What is “Knowing Participation” in Breach of Fiduciary Duty?

What is “Knowing Participation” in Breach of Fiduciary Duty?

TexasBarToday_TopTen_Badge_VectorGraphicThe knowing participation in breach of fiduciary duty theory in departing employee litigation

Conspiracy. Cooperation. Participation. “Collusion.” Which of these will get a company in legal trouble when it hires an employee away from a competitor?

A recurring problem in the law is deciding when a third party, let’s call it a “secondary” actor, is liable for the wrongful conduct of a “primary” actor. There are numerous legal theories for this, but in essence they all share two common elements:

(1) some level of knowledge or intent by the secondary actor

(2) some level of action taken by the secondary actor

The arguments usually center around how much knowledge and what level of action.

Let’s apply this to a common legal theory in departing employee litigation: breach of fiduciary duty. When an employee leaves a company to work for a competitor, the first company will often claim that the employee breached her fiduciary duty to the company, and that the subsequent employer “knowingly participated” in the employee’s breach of fiduciary duty.

What kind of evidence is necessary to prove such a claim?

An employee’s “fiduciary” duty

Before we get to that, let’s back up a bit and ask a more fundamental question: does an employee owe her employer a fiduciary duty?

The short answer: “sort of.” In Texas, where I practice law, an employee owes a kind of “fiduciary” duty to her employer, which I call Fiduciary Duty Lite.

I say “kind of” because a true fiduciary duty would include a duty to put the employer’s interests first and to disclose all material facts to the employer, but no one says an employee owes that kind of fiduciary duty.

Texas courts have said that it is not a violation of the employee’s fiduciary duty to make plans to compete with the employer and even to conceal those plans from the employer. See Johnson v. Brewer & Pritchard, P.C., 73 S.W.3d 193, 201 (Tex. 2002); Wooters v. Unitech Int’l, Inc., 513 S.W.3d 754, 763 (Tex. App.—Houston [1st Dist.] 2017, pet. denied); Abetter Trucking Co. v. Arizpe, 113 S.W.3d 503, 510 (Tex. App.—Houston [1st Dist.] 2003, no pet.). This policy recognizes the need for employee mobility.

So what kind of conduct violates an employee’s “fiduciary” duty? There are two key categories:

(1) misappropriating the company’s confidential information or trade secrets*

(2) soliciting the company’s employees or customers while still employed by the company

Why the asterisk on the first category? The problem is that the Uniform Trade Secrets Act expressly preempts common-law civil remedies for misappropriation of trade secrets. See Tex. Civ. Prac. & Rem. Code § 134A.007.

So, despite references to misappropriation of trade secrets in the fiduciary duty cases, in Texas you cannot assert a common-law breach of fiduciary duty claim based on allegations of taking or using trade secrets. Super Starr Int’l, LLC v. Fresh Tex Produce, LLC, 531 S.W.3d 829, 843 (Tex. App.—Corpus Christi 2017, no pet.).

The open question is whether TUTSA also preempts a fiduciary duty claim that is based on alleged misappropriation of information that is confidential but not a trade secret. So far, courts in Texas are split on that question. See 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).

That means in most cases the fiduciary duty claim is going to focus on allegations of solicitation of employees or customers.

Why does fiduciary duty matter?

But why does this matter when employment agreements often prohibit such solicitation? There are a few reasons.

First, in some cases the employee may not have a contract that prohibits soliciting employees and customers.

Second, even if the employee already has a contractual non-solicitation obligation, a breach of fiduciary duty claim gives the employee a potential remedy that a breach of contract claim typically does not: forfeiture or “disgorgement” of compensation as an alternative to actual damages. For a recent case awarding forfeiture on this theory, see Orbison Case Shows Need for Texas Courts to Limit Employee “Fiduciary” Duties.

Third, the fiduciary duty theory gives the first employer a potential claim against the second employer, who is usually a deeper pocket. The first employer can assert a claim for “knowing participation” in breach of fiduciary duty, which allows recovering damages from the second employer.

Knowing participation in breach of fiduciary duty

That brings us back to my original question: how does the first employer in a departing employee lawsuit prove knowing participation? I glean three essential elements from the case law:

  1. The employee solicited while still employed by the company
  2. The second employer knew about the solicitation
  3. The second employer participated in the solicitation

In practice, the knowledge element is somewhat redundant. If the second employer participates in the solicitation, it will almost always have knowledge of the solicitation. You are rarely going to find a case of “unknowing” participation. So the second employer’s participation is really the key element.

“Participation” sounds simple enough, but like “collusion” it can be more difficult to define in practice. To understand participation better, let’s take a look at a couple recent Texas cases applying knowing participation in breach of fiduciary duty to typical departing employee scenarios.

At the bottom of the deep blue sea . . .

In Wooters v. Unitech International, Inc., 513 S.W.3d 754 (Tex. App.—Houston [1st Dist.] 2017, pet. denied), Unitech operated in the offshore and subsea oil and gas production industry. Two Unitech employees made plans with Wooters, who has not a Unitech employee, to form a competing business called Infinity Subsea.

The jury found that Wooters conspired with the Unitech employees to breach their fiduciary duties, but the Court of Appeals held that the evidence was insufficient to support the jury’s verdict.

In reaching this decision, the court emphasized what is and is not a breach of an employee’s “fiduciary” duty. As we’ve seen already, making secret plans to compete with your employer is not a breach of fiduciary duty, even if it violates a contractual duty. Therefore, even though there was evidence that Wooters communicated with the employees about their plans to compete, that was no evidence that Wooters participated in any breach of fiduciary duty.

What about misappropriation of confidential information and trade secrets? As pointed out earlier, that can be a breach of fiduciary duty (putting aside the preemption problem).

There was evidence that the two employees misappropriated Unitech’s secret design information, and the jury even found that the two employees committed theft. But the jury answered “no” when asked if Wooters conspired with the employees to commit theft. So the jury’s “yes” answer to the conspiracy to breach fiduciary duty question had to be based on something else.

The only thing left was the possibility that Wooters participated in solicitation of Unitech customers or employees. But there was no evidence of this. “[N]othing in the record shows that Wooters possessed knowledge of and was complicit in Pennington and Kutach’s solicitations of employment of any Unitech employees,” and “Infinity Subsea did not hire any Unitech employee.” Id. at 766.

So the Court of Appeals reversed the trial court’s judgment against Wooters and rendered judgment that Unitech take nothing against Wooters. A big win for Wooters, obviously. (And this summary of the case does not do justice to the juicy facts, which included things like video surveillance of an employee and an office break-in.)

The practice tip I derive from Wooters is that if you represent the plaintiff claiming “knowing participation,” you need to tie the secondary actor’s participation to the part of the scheme that breached the employee’s fiduciary duty, not just to the scheme in general.

In other words, it’s not enough to show that the “participator” joined in a plan for the employees to compete with their employer. You’ve got to show he participated in the solicitation of employees or customers, or some other conduct that violated the employees’ fiduciary duties. This was the evidence that was lacking in Wooters.

But what if there had been evidence like that? Let’s say the Unitech employees, while employed by Unitech, had solicited a key Unitech engineer to go to a competing company they planned to join. Generally, that would be a breach of their fiduciary duty. And let’s suppose the new venture, Infinity Subsea, had communicated with the Unitech employees about the solicitation and hired the key engineer away from Unitech.

Surely, that would be sufficient evidence of the second employer’s “participation” in the employees’ breach of fiduciary duty, right?

I went down to the Crossroads . . .

Not necessarily. In Crossroads Hospice, Inc. v. FC Compassus, LLC, __ S.W.3d __, 2020 WL 1264188 (Tex. App.—Houston [1st Dist.] March 17, 2020), the same Court of Appeals held that facts like these were insufficient to prove that the second employer participated in the employee’s solicitation of another employee.

In the Crossroads case, Clement was the executive director of Compassus, a hospice care provider. Clement and several colleagues discussed leaving Compassus, Clement discussed those plans with a competitor, Crossroads, and Crossroads expressed hope that Clement could “bring her whole team.” While still employed by Compassus, Clement emailed Crossroads a list of staff and an introduction to another Compassus employee, Dr. Lee.

Here’s the kicker: when Crossroads later hired Dr. Lee, a Compassus VP asked Clement if she knew what was going on, and Clement pulled a Sargent Schultz: I know nothing.

Those facts were probably sufficient to make a case for breach of fiduciary duty against Clement, but the question was whether those facts established knowing participation by Crossroads. The Court of Appeals said no, for two reasons.

First, every one of the actions cited by Compassus was taken by Clement, not by Crossroads. Id. at *8.

Second, the fact that Crossroads knew what Clement was doing was not evidence that Crossroads participated in what Clement was doing.

“That Crossroads knew about Clement’s actions, and even approved of and benefited from them,” the court reasoned “does not constitute interference in the employment relationship or participation in the solicitation of these employees.” Id. The fact that Crossroads hired employees from Compassus was not “in and of itself” evidence that Crossroads knowingly participated in soliciting those employees. Id.

Thus, the Crossroads opinion sets the bar pretty high for evidence of participation. Perhaps too high. It seems clear from the emails that Clement and Crossroads were cooperating–perhaps even “colluding”?–in a plan for Clement to bring her “team” to Crossroads, with Crossroads at least implicitly encouraging Clement to do so. Is that not “participation”?

Wherever you come down on this, you probably agree that the decision in Crossroads slices the cheese pretty thin on what constitutes “participation.”

Don’t encourage him

That leads to my second practice tip. If you represent Employer 1 in this scenario, you need to try to obtain evidence that Employer 2 contributed to causing Employee 1 to solicit Employee 2. It may not be enough to show that Employee 1 and Employer 2 talked about soliciting Employee 2. Ideally you want to offer evidence that Employee 1 would not have solicited Employee 2 if Employer 2 had not encouraged it.

In a deposition or courtroom cross-examination of Employee 1, it might go something like this:

Screen Shot 2020-05-25 at 5.33.10 PM

It won’t always go this smoothly in practice. But if you can get testimony like this, it may be enough to clear the “participation” hurdle the Crossroads opinion sets up.

On the other hand, if you represent Employer 2, you want to prepare Employee 1 for this kind of questioning.

Of course, there is only so much you can do. If the fact is that Employer 2 caused Employer 1 to solicit Employer 2, there may be no way around that. But if the second employer didn’t encourage the solicitation, you want to make sure the witness doesn’t stumble into saying it did.

Or maybe just tell the witness to repeat “there was no participation” a hundred times. It’s the new “collusion.”

_____________________________________

IMG_4571

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Orbison Case Shows Need for Texas Courts to Limit Employee “Fiduciary” Duties

Orbison Case Shows Need for Texas Courts to Limit Employee “Fiduciary” Duties

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.

boat-boating-close-up-275637
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).

The Matrix: Making Sense of the Patchwork of Employee Confidentiality Duties

The Matrix: Making Sense of the Patchwork of Employee Confidentiality Duties

What if I told you that to understand an employee’s confidentiality duties, you need to understand there are three kinds of confidential information covered by at least four different areas of law?

You see, employers have three kinds of confidential information:

  1. Trade secrets
  2. Confidential information that is not a trade secret
  3. “Confidential” information that is not actually confidential

A trade secret is confidential information that has “independent economic value” and is “not readily ascertainable” by competitors. Secret technology, secret business plans, the literal secret sauce—these are obvious trade secrets. Less obvious things like customer lists and company prices can be trade secrets if they have independent economic value and are not readily ascertainable. In other words, you can tell that information is a trade secret if obtaining the information gives a company a competitive advantage.[1]

A typical employer is going to have a lot of confidential information that is not a trade secret. For example, a social security number or other personal identifying information of an employee is highly confidential. Same for an employee’s personal healthcare history. But information like that is typically not going to give the company any competitive advantage.

Of course, employees learn all kinds of information about the company that is not confidential at all. People outside the company may not know how to get to the company cafeteria, but that information isn’t really confidential. (Think Tom Cruise pointing out that the location of the mess hall is not in the Marine manual in A Few Good Men.)

So why do I include non-confidential information in the list of types of confidential information? Because many companies define virtually all company information as “confidential” in their employment agreements or employee policies. I’ve seen a lot of employment agreements like this, and you’ve probably seen the same thing.

So what does the law say about an employee using these three types of confidential information after leaving the company? There are four key areas of law that govern an employee’s duties concerning confidential information.[2]

Four areas of law. Three types of information. I feel a matrix coming.

And here it is. This chart shows which areas of law cover which types of information:

Screen Shot 2018-03-25 at 9.11.57 PM

Don’t worry, I’ll explain.

Trade Secrets Law

Most states, like Texas where I practice, have some version of the Uniform Trade Secrets Act, affectionately known as UTSA. Then there is a federal statutory overlay called the Defend Trade Secrets Act (DTSA). These statutes provide civil remedies for “misappropriation” of trade secrets, including injunctions, actual damages, and, in some cases, punitive damages and attorneys’ fees. See Trade Secrets 101.

But the trade secrets statutes do not apply to misappropriation of confidential information that is not a trade secret. And whether the information at issue is actually a trade secret is often a major point of contention. So employers don’t want to limit themselves to protecting trade secrets.

Confidentiality Agreements

Enter the confidentiality agreement. Almost every employment agreement is going to have some kind of confidentiality clause. And while the definitions of confidential information vary, the tendency is to define confidential information very broadly. As a result, most confidentiality agreements are not limited to trade secrets.

Heck, most confidentiality agreements are not even limited to confidential information. And thus the question mark in the “Non-Confidential Information” column above. Is it really a breach if the employee uses or discloses information that is not actually confidential?

To make this less abstract, let’s say while working for Paula Payne Windows, Dawn Davis learns the name and phone number of the right person to contact at a window manufacturer to check prices and place orders. Dawn quits and goes to work for Real Cheap Windows. Does she violate her agreement if she uses her knowledge to place a call to the guy she knows at the window manufacturer?

This may be a technical breach, but it is unlikely to give Paula Payne a solid claim for damages, for at least two reasons.

First, it would be hard for Paula Payne to prove that the breach caused damages, especially if Dawn Davis could have found the same person simply by calling up the manufacturer and asking who to talk to. (It would become more complicated if the agreement also has a liquidated damages clause, which to the delight of Contracts professors has been in the news lately.)

Second, defining confidential information to include virtually everything is arguably an illegal restraint of trade or commerce. It is a restraint of trade because, if applied literally, it would effectively prevent an employee from doing anything in the same industry after leaving the company.

So, disclosure of non-confidential information probably isn’t an actionable breach of a confidentiality agreement. But it’s still a question mark.

Fiduciary Duty Lite

Fiduciary Duty Lite is the term I use for the limited kind of “fiduciary” duty that employees owe employers. An employee’s Fiduciary Duty Lite includes a duty not to use the employer’s confidential information or trade secrets in competition with the employer.

So why no check mark for Fiduciary Duty Lite under the Trade Secrets column? In a word: preemption. The Texas Uniform Trade Secrets Act expressly states that it displaces any conflicting law providing civil remedies for misappropriation of a trade secret.[3] Texas courts have interpreted this to mean that TUTSA preempts a breach of fiduciary duty claim that is based on alleged misappropriation of a trade secret.[4] Thus, no check mark.

But what about a breach of fiduciary duty claim that is based on an employee’s use of confidential information that is not a trade secret? Does the trade secrets statute displace that claim?

Courts are split on this question. The “majority” rule seems to be that the trade secrets statute preempts this type of claim, even though the claim does not require proof of a trade secret.[5]

This rule should bother advocates of textualism. The plain language of the trade secrets statute says it displaces “conflicting” law providing civil remedies for misappropriation of a trade secret. A claim for breach of Fiduciary Duty Lite that is based on information that is not a trade secret does not conflict with the statute.

But I get it. The rationale is that allowing an employer to characterize what is really a trade secrets claim as a claim for breach of fiduciary duty would conflict with the preemptive purpose of the trade secrets statute.

Anti-Hacking Statutes

The relevant statutes are not limited to trade secrets. Consider also the federal anti-hacking statute, the Computer Fraud and Abuse Act (CFAA).[6] The Texas version is the Breach of Computer Security and Harmful Access by Computer Act (BCS).[7]

College football fans know that BCS also stands for Bowl Championship Series, but that is probably just a coincidence.

I would summarize these statutes, but I really can’t improve on the article here by Texas lawyer and cybersecurity expert Shawn Tuma. Bottom line: these statutes prohibit “unauthorized access” to computers and provide civil remedies for knowing and intentional violations.

I will use the BCS as an example. If a company hacks into a competitor’s server and steals confidential information, that is an obvious violation. But the BCS is not limited to hacking by outsiders. An insider who accesses the company computer system for an improper purpose or exceeds the scope of his authorized access can also violate the statute, because the statute prohibits access without the company’s “effective consent.”

The picture gets fuzzier when an employee’s access was authorized at the time. Let’s take the typical departing employee scenario where an employee legitimately obtains confidential information from the employer’s computer system in the course of employment for a legitimate purpose, but the employee later misuses the information for the improper purpose of competing with the employer. Whether that conduct violates the statute is a more difficult question.

Another tricky question is whether the employer could have a claim under the anti-hacking statute for an employee obtaining non-confidential information from the company’s computer system. The BCS is not limited to confidential information, but it does require proof of “damages as a result” of the unauthorized access, i.e. causation. As with confidentiality agreements, it may be difficult to prove a violation caused damages if the accessed information was not really confidential.

Oh, one more thing just to add another layer of complexity. As with fiduciary duty, a claim under the anti-hacking statute that is based on misappropriation of trade secrets is preempted by the trade secrets statute.[8]

Are we clear?

___________________________________________________________________

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. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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] The words “competitive advantage” don’t appear in the statutes that now define trade secrets in most states and under federal law, but you see the phrase in the common-law case law, e.g. In re Bass, 113 S.W.3d 735, 739 (Tex. 2003), and it is useful for understanding what is and is not a trade secret.

[2] I can’t wait for one of my Fivers to point out I have left out some crucial additional source of employee confidentiality duties, like HIPPA.

[3] Tex. Civ. Prac. & Rem. Code § 134A.007(a). But note the statute does not preempt a breach of contract claim.

[4] 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.).

[5] 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).

[6] 18 U.S.C. § 1030. USC also stands for University of Southern California, a traditional college football power. Noticing a pattern here?

[7] Tex. Penal Code § 33.02; Tex. Civ. Prac. & Rem. Code § 143.001.

[8] Embarcadero, 2018 WL 315753 at *5.

Is That Your Final Answer? Lost Profits Damages in “Fiduciary Duty Lite” Cases

Is That Your Final Answer? Lost Profits Damages in “Fiduciary Duty Lite” Cases

Last month, the Beaumont Court of Appeals issued a revised opinion on lost profits damages in Rhymes v. Filter Resources, a typical Fiduciary Duty Lite case.

Fiduciary Duty Lite? As I wrote here, that is the flavor of fiduciary duty that an employee owes to an employer under Texas law. As I explained, it doesn’t really make sense to call it “fiduciary” duty, but that’s the label Texas courts have used so we’re probably stuck with it.

Winneconne WI - 17 Feb 2016: Six pack of Miller Lite in cans.
“Fiduciary Duty Lite” allows an employee to make plans to compete

Essentially, Fiduciary Duty Lite says that an employee can prepare to compete with his employer while still employed but cannot actually start competing until after leaving the employer. If you suspect that maintaining this distinction is easier in theory than in practice, you may have a bright future in Fiduciary Duty Lite litigation.

But first you have to pass this quiz. Here are the facts of Rhymes in simplified form:

  1. Employee signs agreement with Company that says Employee will not solicit the Customers for one year after leaving Company.
  1. Employee speaks to attorney who provides formal legal opinion that non-solicitation clause is “not worth a s**t.”
  1. Employee gets access to Company’s double super-secret information, such as “products, prices, contracts, and financial, vendor, and customer information” (i.e. the same kind of information every sales employee gets).
  1. Employee, while employed by Company, prepares to compete with Company, including forming Competitor and communicating with Customers about Employee’s plans.
  1. But Employee testifies he did not actually “solicit” Customers before leaving Company (whatever that means).
  1. After leaving Company and joining Competitor, Employee quickly begins selling to his old Customers from Company.
  1. Company sues Employee and Competitor. Law firm partner who represents Company buys new Lexus. At trial, Company’s damages expert presents these numbers for Year 1:

screen-shot-2016-10-23-at-7-49-14-pm

  1. Company’s expert also testifies that Company’s lost profits for a five-year period would be $622,800, using Year 1 as a base line and assuming a gradual decrease over Years 2-5 to account for risk and customer attrition.
  1. Employee and Competitor present no contrary expert testimony.
  1. Jury finds that Employee breached his Fiduciary Duty Lite and finds damages of $620,000 for Year 1 and zero dollars for Years 2-5.

Got it? Now, here is the multiple choice question.

QUESTION: Assuming there was sufficient evidence that Employee breached his Fiduciary Duty Lite, what is the right amount of damages to award to Company based on the jury verdict?

A. $620,000. This is the amount found by the jury, and there is some evidence to support it because Employee earned revenue of over $638,000 in Year 1.

B. $206,767. Lost profits damages must be based on net profits, not gross revenues, so there is insufficient evidence to award $620,000 for Year 1 but sufficient evidence to award $206,767 for Year 1.

C. $622,800. Company’s damages expert testified to this amount of net profits for Years 1-5 without contradiction.

D. Zero dollars. There is legally insufficient evidence to support the amount of damages found by the jury.

E. None of the above. A new trial should be ordered. (I added this choice strictly for my appellate ninjas.)

If you’re struggling, don’t feel bad. It took the Beaumont Court of Appeals two tries to come up with its final answer.

Here’s one important clarification: you are allowed to suggest a “remittitur,” which means giving the winning party the choice of a lower amount of damages or a new trial. With that clarification, the best answer–and the answer ultimately chosen by the Beaumont Court of Appeals in this revised opinion–is B. But you could make a plausible case for each of these answers.

A. $620,000. To support this answer you could cite the principle that the jury’s answer must be upheld as long as there is some evidence to support it. In fact, this was the answer the Beaumont Court of Appeals chose in its original opinion, reasoning that this amount was within the range of evidence presented at trial. But the problem with this answer is that the jury’s answer on damages was specifically broken down by time period, and there was no evidence that the Company would have made net profits of $620,000 during Year 1.

B. $206,767. There was evidence that this was the amount of net profits for Year 1. For this reason, this was the answer ultimately chosen by the Beaumont Court of Appeals (in a revised opinion), suggesting a remittitur of this amount.

C. $622,800. There was some evidence to support this amount–testimony from the Company’s damages expert–but the problem with this answer is that the jury is free to reject even un-contradicted expert testimony.

D. Zero dollars. It is true that there  was legally insufficient evidence to support the amount of damages found by the jury. But when there is evidence of some amount of damages, the Court of Appeals typically will not reverse and render judgment for the defendant, but will reverse and remand for a new trial. Which leads to . . .

E. None of the above – order a new trial. The Court of Appeals could have chosen this answer, because there was insufficient evidence to support the amount of damages awarded by the jury. But this is why the remittitur procedure exists, to give the Court of Appeals the more efficient option of awarding a smaller amount of damages rather than subjecting the parties to the time and expense of a new trial.

Thank you for playing!

_________________________________________________________________

IMG_4571

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. He made up the part about the Lexus.

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.

Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving

Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving

When an employer sues a former employee who went to a competitor, the employer almost always claims breach of fiduciary duty.  But do employees really owe employers a fiduciary duty under Texas law?  If the employee is also an officer or director, the answer is yes.  But for ordinary employees, the answer is “sort of.”  Employees owe employers what I call Fiduciary Duty Lite.

A true fiduciary duty arises from certain relationships where a person trusts and depends on another person to act on his behalf.  The attorney-client relationship is the prime example.   It includes a duty of loyalty, duty of disclosure, and duty of care, but the essence of the duty is that the fiduciary must put the other person’s interests ahead of his own.

So, for example, as a trial lawyer I have a fiduciary duty to tell my client if accepting a settlement offer is the best move, even if I would like the client to reject the offer so I can make more money on litigation fees (not that any lawyer would ever think like that).

No one seriously thinks that all employees owe the employer that kind of fiduciary duty.  If employees had to put the employer’s interest ahead of their own, employees could never start looking for another job without telling the employer first.

But employees do sometimes act as agents of their employers, and generally an agent owes a fiduciary duty to her principal.  So Texas courts have reasoned that an employee who acts as an agent of the employer owes the employer a fiduciary duty.

But Texas courts also recognize limits on an employee’s “fiduciary” duty.  In Johnson v. Brewer & Pritchard the Texas Supreme Court said “courts have been and should be careful in defining the scope of the fiduciary obligations an employee owes when acting as the employer’s agent.”  The court agreed with other states that “an employee does not owe an absolute duty of loyalty to his or her employer.”[1]  In other words, Fiduciary Duty Lite.

*Caveat: A claim for breach of fiduciary duty based on misappropriation of trade secrets is preempted by the trade secrets statute, as discussed here.

Texas courts have defined certain things an employee can and cannot do.[2]  While still working for the employer, an employee cannot:

  • Use the employer’s confidential information or trade secrets
  • Cross the line between preparing to compete and actually competing
  • Solicit the employer’s customers or other employees
  • Accept a fee for diverting a business opportunity away from the employer
  • Use the employer’s resources to establish a competing business

On the other hand, Fiduciary Duty Lite recognizes certain things an employee is allowed to do:

  • Make plans to compete with the employer
  • Take “active steps” in pursuit of the plan
  • Join with other employees in the plan
  • Form a competing business
  • Conceal all of the above from the employer

Wait a minute, you might say.  Doesn’t a fiduciary have a duty of loyalty, a duty of full disclosure, and a duty to put the employer’s interests ahead of his own?  How can taking active steps towards competing with the employer and concealing that from the employer possibly be consistent with a fiduciary duty, the highest legal duty known to man?

You would have a point.  It doesn’t really make sense to call an employee a “fiduciary” (unless that employee is also an officer or director).  Perhaps instead of saying that employees have a “fiduciary” duty and then curtailing that duty almost beyond recognition, Texas courts should have used some other terminology.

But it’s too late for that.  “Fiduciary” is the word.  So when the judge asks “are you telling me all employees have a fiduciary duty?” just say “they have Fiduciary Duty Lite” and cite fiveminutelaw.com.  I look forward to seeing the term in future Texas court opinions.

*Update: The El Paso Court of Appeals endorsed the concept of “Fiduciary Duty Lite” (sort of) in Salas v. Total Air Services (Feb. 14, 2018), saying the employee in that case owed “some measure of a fiduciary duty” to the employer. That strikes me as kind of like saying someone is “a little bit pregnant.”

*2nd Update: The Fifth Circuit weighed in on Fiduciary Duty Lite in D’Onofrio v. Vacation Publications (Apr. 23, 2018). The court held the employee did not breach her “limited” fiduciary duty by becoming part owner of a competing franchise, using a screenshot of sales records to demonstrate sales ability, and attending a training for a competitor.

*3rd Update: When the employee breaches his fiduciary duty, can the employer seek forfeiture of part of the employee’s salary? This was one of the issues in Orbison v. Ma-Tex Rope Co. (Tex. App.–Texarkana June 15, 2018).

*4th Update: In Crossroads Hospice, Inc. v. FC Compassus, LLC, No. 01-19-00008-CV, 2020 WL 1264188, at *6-8 (Tex. App.–Houston [1st Dist.] March 17, 2020, no pet. h.), the court held that the first employer failed to establish a prima facie case (under the TCPA) that the second employer knowingly participated in the employee’s alleged unlawful solicitations of the first employer’s at-will employees.

_________________________________________________________________

IMG_4571

Zach 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 John Madden.

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] Johnson v. Brewer & Pritchard, PC, 73 S.W.3d 193, 202 (Tex. 2002), citing Augat, Inc. v. Aegis, Inc., 409 Mass. 165, 565 N.E.2d 415 (1991).

[2] Johnson, 73 S.W.3d at 202; ; Navigant Consulting, Inc. v. Wilkinson, 508 F.3d 277, 284 (5th Cir. 2007); Ameristar Jet Charter, Inc. v. Cobbs, 184 S.W.3d 369, 373-74 (Tex. App.—Dallas 2006, no pet.); Abetter Trucking Co. v. Arizpe, 113 S.W.3d 503, 512 (Tex. App.—Houston [1st Dist.] 2003, no pet.); M P I, Inc. v. Dupre, 596 S.W.2d 251, 254 (Tex. Civ. App.—Fort Worth 1980, writ ref’d n.r.e.).