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TN Court of Appeals offers guidance on when preparing to compete crosses the line

All Tennessee employees owe a duty of loyalty to their employer. Among other things, that means they can’t compete with their employer while still employed. In addition, certain employees may be subject to noncompete agreements that restrict their activities both during and after their employment. But what if the employee isn’t actually competing but instead is only taking preliminary measures to prepare to compete? In two recent decisions, the Tennessee Court of Appeals has offered guidance on this issue.

Testing the waters

Todd Heins served as a manager at a Memphis store owned by Leslie’s Poolmart, a national swimming pool company. Although he signed a nonsolicitation and noncompetition agreement, it prevented him from competing only while still employed by Leslie’s. In 2015, customer Jay Karcher approached Heins about opening a competing business. For several months, Karcher and Heins—while Heins was still employed by Leslie’s—scouted potential locations, filed paperwork to start a new company, and took other actions to prepare to open the business.

The next year, Heins quit so he could pursue the competing venture. Leslie’s sued him for breach of contract, breach of fiduciary duty, and other claims. The trial court found that Heins’ preparatory actions were fair game, and the Tennessee Court of Appeals agreed.

Noting that “competition is, obviously, a key element of the free enterprise system,” the court stated that employees generally are allowed to prepare to compete while still employed. The court rejected Leslie’s position that “Heins, in order to adhere to his contractual duties and fiduciary duty, somehow was compelled to reject Karcher’s idea, change the subject, or else resign on the spot if he wished to pursue the idea with Karcher.” The court also noted that the outcome may have been different “had Heins undermined Leslie’s in some fashion while [he] still worked for Leslie’s.” Leslie’s, however, presented no evidence of any foul play, and therefore, Heins’ preparatory actions were acceptable. Leslie’s Poolmart, Inc. v. Blue Wave Pool Supply of Memphis, LLC, 2018 WL 3738666 (Tenn. Ct. App., Aug. 6, 2018).

Missed opportunities

In another recent case, the Tennessee Court of Appeals enforced a provision of a noncompete agreement that prevented an employee from “prepar[ing] to compete directly or indirectly” while still employed. Before leaving to work for a competitor, Brad Patterson “concocted a plan to leave,” provided his new employer with a client list and sales estimate, and signed an agreement with his new employer. Within four days after leaving, he made 12 customer agreements for his new employer despite establishing only half that number for his former employer during the months leading up to his resignation. That seemed fishy.

Following a trial, the trial court ruled that Patterson breached his agreement. The court of appeals affirmed that finding. According to the court, “these facts establish, at the very least, that [Patterson] was preparing to compete and failed to dedicate his best efforts while still employed by” his former employer. Great Am. Opportunities, Inc. v. Patterson, 2018 WL 1678077 (Tenn. Ct. App., Apr. 6, 2018).

Bottom line

The key in determining whether an employee’s preparatory actions cross the line is whether the employer is being unfairly harmed. Courts have found that it’s OK for an existing employee to take the following preparatory steps:

  • Form/incorporate a business that will compete;
  • Develop a business plan;
  • Negotiate for the purchase of a business;
  • Conduct preliminary research and development to determine feasibility;
  • Register a trademark;
  • Make arrangements for financing;
  • Gather basic information;
  • Purchase equipment;
  • Open a bank account;
  • Lease office space;
  • Obtain a telephone listing; and
  • Tell clients of the employee’s future plans provided that the communications aren’t solicitations.

On the other hand, courts have found that it’s not OK for a person to do the following while still employed:

  • Use the employer’s trade secrets or other confidential information;
  • Solicit customers or coworkers;
  • Leave the employer in a lurch;
  • Take preparatory actions while “on the clock” or use the employer’s office or property;
  • Usurp a corporate opportunity; or
  • Undertake substantive design and development activities.

Based on the Great Am. Opportunities case, an employer may be able to limit the scope of employees’ preparatory conduct by implementing noncompete agreements that include language preventing preparatory actions to compete. However, you will need to be ready to justify the language. At the end of the day, the ultimate question for the court often is whether the employee’s preparatory actions are placing you at an unfair competitive disadvantage.

David L. Johnson is a partner in Butler Snow’s labor and employment practice group in the Nashville office. He may be reached at david.johnson@butlersnow.com.

Originally published in the Tennessee Employment Law Letter on 10/01/2018. Edited by: Kara E. Shea and David Johnson of Butler Snow LLP.