Fidudiary Duties in Unfair Competition Case

Posted by Jay McDaniel on March 14, 2011

You just learned that an employee secretly formed and operated a competing business while employed by you.  Is there a claim against the competing business or just the employee? Most likely there are viable claims against both.  The fiduciary duties of the employee are likely to be imputed to the company he or she formed.

Breach of Fiduciary Duties

Similar facts were before the court recently in an unfair competition and breach of fiduciary duty case, Vibra-Tech Engineers, Inc. v. Kavalek, Civil Action No.: 08-cv-2646, in the United District Court for the District of New Jersey. (opinion here) A vice president and director of Vibra-Tech, along with his wife, formed two businesses.  One of the businesses sold equipment to Vibra-Tech; the other competed directly for the same customers.  Vibra-Tech, of course, had no idea that one of their executives was involved in the two businesses.

The two companies formed by the employee moved for summary judgment, arguing that neither owed Vibra-Tech any fiduciary duties.  Normally that would be the case.  Fiduciary duties are created by the specific nature of a relationship.  The hallmark of a fiduciary duty is that one party places "trust and confidence" in the other, who has the ability to exercise discretion and expertise on their behalf.  Officers, directors and management employees generally owe their employers fiduciary duties.

Directors and Officers Duty

The fiduciary duty of a director, officer or management employee is to exercise their discretion on behalf of the best interests of the corporation, limited liability company or partnership.  This is true even when his or her personal interests may be at odds with the best interests of the business.  The fiduciary duty usually falls into one of two types: the duty of care or the duty of loyalty.

Competitors and others who contract at arms length owe no fiduciary duties.  It is presumed that they will act in their own self-interest.  That was the argument made by the New Jersey attorney representing the two businesses formed by the defendants in the Vibra-Tech case.  They argued that since they had no direct relationship with the plaintiff, they could have not fiduciary duties.

The court agreed that there were no fiduciary duties between the corporations, but held that the duties of the former employees and officer could be imputed to the businesses formed by the defendant.  New Jersey courts recognize that when an employee secretly forms a corporation to compete with his or her employee, the employee's breach of duty of loyalty can be imputed to the newly formed corporation.

Preparation to Compete

It is probably worth noting that employees who prepare to compete, but who do not actually compete, are usually not breaching any fiduciary duty.  Unless there is a restrictive covenant or non-competition agreement in place, employees can lawfully form new businesses and then resign to compete with their former employers.

There are a few caveats to the former employee's right to compete, however.  He or she may not use their employer's time to set up the business, may not take proprietary information -- including in most cases customer lists -- and may not solicit customers while still employed.

 

VIBRA-TECH ENGINEERS, INC., Plaintiff, v. SCOTT KAVALEK, et al., Defendants, Civil Action No. 08-2646-NLH, United States District Court, D. New Jersey, January 14, 2011.

EDWARD F. BORDEN, JR. DELIA ANNE DOUGHERTY EARP COHN CHERRY HILL, NJ Attorneys for Plaintiff Vibra-Tech Engineers, Inc.;JOHN JOSEPH MASTER, JR. LAW OFFICES OF JOHN J. MASTER, JR. HADDONFIELD, NJ, Attorney for Plaintiff Vibra-Tech Engineers, Inc.; STEPHEN J. LABROLI LEONARD, SCIOLLA, HUTCHISON, LEONARD & TINARI, LLP MOORESTOWN, NJ Attorney for Defendants Scott Kavalek, Roberta Kavalek, Intergrated Geotechnical Solutions, Inc. and Geotech Instruments, Inc.; ANDREW JOHN PODOLSKI Stark and Stark, PC Princeton, NJ Attorney for Defendant Charles Bauman; EDWARD G. ENGELHART SOMMER, ENGELHART & PESCATORE, ESQS. FAIRFIELD, NJ Attorney for Interested Parties Newmark Engineering, P.C. and Glenn Newmark.

 

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Employer E-Mail Policy Creates Privacy Rights

Posted by Jay McDaniel on February 16, 2011

As an employer, we may assume that because we own the computer equipment, that includes any data left on there by our current or former employees. Thus, if an employee wants to use company time or our equipment for personal e-mail, then they do so at their own peril.  If we’re not careful, however, we may be wrong.

Whether an employee working in New Jersey has an expectation of privacy in e-mails sent during working hours and whether the employer can read those e-mails --will depend on the policies that the company establishes, particularly those in writing, and its actual practices.To be safe, the policy should be clear and it should be in writing.

The New Jersey Supreme Court recently held that an employee had a reasonable expectation of privacy in workplace e-mails sent to her attorney through a web-based personal e-mail account, but using a company computer, largely because the company was less than clear about its policy.  Stengart v. Loving Care Agency, Inc., 201 N.J. 300 (N.J. 2010).  (copy of opinion here). In Stengart, employee Marina Stengart’s e-mails sent to and received by her attorney on her work laptop were viewed by her former employer, Loving Care Agency, whom she was then suing for employment discrimination. The e-mails were discovered by her attorneys when her laptop was examined by an expert during the litigation.

 

Reasonable Expectation of Privacy in a Workplace

Loving Care’s attorneys read the e-mails and did not follow normal procedures by notifying opposing counsel of their access to confidential communications. Instead they assumed that the attorney-client privilege was waived by Stengart due to the combination of her use of a company computer and the existence of Loving Care’s Electronic Communication Policy (which stated that the company reserves the right to access all communications conducted on the company’s server).  The Supreme Court of New Jersey rejected these arguments, finding in favor of Stengart.

In upholding the employee’s privacy rights, the Court found that Loving Care’s online privacy policy was unclear because it did not address the monitoring of messages sent on a personal, web-based e-mail, nor did it warn employees that contents of such e-mail would be stored on a hard drive that can be later retrieved.  The court also noted, using a bifurcated subjective/objective reasonability standard derived from Fourth Amendment and common law privacy jurisprudence, that Stengart’s expectation of privacy in her attorney-client communications, which also pertains to e-mails, was subjectively reasonable.  Stengart took steps to protect the privacy of those emails and shield them from her employer (using a personal password protected e-mail and did not save the passwords on her computer).  

Stengart’s expectation of privacy was also objectively reasonable, the court held, since the company communications policy did not address the use of personal, web-based e-mail accounts accessed through a company computer. This, coupled with the fact that all attorney-client communications bore a warning that the e-mails are personal, confidential, and may be attorney-client communications, proved to the court that there was an objectively valid expectation of privacy that vested with Stengart.

 

Clarity is Key

The court noted that in order to waive the attorney-client privilege in her communications with her attorney, she must “without coercion and with knowledge of [her] right of privilege, [make a] disclosure of any part of the privileged matter or consent[] to such a disclosure.”  Stengart did not waive her attorney-client privilege of confidentiality because she never knowingly made a waiver, but rather took a proactive stance on keeping such communications private.

Employers should be clear.  If they want to prohibit personal e-mail accounts from being accessed from company equipment, they should do so in a way that cannot be misunderstood.  Of course, as a litigation attorney, there is another lesson here.  Before you go fishing around on an employee’s computer, find out exactly what the employer’s policy was. The attorneys who read the e-mail communications without doing so – or warning the other side that they planned to do so – brought consequences on themselves and their client.

Limited Liability Company Subject to Claims By Former Managers Holding Membership Interests

Posted by Jay McDaniel on June 11, 2010

I often find myself counseling caution to business owners that want to use equity to reward or attract key employees.  The reason, quite simply, is that if the relationship sours, the employee not only has to be fired but you then have to deal -- at best -- with a disgruntled former employee as owner or, more likely, he or she likely will have to be bought out. 

It's Not Easy to Fire the Owner-Employee

To get a sense of how difficult these circumstances can be, let's look at Ross Holding and Management Co. v. Advance Realty Group (Ross Holding v. Advance Realty (Del).pdf), a case recently decided in Delaware construing New Jersey law.  Advance Realty Group managed real estate properties on the East Coast and awarded membership interests to key managers.  The managers received "Class A" general ownership units and "Class B" units reserved for management.  Reading between the lines of the opinion, it seems that a new investor came into the business and the old management team got their walking papers.

The departing managers redeemed their "B" units for cash and also signed general releases of any employment related claims.  The "A" units were carved out for later redemption.  When the redemption failed to happen, the former managers brought suit alleging various claims of wrongdoing and mismanagement.

Release Did Not Cover Claims Brought As Owners

Construing New Jersey law, the Court held that most of the claims would survive a motion to dismiss because they were brought not as former employees, but as holders of "A" units, including acts that allegedly occurred before the managers were let go.  The releases given by the former management team simply did not extend to their claims as equity holders.

Thus the current management of Advance Realty found itself subject to claims concerning the sale of properties, alleged self-dealing and the like.  Moreover, it likely discovered that the former management team knew far more about the business than would a passive investor, which would certainly make it more difficult to prevail.

Pitfalls of Equity Awards

When dealing with a small limited liability company, or a corporation for that matter, in which employment is bound up with ownership, you don't simply fire one of the owner-employees.  In many corporate oppressed shareholder cases, that termination amounts to per se oppression unless there are reqular dividend payments.  In limited liability companies, the rights may be less clear, but former employees can be well motivated and the litigation costs may be substantial.

There are a couple of approaches that one might take, none of them very satisfactory.  One is the use of a tiered equity structure - the so-called limited equity owners.  These un-owners are have some of the rights of owners (voting, ability to bind the business, etc.) but no right to participate in the upside of the business through equity.  The other way is to set the equity for the employee-owner in advance at a modest amount.  (I was once a limited equity owner of a law firm and my interest was worth the princely sum of $100.)

The better view is simply to beware.  You don't want to grant anyone equity unless you are willing to take on the burdens, and hopefully rewards, of having them as a full owner of the business.  In many cases, if it doesn't work out, the business will have the same headaches as it would if they were one of the founders.