Texas Non-Compete Law Blog : Texas Non-Compete Agreements Lawyer & Attorney : K&L Gates : Trade Secret Litigation : Serving Austin, Dallas, San Antonio

It’s long been the law in Texas that an employee can, while still employed, prepare to compete with his employer, as long as he doesn’t actually do so. If he does compete with his employer, he can be found liable for breach of fiduciary duty. In a recent case decided by the federal Fifth Circuit Court of Appeals, the court explained the reason for the preparation vs. competing distinction:

In general, an employee or other agent who plans to compete with the principal does not have a duty to disclose this fact to the principal. To be sure, the fact that an agent has such a plan is information that a principal would find useful, but the agent's fiduciary duty to the principal does not oblige the agent to make such disclosure. . . .  In this respect, the social benefits of furthering competition outweigh the principal's interest in full disclosure by its agents.

The relevant facts in the case were as follows:

The plaintiff employer was a national consulting firm. One of its offices was a claims administration practice in Dallas, Texas (the “Claims Practice”). The Claims Practice’s primary business was administering complex class-action settlements. 

The two defendants in the case were high level employees who worked for the Claims Practice. Some of their responsibilities included staffing, business development, client relations, and contract negotiations for the Claims Practice. 

In the spring of 2001, one of the defendant employees was contacted by a competitor of the company. The competitor was interested in buying the employer’s Claims Practice. In response, the defendant employees prepared a proposal for the competitor to purchase virtually all of the Claims Practice’s clients and employees for $22.5 million. The proposal contained confidential business information about the Claims Practice: revenue projections, backlog estimates, margin rates, staff turnover rates, and profit margins on specific employees. The transaction was to be routed through a “management-owned corporation” – a corporation owned by the two defendants and unrelated to their employer. The defendant employees never informed their employer of this proposal to sell the Claims Practice.

Although the first proposal fell through, the defendant employees continued to submit similar proposals to other competitors – at least three different competitors between 2001 and 2002. In addition, the defendant employees brought representatives of the competitors into the Dallas Claims Practice office and introduced other employees to those representatives.

In May 2001 – just after the initial contact between the defendant employees and the competitor – one of the defendant employees negotiated and signed a four-year lease in a Dallas office building on behalf of the employer. The employer was aware of and approved of the lease; however, the employer was not aware of the proposals being submitted to various competitors.

In June 2002, about a year later, another employee– a computer technician – was instructed to copy company data onto a portable, non-company server as a “special project” for one of the defendant employees. The corporate office became suspicious and visited the Dallas office, telling the employees to stop copying company data.

In September 2002, soon after the visit from the company’s corporate office, a defendant employee contacted one of the competitors that had received a proposal and urged that the two parties quickly reach a deal. Soon after, the defendant employees provided that competitor with a new proposal. The new proposal specifically identified the defendant employees and two other individuals as the sellers of the Claims Practice. The purchase of the Claims Practice was again to be routed through the corporation owned by the defendant employees. The purchase of the Claims Practice was to be for $1.2 million cash, payable to the defendants’ corporation, and 250,000 shares of the competitor’s stock. That same defendant employees also sought to become the competitor’s agents for the progression of the deal.

In late September 2002, the defendant employees approached their employer’s corporate office and asked if they could acquire the Claims Practice in exchange for assuming the four year lease on the Dallas office building. The employer rejected their offer and the defendant employees resigned. Soon after, both accepted employment with the employer’s competitor. Less than two weeks later, the employer filed suit against the defendant employees.

In upholding a jury verdict in favor of the employer, the Fifth Circuit had this to say about the breach of fiduciary duty claim:

Based on the foregoing evidence, there was a sufficient basis for the jury to conclude that in attempting to sell the Claims Practice, Wilkinson and Taulman breached their obligation of fair dealing and good faith, and in the process disclosed Navigant's confidential information.. The jury could have concluded that their acts of introducing Navigant employees to competitors' representatives and flying an employee to interview with a competitor rose to the level of solicitation. There was also sufficient evidence for the jury to conclude that Wilkinson and Taulman breached their fiduciary duty by failing to disclose their plan to sell the Claims Practice before the lease was signed. We do not mean to suggest that the mere fact that an employer signs a new lease gives rise to a duty of disclosure in all employees who have plan to compete with the employer. But in this case. Wilkinson and Taulman were the two top employees in the Dallas office, and they had active roles in negotiating, recommending, and signing the lease. There was also evidence that the plan to compete was itself wrongful, and that part of this plan was to use the lease as leverage against Navigant in future negotiations to acquire the Claims Practice on favorable terms. The reasonable inference for the jury to draw was that Wilkinson and Taulman had a conflict of interest on the lease, because though they were charged to act for Navigant's benefit when recommending it, they also had an interest in seeing Navigant burdened with a liability that they could use as leverage against it in the future. Given these specific facts, the jury was entitled to conclude that Wilkinson and Taulman's failure to disclose their activities before Wilkinson signed the lease constituted a breach of fiduciary duty.

            As this case illustrates, determining whether a breach of fiduciary claim exists is a fact-intensive endeavor. In cases in which the employee, while still employed by his employer, telephones the employer’s clients and solicits business for the employee’s new enterprise, the factual and legal analysis is comparatively easy. In this case, though, the conduct was not as egregious—or at least not as blatant—as that. But the cumulative effect of the acts in this case was enough to constitute a breach of fiduciary duty. Perhaps most interestingly, the court held that the employees’ failure to disclose—i.e., their mere silence—was one of their actions forming the basis of the breach of fiduciary duty claim.

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To get an injunction restraining former employees from competing, an employer needs a valid non-compete agreement or a misappropriation of trade secrets claim, right?  Wrong.  A breach of fiduciary duty (duty of loyalty) can also warrant injunctive relief.

In a case decided several years ago, two employees worked for a company (“the Corporation”) that was involved in the institutional detergents business.  While still employed by the Corporation, the employees started their own detergent business, and they began competing with the Corporation (while still working for the Corporation).  Their competition included converting some of the Corporation’s customers into customers of their own business.

Eventually, the Corporation terminated the employees, and it sought an injunction against them.  The court, holding that the employees were “not entitled to benefit from such unlawful and disloyal conduct,” enjoined them from “contacting or calling on for the purposes of selling detergent products . . . any former customer of [the Corporation] whose account [the employees] obtained for [their] own competing business.”

The important holding in this case is, even without a valid (a) non-compete agreement or (b) trade secrets claim, a Texas court may enjoin an employee from benefiting from his breach of fiduciary duty.  Thus, an employer should attempt to determine whether a departing employee was competing with the employer while still employed by the latter.  If the employee was doing so, it may be possible to get an injunction to prevent the employee from continuing to benefit from the disloyalty, even in the absence of a non-compete agreement.

Gaal v. BASF Wyandotte Corp., 533 S.W.2d 152 (Tex. Civ. App.—Houston [14^th Dist.] 1976, no writ.).

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An employee may be liable for breach of fiduciary duty to his employer—even if his employer suffers no actual damages as a result of the offending conduct.  So learned an employee in a recent case.

In that case, the employee, a Project Manager for a general construction contractor, was responsible for locating potential subcontractors for the project, soliciting bids from them, and directing the work of the subcontractors that were actually hired.

At one point, the Project Manager hired a subcontracting company owned by his mother-in-law and father-in-law.  Unbeknownst to his employer (the general contractor), the Project Manager and his wife personally profited in excess of $300,000 as a result of his wife’s parents being awarded the subcontracting work.  When the general contractor subsequently learned what the Project Manager had done, it sued the Project Manager for breach of fiduciary duty.  A bench trial verdict in the general contractor’s favor was affirmed on appeal.

Lessons:

1.   The court of appeals noted that a “fiduciary” is a person “who occupies a position of peculiar confidence towards another.”  The court added that a fiduciary relationship is characterized by “integrity and fidelity,” and it contemplates “fair dealing and good faith.”  The court concluded that the Project Manager’s duties were sufficiently important to make him a fiduciary of the general contractor.

2.   In a principal/agent fiduciary relationship, the duties owed by the agent include:  the duty to account for profits arising out of his employment, the duty not to act as (or on account of) an adverse party without the principal’s consent, the duty not to compete with the principal on his own account or for another in matters relating to the subject matter of the agency, the duty to deal fairly with the principal in all transactions between them, and the duty to deal openly and to fully disclose to his employer information that affects his employer’s business.

3.   In this case, the Project Manager argued that his use of his mother-in-law and father-in-law’s subcontracting company was for the general contractor’s benefit (and that the general contractor was not in any way harmed).  But the court held that the Project Manager’s failure to inform his employer that he personally benefited from using the subcontractor company constituted a breach of his fiduciary duty, and the Project Manager had to account for all profits he earned as a result of his breach.  The court held that it was “beside the point” that the general contractor may have suffered no damages; the Project Manager’s betrayal of trust warranted the verdict against him.

Daniel v. Falcon Interest Realty Corp., 190 S.W.3d 177 (Tex. App. Houston [1st Dist.] 2005, no pet.).

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Employees owe various duties to their employers, including a general duty of loyalty. This duty requires employees to act primarily for the benefit of their employer in all matters connected with their employment. Failure to do so may constitute a breach of fiduciary duty, or breach of the duty of loyalty.
 
For example, an employee must deal openly with her employer and fully disclose information about matters affecting the company's business. An employee cannot exploit for her own benefit an asset or opportunity that should belong to the employer. That is, the employee may not divert opportunities from the employer to the employee's own benefit. If an employee, while employed by his employer, uses his position to gain a business opportunity belonging to the employer, such conduct constitutes an actionable wrong. Indeed, an employer may succeed in a claim for diversion of a business opportunity without demonstrating that it would have availed itself of the business opportunity had the employee not diverted it.

While still employed, an employee may not actively compete with his employer without violating the duty of loyalty. However, an at-will employee may plan to compete with his employer, and may take active steps to do so while still employed. The employee has no general duty to disclose his plans and may secretly join with other employees in the endeavor without violating any duty to the employer. Despite the employee's general right to plan to compete, the employee cannot (while still employed) solicit his employer's customers in preparation to complete with the employer.  Further, at lease one Texas court has suggested that an employee's preparation to compete may constitute a breach of the employee's duty of loyalty if the preparation is "significant"--e.g., where a supervisor or manager acts as a "corporate pied piper" and lures all of his employer's personnel away, thus destroying the business.
 
An employee may also violate the duty of loyalty to his employer by accepting a payment or benefit during the course of employment without reporting it to the employer. An employee is required to give her employer a full accounting of anything of value received while on the job, including tips, gratuities, and gifts. Unreported receipt of a payment or benefit is a potential violation of the employee's duty of loyalty, even if the employer suffers no economic harm as a result of the payment.  This general duty to report is intended to ensure that the employee's loyalty to the employer is not diverted.

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