South Carolina Intellectual Property Litigation

Intellectual Property & Litigation SC

5 (or More) Reasons not to ABANDON the “Duty of Loyalty”

Posted in Confidential Information, ERISA, Fiduciary Duty, General, Jury Issues / Trial, Loyalty, Trade Secrets

This post started as a “5 Things You Need to Know about The Duty of Loyalty,” however, the many lessons to glean from the Western Blue Print case out of Missouri in 2012 covered below caused a title change. So here are 5 thoughts on the often neglected Duty of Loyalty, and reasons why it should not be ignored or abandoned:

1. What is the Duty of Loyalty? The Duty of Loyalty is defined in numerous ways in varying contexts:

  • Cornell University’s Legal Information Institute defines the Duty of Loyalty as follows: “The duty of loyalty stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act without personal economic conflict. The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity.”
  • Black’s Law Dictionary defines the adjective “loyalty” as a “faithfulness or allegiance to a person, cause, duty, or government.”
  • Black’s Law [Free Online] Legal Dictionary defines the Duty of Loyalty as follows: “A legal requirement in certain systems where the BOARD OF DIRECTORS and executives must ensure that any action taken is done in good faith and with the best interests of shareholders in mind. A breach of duty of loyalty can lead to legal action by shareholders.”
  • In pretty much every state, every employee owes a Duty of Loyalty to his or her employer.
  • The [Employee’s] Duty of Loyalty can negate a statutory right to wages, and some stout wage payment remedies, including trebled damages and attorneys’ fees. As stated in our supreme court’s favorite legal treatise at 14 S.C. Jurisprudence 32 (Labor Relations) (citations omitted):
    • “Wage Payment Act provisions requiring employer to pay wages due to terminated employees do not supplant employee’s common-law duties of loyalty and fidelity to employer; if employee breaches duty of loyalty to employer by soliciting employer’s customers for competing company while working for employer, forfeiture of employee’s wages is appropriate.”
    • For example, Judge Ralph King Anderson, Jr.’s South Carolina Requests to Charge provides a charge for Employment Contract – Breach of Duty of Loyalty jury as follows: “An employee is not entitled to any compensation for services performed during the period he engaged in activities constituting a breach of his duty of loyalty even though part of those services may have been properly performed.”
  • Other states, for example, Missouri, provide the following regarding the Employee’s Duty of Loyalty: “Every employee owes his or her employer a duty of loyalty.” Interestingly, the Missouri Supreme Court in Western Blue Print Co., LLC v. Roberts (quoted above) held that the employee(s) in question did not owe their employer a fiduciary duty, and the plaintiff there ABANDONED its Duty of Loyalty claim in favor of the theoretically broader Fiduciary Duty claim. The distinction drawn in casting off the Fiduciary Duty claim was the fact that the scheming employee, Myrna Roberts, was not an officer or a director in the company, and apparently the court was not apt to expand The Fiduciary Duty to all employees. Perhaps because they could affirm the result on the tortious interference claim. It appears that the ABANDONMENT of the Duty of Loyalty claim, in hindsight, may have been a mistake, but could also have been part of a trial strategy as it is commonly believed that the Duty of Loyalty is subsumed within The Fiduciary Duty. Still further, the practical differences between the facts required to prove a tortious interference with contract and a Breach of the Duty of Loyalty are, arguably, minimal in this circumstance given Myrna’s employment contract.
  • A similar interplay of legal duties is involved for attorneys representing insureds under a policy requiring the insurer to indemnify and defend the insured.

Any or all of the above aside, when a jury gets charged on the Duty of Loyalty, we believe their instincts will inform them as to what it means. However the duty may be defined or charged, expect that the factfinder will understand very well the concept as one that is not likely to be twisted by knaves. They will be thinking about their Labrador Retriever that licks their face every morning and sits by their side every night loving them, and barks to warn of any change in circumstances at the house.

It may not be that the jurors can define loyalty, or even care to, but like Justice Potter Stewart / Alan Novak on hard-core pornography, they “know [disloyalty] when they see it.” The jury will not need Carrie Underwood to understand and decide if the accused defendant was “stand[ing] by” the plaintiff or merely or merely pretending.

2. In what context does the Duty of Loyalty most often arise? The great thing about writing a blogging piece and titling it as “The X Things You Need to Know,” is the blogger can offer themselves “softball” questions. But is this really a softball question? Does the duty arise most often in breaches by employees-to-their-employers or by fiduciaries-to-their-beneficiaries, as in the recently reported Tibble v. Edison Int’l case decided by the U.S. Supreme Court, a/k/a SCOTUS, or by Boards of Directors? Certainly the effects of the latter two breaches can be far reaching and impact many employees or shareholders.

3. How does the Duty of Loyalty interact with other legal duties? As noted in our previous “spectra” post, the Duty of Loyalty along with the Duty of Reasonable Care are generally considered to be embodied within The Fiduciary Duty. The Duty of Loyalty could also embody the same duties of confidentiality as provided for in a non-disclosure agreement. As noted above in the Western Blue Print case from Missouri, the Duty of Loyalty, in certain circumstances can be considered separate from The Fiduciary Duty. A key distinction worth noting is that an employee is often free to plan to compete with his or her employer if they chose to resign, however, by taking specific action to plan for competing with his employer while still employed there, they may well be subject to viable claims for breach of the Duty of Loyalty, trade secret theft, etc.

4. Who Can be Sued for Breach of Loyalty? In South Carolina, as provided in the 1972 case Lowndes Products v. Brower, our supreme court held that not just the disloyal employees, but also third-parties that knowingly aided-and-abetted the employees in their breach of loyalty were liable to the plaintiff, Lowndes Products. So the claim for breach of loyalty may not be limited only to the disloyal employees. Interestingly, in Lowndes, the supreme court affirmed the refusal of the trial court (and the master) of plaintiff’s claim for misappropriation of trade secrets because it found reasonable steps were not taken to protect the trade secrets, however, the court noted, “An employee has a duty of fidelity to his employer apart from the question whether he has an obligation to maintain the employer’s processes and system of operation in confidence.” It is not clear what the difference is, if any, between claims against the third-parties for: (i) aiding-and-abetting a breach of loyalty, and (ii) intentional interference with contract (employment contract).

5. How Does the Duty of Loyalty Arise in E.R.I.S.A. / 401(k) Litigation? In the above-referenced Tibble decision, the SCOTUS held that the 401(k) Plan fiduciaries owe the plan participants a Duty of Care in selecting and arranging for the plan’s administrative fees associated with purchasing the same shares from different channels (e.g., retail versus institutional shares). Specifically, the Court held the plan fiduciaries breached their legal duties to the plan participants by allowing retail funds to be available at a much higher per transaction cost to the plan participants, thus reducing the participants’ available investment funds. The court noted evidence in the record that it was customary to simply ask for a reduction in the institutional fee or for a waiver of the mandatory minimum transaction charges. Such a failure by the plan fiduciaries could fall under the category of a breach of the Duty of Care (i.e., not diligent in evaluating and selecting plan options), but could also, in certain circumstances, could constitute a breach of the Duty of Loyalty. For example, suppose that the party recommending the particular investment option had other arrangements with the party earning the higher sales commission? The Duty of Loyalty differs from the Duty of Care in that its adds the duty of disclosure (transparency) and also the duty to undertake to both avoid and disclose conflicts of interest.

Conclusions

Whether your analysis of the ever-present Duty of Loyalty arises in the context of: (i) employment relationships; (ii) publicly traded board-member-to-shareholder duties; (iii) as a member of an LLC or other closely held corporation; (iv) ERISA plan fiduciaries of defined contribution 401(k) plans; or (v) otherwise, knowledge of the duty, its breadth and nuances, and situations in which it has been consistently applied by the courts can be critical to the success (or failure) of your cases.

And remember, don’t ABANDON this duty in your individual obligations, or when you get your case to the jury. In the 1972 Lowndes Products case referenced above the Duty of Loyalty was used to save what was considered a trade secret misappropriation case. In the Western Blue Print case from 2012, the Court there allowed a tortious interference claim to save what was likely considered primarily a Breach of Loyalty case. These two cases illustrate very well why your pleadings should include all available options for relief (and defenses) for your clients.

 

Ordinary Care, Reasonable Care and The Fiduciary Duty – The First in a Series of “Spectra” Posts

Posted in Confidential Information, ERISA, Fiduciary Duty, General, Jury Issues / Trial, Non-Disclosure Agreements, Policy

We like to put things in order, right? It helps us understand the concepts and the analytical process further identifies distinguishing characteristics. In the legal world, however, complex concepts are more appropriately placed on a spectrum, rather than a list. Dictionary.com provides a non-physics definition of “spectrum” as follows: “a broad range of varied but related ideas or objects, the individual features of which tend to overlap so as to form a continuous series or sequence, e.g., the spectrum of political beliefs.”

Key words: range, related and overlap. Today, we look at the following three related legal duties, each of which overlap, but are also unique and distinct:

1. Ordinary Care, e.g., as owed by a bank to its depositors and customers in the handling of their checking transactions (likely a result of privity of contract and statute);

2. Reasonable Care, most commonly found in auto accident cases (arises the moment you turn the key and engage a pedal), medical malpractice, and other so-called “negligence” cases;

3. The Fiduciary Duty, e.g., as owed by a Trustee to a beneficiary, a lawyer in a lawyer-client relationship, or a by a 401(k) plan fiduciary to the participating employees (limited generally to special relationships, but also created by statute, as in case of ERISA and 401(k) plans).

To begin to illustrate how these three duties are related and can overlap, we introduce a fourth: The duty of confidentiality is generally included within The Fiduciary Duty. This duty can also arise in conjunction with all three duties identified above by: (a) special relationship; (b) contract, for example as a non-disclosure agreement (NDA); (c) court order; or (d) statute, as in duty to protect personal information such as social security numbers, etc., to the extent that hackers do not already have all that.

How Do These Three Legal Duties Differ?

Ordinary Care is characterized by what is customary in any given context. In other words, are you doing what others like you in your field are also presently doing? For example, just because average speed on a Detroit-to-Novi freeway is 96 mph, making such conduct “customary,” that speed is still likely a violation of applicable law. As such, the person driving 96 mph causing an accident violates her duty of Reasonable Care. Recall from the link above, Reasonable Care is defined as, “the level of care that someone of ordinary prudence would have exercised under the same circumstances.” Note that establishing evidence of the Ordinary Care standard will likely require “expert” testimony. For example (back to banking), what if the expert witness testifies that Bank of America is doing something to protect your accounts that Wells Fargo is not doing? Would Chase or JP Morgan then be held to the Ordinary Care standard set by BoA, or could that be an issue for the jury?

So how do we determine what is prudent (Reasonable Care) vs. what is customary (Ordinary Care)?

Assume a “hypothetical utopian” community has 100% of its citizens acting with the utmost level of care, liability under a Reasonable Care standard is still evaluated by what would a reasonable person have done, not as compared to the hyper-vigilant utopians. In contrast, if a “hypothetical” community of reckless people is used to establish Ordinary Care, then the level of care owed under an Ordinary Care could be far less than that of Reasonable Care.

So how does The Fiduciary Duty differ from Reasonable Care and Ordinary Care?

The Fiduciary Duty, arguably, subsumes the Duty of Reasonable care and adds to it the Duty of Loyalty. One held to a Fiduciary Duty standard is required to act with respect to the affairs of the client-beneficiary in the same manner he or she would act with respect to their own affairs. Avoidance of conflicts of interests is implicit in The Fiduciary Duty.

So does this mean that the person owing The Fiduciary Duty, if a reckless person in their own right, then only owes the client the same recklessness for which they would apply to their own affairs? Certainly not. In fact, one of the primary differences between a Reasonable Care Duty and The Fiduciary Duty is that The Fiduciary Duty is owed to a specified individual or group of people, whereas, the duty of Reasonable Care is generally owed to all persons in any particular context, e.g., all persons driving or riding on the road in which you drive your vehicle.

Can the conduct of the client or beneficiary of the duty owed negate or reduce the duty owed?

Yes. For example, in banking law, frequently referred to as the UCC, the bank owes a duty of Ordinary Care unless the customer has failed, ironically, to exercise Reasonable Care by inspecting returned checks for forgeries, or for forgeries by the “same wrongdoer.” Similarly, in a common law negligence case where the duty of Reasonable Care is owed, if the plaintiff is negligent or “comparatively negligent,” then he or she may also lose the benefit of the legal duty owed as the cause of the injury is attributed to their own actions.

The Fiduciary Duty necessarily implies that the party owing this duty must act in the best interests of the beneficiary (loyalty), and no such legal concept like comparative fault can be used to mitigate or eliminate The Fiduciary Duty owed. This is true of lawyers and their clients, of a Trustee for children who have lost their parents and have trust funds to care for them left behind, and also recently covered when a party takes on the “fiduciary” responsibility to ensure that a company’s 401(k) plan is managed in a way that is in the best interests of the employees and not to provide for unnecessary fees or unnecessarily excessive management charges over and above what would have been customarily available.

What to do if you think you have a claim for breach of a legal duty owed?

If you or someone you know has a claim or thinks you might have a claim for breach of Fiduciary Duty, contact me to discuss it and learn what options may be available to you. While past results are no guaranty of future performance, our firm has the experience and ability to handle these types of cases and take them to trial, if necessary.
[Future “spectra” series posts will include: (1) standard of review for appellate matters including / ranging from any evidence, to abuse of discretion, to de novo review; and (2) trademarks including from fanciful, to arbitrary, to suggestive, to descriptive, to generic.]

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