee was disloyal not by failing to disclose his intentions to work for the competitor, or by making preparations to compete. Rather, the employee breached his duty of loyalty because the nature of the preparations had clearly harmed the current employer and resulted in the employer losing a number of its employees.

Although not all preparations violate the duty, there are a number of cases when courts have found employees crossed the line. In Stokes v. Dole Nut Co., two employees at one of Dole’s receiving/packaging/processing plants began preparations to start an almond processing plant. When Dole discovered their plans, the employees were terminated. The two former employees brought suit for breach of an employment contract and breach of the covenant of good faith and fair dealing. The Court of Appeal found that the employees were at a managerial level, had access to confidential information, had been trying to establish a competing business and would rely on contacts they had made at Dole to run their competing business. Under such circumstances, the court held it would be impossible for the employees to represent Dole’s interests with undivided loyalty and Dole had good cause to terminate them.

In Fowler v. Varian Associates, the Court of Appeal similarly ruled an employer had good cause to terminate an employee who was working to create a new company that would compete with his employer, Varian Associates. In that case, the employee was involved in developing a company that would market a viable alternative product to one of his employer’s products. The employee would eventually be a business partner and the company would pool from the same customer base as Varian. The court found the employee’s involvement with the development of the new company created a conflict of interest. The employee had an obligation to look out for the best interests of his current employer. As the marketing manager, the employee had a duty to use the information about the new company to further his current employer’s business. At the same time, the employee felt he had to treat the developing company’s plans a secret in his best interests as a potential partner in the new business. The court, therefore, held that because the employee could not give Varian his undivided loyalty, Varian had cause to terminate him.

The duty of loyalty is not without limits, of course. Under the Labor Code, employers cannot regulate employees’ lawful off-work activities. Therefore, unless “moonlighting” creates an actual conflict of interest, the employee is free to work other jobs simultaneously. Employees are also free to protest unlawful or dangerous activity, enjoying statutory and common law protections for “whistleblowers.” Employees can attempt to organize and join a union, even though doing so is not necessarily in the employer’s best interests.

Enforcing and Enhancing the Duty of Loyalty

Employers of course may discharge employees who breach their duty of loyalty, whether employment is “at will” or not (as the employers did in Stokes and Fowler, discussed above). Employers contractually bound to discharge employees only for cause must comply with applicable standards for determining whether cause exist, including conducting an investigation that is “reasonable” under the circumstances.

Breach of the duty may be pursued in civil litigation as well. However, employers must be prepared to show misappropriation of trade secrets to enforce restrictive covenants and to obtain relief under the Uniform Trade Secrets Act. Otherwise, employers must prove that a breach of loyalty caused harm, and must consider whether pursuing litigation is more costly than the potential recovery. There are a number of theories available to employers, including breach of contract (such as a confidentiality agreement), fraud, interference with contract or prospective economic advantage, and unfair business practices under the state’s broad Unfair Competition Law.

Litigation is rarely as effective as prevention to solve problems caused by disloyal employees. Employers may take a number of measures to prevent or mitigate employees’ disloyalty. Most obviously, employers should consider personnel policies and practices that engender employees’ loyalty. Employees who feel valued and respected naturally are less likely to act against the employer’s best interests. Employers may wish to train management on the expectation of loyalty, what information is confidential and their obligations to protect it from disclosure.

Granted, there are employees who cannot be persuaded by the carrot. Employers should take additional measures to protect their property. Enforceable confidentiality agreements are one part of a comprehensive approach. Electronic data should be protected by proper security measures, which may include policies and practices such as electronic monitoring, logging of data transfer, and network security levels limiting access to data. Employers also may wish to conduct exit interviews, during which employees may be questioned about company property.

None of these measures will absolutely prevent employees from breaching their duty of loyalty. But employer attention and vigilance can send a message to employees about what is expected, what is wrong, and the employer’s commitment to preventing and pursuing misuse of its property.