Meet Sammy Orbison. For years he managed the wireline recertification business for Ma-Tex Rope Company. Trouble is, he started competing with Ma-Tex while still on the payroll, spending about 10% of his time helping competitor American Pipe Inspections (API) set up its own wireline recertification business. Then he left Ma-Tex and went to work for API, where he used Ma-Tex’s confidential customer and price information to solicit business from Ma-Tex’s customers.

As a result, in his first two weeks at API, Sammy made sales to two Ma-Tex customers totaling (imagine voice of Dr. Evil from Austin Powers) over THREE THOUSAND DOLLARS!

Naturally, Ma-Tex sued Sammy and API for Sammy’s breach of his non-compete and confidentiality agreement, misappropriation of trade secrets, and breach of fiduciary duty. At trial, Ma-Tex’s owner testified—without explanation—that if Ma-Tex had made those two sales, it would have profited $2,300.

The evidence also showed that Sammy received salaries from Ma-Tex and API but did not receive any commissions for the two disputed sales.

You be the judge

Let’s say you’re the judge in this case. What damages would you award to Ma-Tex?

Before you answer, let me give you two important pieces of information about Texas law on departing employees:

(1) Breach of contract and misappropriation of trade secrets require proof of actual damages; breach of fiduciary duty does not. The court can order forfeiture of benefits as a remedy for breach of fiduciary duty, regardless of actual damages.

(2) An employee owes a sort of limited “fiduciary” duty to an employer. I’ve called this Fiduciary Duty Lite. In the simplest terms, it’s a breach of this duty for an employee to actively compete with his own employer while still employed, or to use the employer’s confidential information to compete at any time.

Knowing that, what damages would you order Sammy to pay?

A. Nothing. The lost profits evidence was insufficient, and there was no other evidence of actual damages.

B. Order Sammy to forfeit 10% of his Ma-Tex salary for breach of fiduciary duty for competing with Ma-Tex while employed by Ma-Tex.

C. Order Sammy to forfeit two weeks of his salary at API for breach of fiduciary duty for the use of Ma-Tex’s confidential information at API.

D. B and C.

If you answered D, you are not alone. In a case with roughly these facts (I have simplified, of course), that’s what the Texarkana Court of Appeals recently ruled in Orbison v. Ma-Tex Rope Company.[1]

But the correct answer is B. In my view, ordering forfeiture of benefits an employee receives after leaving the first employer stretches the employer’s “fiduciary” duty too far. I’ll explain.

But first, let’s look at the reasoning of Orbison. The evidence was insufficient to support any award of lost profits as actual damages. An owner of a business can testify to the amount of lost profits, but he has to give some explanation of how the number was calculated. In Orbison, the owner literally said nothing more than “Yes, it was close to $2,300” (and then repeated the figure). That doesn’t cut it.

This defect in the evidence killed Ma-Tex’s claim for actual damages for breach of contract and misappropriation of trade secrets. Both of those causes of action require proof of actual damages. And for both of these claims, the purpose of actual damages is to compensate the plaintiff, not to punish the defendant.[2] So if the evidence isn’t sufficient to prove actual damages, you don’t get any damages for breach of contract or misappropriation of trade secrets.

A different animal

Breach of fiduciary duty is a different animal. A fiduciary duty arises from certain relationships where a person is entrusted with responsibility for guarding the interests of another person. The classic examples are lawyers and trustees. The core of the fiduciary duty is a duty of loyalty, i.e. the fiduciary’s duty to put the other person’s interests ahead of his own.

You can already see that fiduciary duty has a certain moral element. It’s not just against the law to violate a fiduciary duty, it’s wrong.

Most people probably feel the same about breaking a contract. After all, a contract is a covenant—could there be a more morally charged obligation?

But the law doesn’t see it that way. Contract law is basically amoral; its job is to regulate commerce and keep the marketplace running efficiently, not to make moral judgments. Contract law embraces the notion of “efficient” breach, the idea that a breach is fine, even to be encouraged, as long as the breaching party is willing to make the other party whole by paying actual damages.

You might say contract law is cold-blooded, while fiduciary duty law is warm-blooded.

And because of the unique nature of a fiduciary duty, a claim for breach of fiduciary duty has certain special advantages, including: (1) the availability of forfeiture or “disgorgement” of benefits as an alternative remedy to actual damages; (2) shifting the burden of proof to the fiduciary to prove he didn’t breach his duty; and (3) the ability to pursue a third party with deeper pockets for “knowing participation” in the breach of fiduciary duty. These three things are not available for a breach of contract.

Fiduciary duty applied to employees

Now that you know the special advantages of a breach of fiduciary duty, you can see why it matters whether an employee’s duty to an employer is called a “fiduciary” duty. It’s not just semantics.

In Orbison, the employee argued that the forfeiture remedy for breach of fiduciary duty should not be available against an employee who merely receives a salary, and that it should not apply to compensation the employee receives from his new employer. But the Texarkana Court of Appeals rejected both arguments. In both cases, the court reasoned, the fiduciary received compensation for “breaching the trust of his principal.”

But this shows why I suggested in Fiduciary Duty Lite that it was a mistake for Texas courts to label the employee’s duty a “fiduciary” duty. It’s a mistake for two reasons, one descriptive and one normative.

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Does Ma-Tex Rope Company set a precedent that will go too far?

The descriptive reason is that fiduciary duty is a misnomer in this context. Whatever policy preferences you have, the employee’s duty just isn’t a “fiduciary” duty in the full sense of the word. Nobody seriously thinks that an employee owes an employer the same level of duties owed by a lawyer or a trustee. And the Texas cases acknowledge this, expressly stating that it’s not a breach of fiduciary duty for an employee to actively make plans to compete with her employer and even to conceal those plans.

The normative reason is that the legal deck is already substantially stacked against employees.

Think about it. Employers have no legal duty of loyalty to employees. Quite the opposite: under the at-will employment doctrine, the employer can fire the employee any time, for any reason (with some narrow exceptions), or for no reason. Imposing a one-way duty of loyalty on employees just doesn’t seem fair.

On the other hand, it’s not fair for an employee to actively compete with his employer while the employer is paying the employee. You could argue this is just an application of the traditional principle that an agent owes his principal a fiduciary duty as to matters within the scope of his agency.

But if we must use the term “fiduciary” for employees, we should limit the scope of that duty appropriately.

Where to draw the (wire)line

Here’s where I would draw the line. As Texas courts have already said, it should be a breach of the employee’s limited fiduciary duty to compete with the employer (as opposed to preparing to compete) while still employed. And forfeiture of benefits should be an available remedy for that kind of breach.

I don’t see this as unduly punitive. Employees who compete with their current employers should be expected to know they are doing something wrong.

On the other hand, Texas courts should stop classifying an employee’s post-employment use of confidential information or trade secrets as a breach of fiduciary duty. That means forfeiture of benefits the employee receives after leaving the employer should not be an available remedy.

I say this for several reasons.

First, this rule would not leave the employer without a remedy. The employer would still have the remedy of actual damages for an employee’s post-employment breach of contract or misappropriation of trade secrets.

Second, Texas courts are already holding that the Texas Uniform Trade Secrets Act preempts a common-law claim for breach of fiduciary duty based on misappropriation of trade secrets.[3] So any claim for breach of fiduciary duty based on trade secrets should be off the table anyway.

The third reason is prudential. Almost any time an employee who has customer relationships leaves a company to work for a competitor, there is a plausible basis for the first company to claim the employee is using company trade secrets, which can include customer lists and prices. See The Price Undercutting Theory in Trade Secrets Litigation. In Orbison, the forfeited salary from the new employer was only about $2,300, but in future cases it could be a lot more. If we let employers hold the club of salary forfeiture over every departing employee’s head, it could chill competition and tilt the balance of power too much against the employee.

And then employees will really be at the end of their rope.

Rope. Get it? Ma-Tex Rope Company?

Oh, never mind.

___________________________________________________________________

IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. This post is dedicated to Roy Orbison.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Orbison v. Ma-Tex Rope Co., No. 06-17-00112-CV, 2018 WL 2993012 (Tex. App.–Texarkana June 15, 2018).

[2] On the trade secrets claim, the plaintiff can get punitive damages for proving a “willful” violation by “clear and convincing” evidence, Tex. Civ. Prac. & Rem. Code § 134A.004(b), but that’s not part of “actual” damages.

[3] E.g. Super Starr Int’l, LLC v. Fresh Tex Produce, LLC, 531 S.W.3d 829, 843 (Tex. App.—Corpus Christi 2017, no pet.). See discussion in Embarcadero Technologies, Inc. v. Redgate Software, Inc., No. 1:17-cv-444-RP, 2018 WL 315753, at *2-4 (W.D. Tex. Jan. 5, 2018).

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