Confidential information and departing employees - the threat from within

Scenario

One of your company’s longest-serving and most senior employees resigned recently. His departure was cordial. A farewell lunch was held and was enjoyed by all. A few weeks later, you stop hearing from several of your company’s most valuable customers. It soon becomes apparent that your former trusted colleague — contrary to what he had told you during his exit interview — has established a new business in the same field, which is directly competing with your company. A meeting is convened to determine your company’s strategy. To the dismay of your company’s new chief executive officer, it is revealed that the former employee had insisted for many years that detailed records of all transactions with customers be prepared for him and updated on a weekly basis. And nobody could tell why — until now.

Armed with this information, your former trusted colleague sets about poaching more of your company’s valuable customers, offering discounts on “current prices”, and demonstrating an uncanny knowledge of each customer’s previous purchasing preferences and product lines. In six months’ time, all of your company’s major customers have left. The business is no longer viable. Your former trusted colleague feels a level of guilt, as he switches from fifth to sixth gear in his new Aston Martin.

The risks posed to businesses by their former employees have never been greater. But what obligations do employees owe to their current and former employers with regard to confidential information? And, perhaps more importantly, what steps can employers take to minimise the risks of a nightmarish scenario such as the one described above destroying the profitability of their business?^[1]

Employees’ obligations to their employer

Sources of employees’ obligations

Employees’ obligations relating to the use of information obtained during the course of their employment may derive from various sources. These include:

• express and implied obligations owed as part of their contract of employment; 
• fiduciary duties to act in their employer’s best interests and not in their own interests at the expense of their employer, which include a duty not to misuse their employer’s confidential information;^[2] 
• corresponding obligations owed under sections 182 and 183 of the Corporations Act 2001 (Cth);^[3] and
• the equitable obligation of confidence.^[4]

Can a person use confidential information obtained during employment?

Yet despite these various sources of obligation, whether a person may use information obtained during the course of their employment can be determined by reference to the following questions:

• Is the information in question a “trade secret”, “know-how” developed by the employee during the course of their employment, or merely “trivial” information?
• Is the employee subject to a post-employment contractual restraint that seeks to prohibit the use of confidential information? 
• If so, is that provision enforceable?

Trade secret, know-how or trivial information?

The nature of the relevant information is vital to determining whether the (former) employee may use it, and when. The authorities divide information into the three categories mentioned above: trade secret, know-how and trivial information.

Trade secret

From an employer’s perspective, the trade secret is tantamount to the golden ticket. A trade secret is secret information that is confidential to the employer.^[5] It can perhaps be better described as “information which, if disclosed to a competitor, would be liable to cause real (or significant) harm to the owner of the secret”.^[6]

Naturally, an employee may not use such information during the course of their employment for purposes other than those that enhance the interests of their employer. However, after an employee has left their employment, the law will also act to prevent the employee using such information,^[7]“whether or not there is a contractual agreement”^[8] between the former employee and the former employer restricting such use.

Factors relevant to determining whether information is a trade secret

While it is “clearly impossible to provide a list of matters which will qualify as trade secrets or their equivalent”,^[9] it may assist to consider the following factors when assessing whether a particular piece of information is capable of protection by an employer as a trade secret:^[10]

• the extent to which the information is known outside the employer’s business; 
• the extent of measures taken by the employer to guard the secrecy of the information; 
• whether the circulation of the information in question is limited to only certain individuals within the employer’s business;
• the value of the information to the employer and the employer’s competitors; and 
• the ease or difficulty with which the information could be properly acquired or duplicated by others.

Information possessing the quality of confidence

Although each case must be determined on its own facts,^[11] the courts have held that the following information can possess the necessary quality of confidence to be categorised as such a trade secret:

• customer lists;^[12] 
• the prices at which manufacturers sell, and the nature of the products sold and purchased;^[13] 
• pricing information;^[14] 
• costing information;^[15] and 
• profit-and-loss figures.^[16]

Know-how

The second relevant category of information in this context is generally described as “know-how”. This is information that is confidential “but which once learned necessarily remains in the servant’s head and becomes part of his own skill and knowledge applied in the course of his master’s business”.^[17] In this regard, while employers are entitled to protect their bona fide confidential information from being used by former employees to their detriment, this interest must be balanced against the:

"… prima facie right of any person to use and to exploit for the purpose of earning his living all the skill, experience and knowledge which he has at his disposal, including skill, experience and knowledge which he has acquired in the course of previous periods of employment."^[18]

Position of an employee disclosing information while employed, compared to when no longer in service

While an employee remains employed, the employee would breach the duty to act in the employer’s best interests if they disclosed or used this kind of information to the employer’s detriment. However:

"… when he is no longer in the same service, the law allows him to use his full skill and knowledge for his own benefit in competition with his former master … If an employer wants to protect information of this kind, he can do so by an express stipulation restraining the servant from competing with him (within reasonable limits of time and space) after the termination of his employment."^[19]

An example of this kind of information is the identity of the former employer’s customers. Although the former employee may not create a list of the employer’s customers, while still employed, for the purpose of soliciting the business of those customers after they leave,^[20] the former employee may use their (honestly gained) memory of the identity of their former employer’s customers to canvass the business of those customers once the former employee has departed.^[21]

As may be expected, the cases are littered with examples of former employees seeking to establish that the information they have used in their new business was not a trade secret of their former employer, but simply know-how that they had acquired over the course of their many years in the relevant industry.

Often, however, evidence of the actual conduct of the former employee can be used to counter such a submission. For example, in Halliday & Nicholas Insurance Brokers Pty Ltd v Corsiatto,^[22] the court held that where an employee goes “to the trouble of” copying documents of his employer, in doing so the employee “establishes both their importance to himself and their confidential nature”.^[23] In other words, one does not need to copy what one already knows. Similarly, in AIIB Ltd v Beard,^[24] the court noted that where an employee copies information but denies having used it, “it would surely not have been necessary for [the employee] to copy if he already had them at the top of his head”.^[25] In that case, Ward J concluded: “I can only conclude that [the employee] was seeking to equip himself with the information with which to compete”.^[26]

Trivial information

The third category of information that is relevant in this context is “trivial information”. As Megarry J put it in Coco v AN Clark (Engineers) Ltd,^[27]“equity ought not to be invoked merely to protect trivial tittle-tattle, however confidential”.^[28]

In other words, although a piece of information gained by an employee may strictly be confidential, where it is trivial (in the sense that the former employer has no legitimate interest in preventing its further use), the courts will not act to prohibit the employee from using it.^[29]

So, what can a business do to protect its confidential information?

Legal steps: the post-contractual restraint

Express prohibitions in employment contract

The primary legal means by which a business can protect its confidential information is by imposing express prohibitions upon the use of such information in employment contracts.

As explained above, while the law (even in the absence of relevant express contractual terms) will act to prevent employees from using trade secrets either during or after the term of their employment, former employees are free to use the know-how that they honestly gained during their former employment after they leave, even if that information is confidential to their former employer. However, the authorities have established that employers may prevent their former employees from using information in this second category “by means of a restrictive covenant”^[30] or an “express stipulation”^[31] in employees’ contract of employment that prohibits such use.^[32]

Specific descriptions of types of information prohibited from use

In addition, although it is not strictly necessary to impose express obligations upon employees in relation to the use or disclosure of trade secrets, whether a particular piece of information is a trade secret is often difficult to define after the event.

Accordingly, it is useful to set out in an employee’s employment contract specific descriptions of the information that the employee is forbidden to use (both during and after the term of employment). This can be done in the form of a schedule setting out specific examples. It is best practice to have a mechanism to update that schedule as new confidential information is developed within the business and as the employee’s role changes.

Contract drafting: “one size does not fit all”

In this regard, it is important to remember that employment contracts should be drafted with precision, and obligations relating to confidential information should be tailored to the employee concerned. One size does not fit all.

Particular care is required because such express restrictions are subject to the restraint of trade doctrine. Although an extensive analysis of the restraint of trade doctrine as it applies in the employment setting^[33] is beyond the scope of this article, in essence, a court may deem that a post-contractual restraint concerning confidential information is unenforceable if it is found to be beyond what is reasonably necessary to protect the employer’s legitimate interests. In those circumstances, unless the employer can show that the information concerned was a trade secret and thereby invoke the employee’s equitable obligation of confidence, the employee will be free to use the information concerned as they please.

Practical steps

Legal means aside, the best way to prevent an employee or former employee from using the confidential information of your business to its detriment is to take practical steps within the business in order to prevent employees from accessing and/or taking such information with them when they leave.

In particular, it is important to build a fence around corporate confidential information, and keep the gate shut. Knowing what is within the fence is the first step. This can be achieved by conducting regular audits. If you do not know what confidential information is held within your business, you cannot properly develop, commercialise and protect it.

In addition, doing the simple things can make all the difference. If a document is confidential, mark it as such. Only record and share confidential information as appropriate. Limit disclosure to those who need to know — the more valuable the confidential information, the more limited its disclosure should be. Having said that, there is a significant danger in having one employee who is “too valuable” to lose because they hold key confidential information in their head.

It is also important to put in place systems to restrict access to confidential information (such as by using password protection or user access controls for electronic data) and to monitor such access and use. Again, there is little use in having systems in place to control access if those systems are not used.

And, for when an employee resigns…

Finally, your business should have standard procedures for dealing with departing employees. Among other things, those procedures need to deal with the issue of corporate confidential information. In particular, at the exit interview, remind the employee of their continuing confidentiality obligations and require the employee to hand over personal electronic devices (laptops, tablets and smartphones). If the device is the employee’s own, remove corporate confidential information and then return the device to the employee.

Further, where the employee leaves to go to a competitor or to start up their own competing business, quarantine the former employee’s computer (and corporate laptop, tablet and smartphone) for a short period following their departure. If you later become concerned that the employee may have taken confidential information when they left, a forensic analysis of computer systems will be critical in determining what action to take next.

Finally, and most importantly, investigate concerns and take swift action where appropriate. If your business is concerned that an employee may have taken confidential information, seek legal advice and take action to prevent the information being used or further disclosed. Failure to do so could lead your business into the type of situation described in the opening paragraphs of this article — a narrative that is not hypothetical but rather is based on the facts of a case in which we recently acted.

This article was first published in the Employment Law Bulletin Vol 19 No 5, August 2013

^[1] See, generally, M Pittard, A Monotti and J Duns (eds) Business Innovation and the Law: Perspectives from Intellectual Property, Labour, Competition and Corporate Law, Edward Elgar Publishing, London 2013. ^{Back to article}

^[2] Blyth Chemicals Ltd v Bushnell (1933) 49 CLR 66; 6 ALJR 457; Robb v Green [1895] 2 QB 315. ^{Back to article}

^[3] Which are not to any major extent wider than the duties owed by employees under the general rules of equity: see Futuretronics.com.au Pty Ltd v Graphix Labels Pty Ltd (2009) 81 IPR 1 at 45; [2009] FCAFC 2 (Tamberlin, Finn and Sundberg JJ). ^{Back to article}

^[4] Faccenda Chicken Ltd v Fowler [1987] Ch 117; (1985) 6 IPR 155; [1986] 1 All ER 617; [1986] 3 WLR 288. ^{Back to article}

^[5] See, for example, Ansell Rubber Co Pty Ltd v Allied Rubber Industries Pty Ltd [1967] VR 37 at 46; Lansing Linde Ltd v Kerr (1990) 21 IPR 529; [1991] 1 All ER 418; [1991] 1 WLR 251 at 260, 270. ^{Back to article}

^[6] Above, n 5, at 536 per Staughton LJ. ^{Back to article}

^[7] Above, n 4. ^{Back to article}

^[8] Wright v Gasweld Pty Ltd (1991) 22 NSWLR 317 at 334; 20 IPR 481; (1991) AIPC 90-797; 39 IR 256 per Kirby P. ^{Back to article}

^[9] Above, n 4. ^{Back to article}

^[10] Above, n 8; above, n 4. ^{Back to article}

^[11] As to the importance of this, see the comments of Campbell JA in Del Casale v Artedomus (Aust) Pty Ltd (2007) 73 IPR 326 at 355; 165 IR 148; [2007] NSWCA 172. ^{Back to article}

^[12] NP Generations Pty Ltd v Feneley (2001) 80 SASR 151; 214 LSJS 205; [2001] SASC 185 at [19]–[20]; Prime Creative Media Pty Ltd v Vranjkovic [2009] FCA 1030 at [15]. ^{Back to article}

^[13] Consolidated Paper Industries Pty Ltd v Matthews [2004] WASC 161 at [89]. ^{Back to article}

^[14] Ridgeway International Ltd v McCullum (unreported, NSW Supreme Court, 9 April 1988) at [43]; Ithaca Ice Works Pty Ltd v Queensland Ice Supplies Pty Ltd [2002] QSC 222 at [37]; Krueger Transport Equipment Pty Ltd v Glen Cameron Storage & Distribution Pty Ltd (2008) 78 IPR 262; [2008] FCA 803 at [92]. ^{Back to article}

^[15] Thomas Marshall (Exports) Ltd v Guinle [1979] Ch 227 at 248–9; [1978] 3 All ER 193; [1978] 3 WLR 116; [1979] FSR 208; Herbert Morris Ltd v Saxelby [1916] 1 AC 688 at 705; [1916] All ER Rep 305; (1916) 32 TLR 297; Digital Products Group Pty Ltd v Opferkuch [2008] NSWSC 575 at [12]; Gilman Engineering Pty Ltd v Simon Ho Shek On (1986) 8 IPR 313 at 322. ^{Back to article}

^[16] Gasweld Pty Ltd v Wright (1989) ATPR 40-957; 34 IR 91 at 97. ^{Back to article}

^[17] Above, n 4. ^{Back to article}

^[18] Above, n 4. See also Riteway Express Pty Ltd v Clayton (1987) 10 NSWLR 238 at 240; 5 ACLC 1045. ^{Back to article}

^[19] Above, n 4. ^{Back to article}

^[20] See Wessex Dairies Ltd v Smith [1935] 2 KB 80 at 89. ^{Back to article}

^[21] See Robb v Green [1895] 2 QB 315. ^{Back to article}

^[22] Halliday & Nicholas Insurance Brokers Pty Ltd v Corsiatto (2001) 11 ANZ Ins Cas 61-505; [2001] NSWCA 188. ^{Back to article}

^[23] Above, n 22, at [17]. ^{Back to article}

^[24] AIIB Ltd v Beard [2009] NSWSC 1001. ^{Back to article}

^[25] Above, n 24, at [194]. ^{Back to article}

^[26] Above, n 24, at [199]. ^{Back to article}

^[27] Coco v AN Clark (Engineers) Ltd (1968) 1A IPR 587 at 591; [1968] FSR 415; [1969] RPC 41. ^{Back to article}

^[28] See also Commonwealth v John Fairfax & Sons Ltd (1980) 147 CLR 39 at 51; 32 ALR 485; 55 ALJR 45. ^{Back to article}

^[29] Above, n 4. ^{Back to article}

^[30] Above, n 11. ^{Back to article}

^[31] Above, n 4. ^{Back to article}

^[32] See also Wright v Gasweld Pty Ltd (1991) 22 NSWLR 317 at 329 per Gleeson CJ; at 335 per Kirby P and at 340–1 per Samuels; 20 IPR 481; (1991) AIPC 90-797; (1991) 39 IR 256. ^{Back to article}

^[33] See further J D Heydon The Restraint of Trade Doctrine LexisNexis Butterworths (3rd edn) 2008 chs 4–7. ^{Back to article}