Question:

I just discovered that one of my employees may be helping a friend start a business that might compete with my business. It is my understanding that my employees owe a duty of loyalty to my company. What is the duty of loyalty? In situations where an employee breaches the duty of loyalty, what recourse is available to my company?

Answer:

You are correct that an employee owes a duty of loyalty to the employer he or she is working for. Specifically, an employee has a duty to act in the best interest of his or her employer during the course of the employment relationship. In addition, everything an employee acquires through the employment relationship, except for compensation, belongs to the employer. The duty originates from the common law relationship between a principal and an agent, and is codified in the California Labor Code.

Section 2863 of the California Labor Code states, “An employee who has any business to transact on his own account, similar to that entrusted to him by his employer, shall always give the preference to the business of the employer.” In addition, Section 2860 of the California Labor Code explains that “Everything which an employee acquires by virtue of his employment, except the compensation which is due to him from his employer, belongs to the employer, whether acquired lawfully or unlawfully, or during or after the expiration of the term of his employment.”

In Huong Que, Inc. v. Mui Luu, the Court of Appeal explained the obligations which are part of the duty of loyalty. For example, the duty of loyalty includes the duty to refrain from competing with the employer and from taking action on behalf of or otherwise assisting the employer’s competitors. It also includes the duty not to use confidential information of the employer for the employee’s own purposes or those of another party. Moreover, an employee must not acquire a material benefit from a third person in exchange for actions taken by the employee through the employee’s use of his or her position.

If a company believes that an employee has breached his or her duty of loyalty, the company may file a lawsuit against the employee for monetary damages and/or injunctive relief. Depending on the facts, the lawsuit may be based on the statutory duty as well as numerous contract and tort claims. However, before filing such a lawsuit, the company should carefully consider what monetary damages have been caused by the breach of the duty of loyalty and whether filing a lawsuit against the employee is in the company’s best interest. In addition, the company should decide whether the potential recovery is more than the costs of obtaining such recovery (including monetary, emotional, and operational costs).

The duty of loyalty may also be used in the defense of a wrongful termination case. For example, in Fowler v. Varian Associates, an employee was terminated when the employer found out that the employee was creating a competing company. The employee sued, but the Court of Appeal held that the employee’s divided loyalty provided good cause for termination.

The above described duty of loyalty exists in the absence of a company policy or agreement between the employee and employer. However, it is wise to have an employment policy that explains the duty of loyalty. In fact, many employee handbooks have provisions explaining the duty, usually within a conflicts of interest policy. Some provisions are extremely detailed, while others simply restate the language of the Labor Code. Either way, such policies can prevent employees from successfully arguing they were unaware of the duty of loyalty. In addition, employment agreements and confidentiality agreements explain employee obligations and can be drafted to provide additional protection and remedies for employers.

In closing, during the course of employment, an employee owes his or her employer an undivided duty of loyalty. Moreover, an employee’s breach of that duty can be asserted affirmatively or as a defense in a lawsuit. While the above-described duty of loyalty is not owed after the employment relationship ends, other remedies may be available if a former employee has misappropriated trade secrets or engaged in unfair competition.
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