February 10, 2010

Beyond Mere Planning and Preparation: The Duty of Loyalty Owed By Employees to Their Employers

by Kara R. Yancey 

Suppose you represent a company whose former employee has either started a competing company or now works for a competitor.  Unfortunately, the company did not have a non-compete agreement with this employee and, perhaps it is unclear whether the former employee has misappropriated any “trade secrets” belonging to the employer.  What can you do?  One possibility is to consider the actions of the former-employee before he or she left the company.  Did the employee go beyond mere planning and preparation and actually compete or aid the competitor while still employed?  If the answer is, yes, then you may have a cause of action for breach of the duty of loyalty.

What is the Duty of Loyalty?

In the context of the employer-employee relationship, the duty of loyalty requires an employee, while employed, not to act contrary to the employer’s interests.[i]  In the “most common manifestation of the duty,” the duty of loyalty prohibits an employee from aiding a competitor, or competing themselves with the current employer, while still employed.[ii]  Employees, while still employed, may plan and prepare to compete, including agreeing to start a competing business, but they may not go beyond the planning stages and engage in active competition or employ confidential information of their current employer.[iii]

While this might seem to restrict a relatively narrow field of activity, the duty of loyalty is broad in the sense that it applies to all employees, regardless of their title, rank, or pay grade.  There is no special relationship (beyond employer-employee) required to trigger the duty, and the duty applies even in the absence of written non-compete or confidentiality agreements.  Moreover, as indicated above, this is only the “most common manifestation of the duty.”  Though it is unclear under Missouri law what other manifestations of the duty may be, the astute practitioner should consider whether any act taken by the former employee was contrary to the employer’s interest and might support the cause of action.[iv] 

Note, too, that non-compete and confidentiality agreements do not preclude a claim for breach of the duty of loyalty.  Ideally, a company would have its employees sign a well-crafted intellectual property agreement that places reasonable restraints on competition, protects trade secrets and confidential information, and addresses the company’s ownership of inventions and works of authorship, etc. . . .  In that model circumstance, a claim for breach of the duty of loyalty may be only one of several claims that could be brought against a wayward employee.  

History of the Doctrine in Missouri

The existence of a “duty of loyalty”, and the potential for a cause of action based on a breach of this duty, was recognized back in 1966 in the seminal case of National Rejectors, Inc. v. Trieman, 409 S.W.2d 1 (Mo. 1966) (en banc).  Though ultimately reversing in large part the trial court’s determination of liability against the former employees, the Missouri Supreme Court in National Rejectors nevertheless indicated that every employee owes his or her employer a duty of loyalty “‘as one of the incidents of the employer-employee relationship.’”[v]  The National Rejectors court, however, also noted that there is a conflicting public policy favoring free competition and an individual’s right to “improve his socioeconomic status” and earn a living.[vi]  The court, therefore, concluded that there must be a balancing of the equities between these two rights and that “[e]ach case of this nature must be decided upon its particular facts.”[vii]

Applying these precepts, the court in National Rejectors concluded that the ex-employees in that case had committed no wrong when they secretly decided to leave the plaintiff-company and start a competing company.  Citing the Restatement, the court explained that “[t]he law recognizes that employees may agree among themselves to compete with their then employer upon termination of their employments.”[viii]  Moreover, “[s]uch employees are not limited merely to so agreeing during their employment with the employer with whom they intend to compete.  They may plan and prepare for their competing enterprises while still employed” and they may do so in secret.[ix]  For these reasons, the court found that the employee-defendants were generally not liable for covertly organizing a new corporation, obtaining equipment and beginning design work before tendering their resignations.  The court stated that while employed, an employee may “make plans for his new enterprise so long as he does not use his employer’s time or any trade secrets in so doing.”[x] 

In the years following National Rejectors, a handful of Missouri cases addressed the duty of loyalty.  The first federal court to do so was Metal Lubricants Co. v. Engineered Lubricants Co., 411 F.2d 426 (8th Cir. 1969).   In Metal Lubricants, the manager of the St. Louis division of the plaintiff-company resigned to form a competing company, taking most of the other employees of the St. Louis division with him.[xi]  In addition to claims for trade secret misappropriation and violation of the Sherman Act, the company sued for breach of the duty of loyalty.  In affirming the lower court’s denial of preliminary relief to the company-plaintiff, the Eighth Circuit found that there was no breach of the duty of loyalty.  In particular, the Court noted the total absence of evidence indicating:

(1) soliciting of plaintiff’s customers while defendants were still employed by the plaintiff,

(2) wrongfully disparaging plaintiff or plaintiff’s product or

(3) hiring of employees to obtain confidential information or trade secrets.[xii] 

Relying on National Rejectors, the court concluded that under Missouri law, “absent [a] covenant not to compete or breach of a confidential relationship, an employee is free to leave his employment and enter into competition with his former employer.”[xiii] 

After Metal Lubricants several published opinions discussed the duty of loyalty concept, but did so in the context of other causes of action.[xiv]  For example in Zemitzsch, the appellate court cited National Rejectors and Metal Lubricants, but in the context of claims of trade secret misappropriation and breach of fiduciary duty.  These other causes of action led the court to examine the former vice-president’s role within the plaintiff-company and to consider to what extent the ex-employee was a fiduciary of the company.[xv]  In so doing, the court noted that “an employer-employee relationship, without more, is insufficient to cause a confidential relationship to exist as to knowledge naturally acquired during employment.”[xvi] 

The “duty of loyalty” as a distinct cause of action faded from the discourse of Missouri cases, and it is perhaps for this reason, coupled with language from cases like the one discussed above, that in 1998 the Eighth Circuit Court of Appeals, when faced with a dismissal of duty of loyalty claims brought against former employees, concluded that “[i]f in fact Missouri recognizes a breach of a duty of loyalty, it is only within the larger class of actions of breach of a fiduciary duty.”[xvii]  The court went on to conclude that in the employer-employee context, the existence of fiduciary obligations, and any concordant duty of loyalty, depends on the existence of a confidential relationship between the employer and the employee – a relationship not found in just any employer-employee setting.[xviii]

The Scanwell Decision

In 2005, the Missouri Supreme Court corrected this mistaken-impression and re-confirmed the holding of National Rejectors that every employee owes a duty of loyalty to his or her employer and must not act contrary to that duty.[xix]  In reaching this conclusion, the Missouri Supreme Court addressed, in part, the confusion between claims for breach of fiduciary duty and claims for breach of the duty of loyalty.  The court explained that “[a]lthough the law is unclear whether or to what degree the two concepts overlap, in this case the question need not be resolved.  In the employer-employee relationship, this Court, drawing on the Restatement (2d) of Agency, has implicitly recognized a separate cause of action for breach of the duty of loyalty” and the court found that it was this separate cause of action that was implicated in the case.[xx] 

In Scanwell, the defendant was a former general manager of the plaintiff-company.  While still employed by Scanwell, the defendant made arrangements with Dimerco, a Scanwell competitor, to open a Dimerco office in St. Louis.  At Dimerco’s request, the general manager also created a business plan and arranged for Dimerco to take over Scanwell’s lease when it expired; a lease that the defendant had originally obtained for Scanwell, and that defendant let lapse without bringing the impending expiration to the attention of anyone at Scanwell.  Five days after signing the lease on behalf of Dimerco, the general manager tendered her resignation.[xxi] 

Though reversing the judgment for Scanwell based on an improper jury instruction, the Missouri Supreme Court held that the plaintiff had made out a submissible case for breach of the duty of loyalty.[xxii]  Noting that the case, in fact, involved the “most common manifestation” of the duty of loyalty (i.e. an allegation for breach of the duty of loyalty presented in the context of an employee acting in competition), the court explained that while an employee may make arrangements to compete, he may not “use confidential information peculiar to his employer’s business and acquired therein” nor may he “solicit customers for such rival business before the end of his employment” or otherwise act in direct competition, as “even ‘slight assistance to a direct competitor can constitute a breach of the employee’s duty of loyalty.’”[xxiii]  Based on the facts presented, the court found that a jury issue existed as to whether the duty of loyalty was breached. 

Importantly, liability also potentially existed for Dimerco, the competitor that hired the ex-Scanwell employee.  Though the court said little about this, the jury had awarded Scanwell $54,000 in damages from the ex-employee, and $254,000 from the competitor, Dimerco, under a conspiracy theory.  Though also reversing the award against Dimerco because it was “derivative” of the breach of duty of loyalty claim, the court implicitly approved of the result had the correct jury instruction been employed.  On remand, the court directed that a proper definitional instruction must set out the following elements: 

1) [i]n general, an employee must not, while employed, act contrary to the employer’s interest;

2) however, an employee may agree with others to compete upon termination of employment and may plan and prepare for their competing enterprise while still employed; and

3) but an employee may not, while still employed, go beyond mere planning and preparation and act in direct competition with the employer.[xxiv]     

The Post-Scanwell Landscape

Since Scanwell, a few cases have addressed the duty of loyalty, though several only in cursory way due to the nature of the claims or the type of review at issue in those cases.[xxv]  One case to look at the doctrine in more depth was Synergetics, Inc. v. Hurst, 477 F.3d 949 (8th Cir. 2007).  In Synergetics, two high-level sales associates, while still employed by the plaintiff-company, decided to form a competing business.  As part of this plan and while still employed, the sales associates (1) entered into a confidentiality agreement with a manufacturer (that was also a manufacturer for Synergetics) so that they could discuss the production of competitive products, (2) contacted Synergetics’ customers to discuss formation of the new company and (3) hired a prototype maker, who was also a consultant for Synergetics and who used spare parts belonging to Synergetics, to make competing products.[xxvi] 

Following the sales associates’ departure and incorporation of a competing company, Synergetics filed suit against them, ultimately trying to a jury claims of trade secret misappropriation, breach of confidentiality agreements (but not non-compete agreements which were not at issue in the case), tortious interference and breach of the duty of loyalty.[xxvii]  In affirming the judgment in favor of Synergetics on all counts, the Eighth Circuit confirmed that the evidence supported the verdict for breach of the duty of loyalty:

When viewed in the light most favorable to the verdict, it is clear that the Appellants’ actions violated their duty of loyalty to Synergetics.  Appellants used confidential trade secret information to begin the design of competitive products, used pricing and product information to target Synergetics’ customers, and began solicitation of Synergetics customers prior to the termination of their employment.[xxviii] 

Relying on Scanwell and the Restatement, the Eight Circuit emphasized that though permitted to make preparations to compete, an employee may not use confidential information peculiar to or acquired from his employer, or solicit customers for the competing enterprise.[xxix] 

Another development since Scanwell is codification of a form instruction on the duty of loyalty.  Effective January 1, 2006 the Missouri Approved Jury Instructions included a new verdict directing form for breach of the duty of loyalty by an employee.  The instruction, re-produced below, is as follows:

23.14 [2006 New] Verdict Directing—Employee’s Breach of Duty of Loyalty (Approved August 30, 2005; Effective January 1, 2006)

Your verdict must be for plaintiff if you believe;

First, defendant was employed by plaintiff, and 

Second, while so employed, defendant (here describe the act(s) alleged to be beyond mere planning and preparation for a competing enterprise that constitute direct competition with the plaintiff), and

Third, defendant thereby went beyond mere planning and preparation and acted in direct competition with plaintiff, and

Fourth, as a direct result of such conduct, plaintiff sustained damage. *[unless you believe plaintiff is not entitled to recover by reason of Instruction No. _____ (here insert number of affirmative defensive instruction)][xxx]

Interestingly, while this instruction allows some flexibility to describe the acts alleged to go beyond mere planning and preparation, the instruction generally contemplates only a scenario in which it is alleged that the former employee competed with the former employer.  Other possible breaches of loyalty, i.e. breaches of other “manifestation[s] of the duty of loyalty” are not addressed.  What these other manifestations of the duty may be or the boundaries of these manifestations is not clear.  For example, could an employee breach his duty of loyalty without the element of competition?  What if in Scanwell, the office manager had allowed the lease to expire not for the purpose of aiding a competitor, but instead out of a motive for deliberate sabotage?  Though the Missouri Supreme Court’s language in Scanwell would seem to suggest that this scenario could breach the duty of loyalty (as an action contrary to the employer’s interests), the new jury instruction does not fit that factual scenario. 

As a practitioner, then, the new jury instruction should be seen as a guide to only the most common breach of the duty of loyalty scenario, and care should be taken to consider any action by an employee that was contrary to the employer’s interests. 

Conclusion

Though employees, absent a non-compete agreement, are free to compete with former employers upon termination of the employment relationship, employees may not go beyond mere planning and preparation while still employed.  To the extent they do, the Missouri Supreme Court has empowered employers to take action against them for breach of the duty of loyalty, and, as an advocate, the doctrine can serve as an effective tool in obtaining relief for your client-companies when employees have acted contrary to the employers’ interests.

*Reprinted with permission of the Bar Association of Metropolitan St. Louis and the St. Louis Bar Journal.

 


 

[i]   See Scanwell Freight Express STL, Inc. v. Chan and Dimerco Express (U.S.A.) Corp., 162 S.W.3d 477, 479-481 (Mo. 2005) (citing Restatement (Second) of Agency §387 (1958) and National Rejectors v. Trieman, 409 S.W.3d 1 (Mo. 1966)). 

[ii]   Id.  

[iii]   Id.; see also Synergetics v. Hurst, 477 F.3d 949, 959 (8th Cir. 2007); Restatement (Second) of Agency §393, cmt. e (1958).

[iv]   This article focuses on Missouri jurisprudence and the duty of loyalty as it is articulated here.  According to a leading treatise, “[t]here is some dispute over the nature and extent of an employee’s duty of loyalty to his or her employer,” depending on whether the courts of that jurisdiction maintain that a disloyalty claim must be based on a breach of a fiduciary duty or not. See Richard A. Lord, 19 Williston on Contracts § 54:26 (4th ed. 2006) (citing case examples by jurisdiction).  If you represent a company in another jurisdiction and another state’s law applies, you will want to research the law of that jurisdiction carefully to gain an understanding of the types of activities that courts in that specific jurisdiction have found violate the duty, as well as, the types of employment relationships that have formed the basis of successful claims.

[v]   National Rejectors, 409 S.W.3d at 41 (quoting Midland-Ross Corp. v. Yokana, 293 F.2d 411, 412-13 (3d Cir. 1961) and citing Restatement (Second) of Agency § 387).

[vi]   Id. at 39. 

[vii]  Id. at 39-40.

[viii]   Id. at 26 (citing Restatement (Second) of Agency § 393, cmt e (1958)).

[ix]   Id. at 26-27.

[x]   Id. at 52.

[xi]   Metal Lubricants Co. v. Engineered Lubricants Co., 411 F.2d 426, 427-28 (8th Cir. 1969).

[xii]   Id. at 431. 

[xiii]   Id. at 429-30. 

 [xiv]   See, e.g., Thau-Nolde, Inc. v. Krause Dental Supply & Gold Co., Inc., 518 S.W.2d 5 (Mo. 1975) (discussing employee duty in context of cause of action for conspiracy in violation of antitrust laws); Salomon v. Crown Life Insurance, 536 F.2d 1233 (8th Cir. 1976) (discussing employee duty in context of tortious interference claim); Zemitzsch v. Harrison, 712 S.W.2d 418 (Mo. Ct. App. 1986) (discussing employee duty in context of trade secret misappropriation, unfair competition and breach of fiduciary duty claim); Dwyer, Costello and Knox, P.C. v. Diak, 846 S.W.2d 742 (Mo. Ct. App. 1993) (discussing employee duty in context of breach of fiduciary duty claim).

[xv]   Zemitzsch v. Harrison, 712 S.W.2d 418, 421 (Mo. Ct. App.1986)

[xvi]   Id.

[xvii]   Pony Computer, Inc. v. Equus Computer Sys. of Mo., 162 F.3d 991, 999 (8th Cir. 1998).

[xviii]   Id.

[xix]   See Scanwell Freight Express STL, Inc., 162 S.W.3d at 479-80.

[xx]   Id. at 479 (citing National Rejectors, Inc., 409 S.W.2d at 41).

[xxi]   Id. at 478-81.

[xxii]   Id.  480-82.

[xxiii]   Id. at 480 (quoting Restatement (Second) of Agency, § 393, cmt e and Cameco, Inc. v. Gedicke, 724 A.2d 783, 789 (1999)).

[xxiv]   Id. at 481.

[xxv]   See, e.g., Terminix Inter’l Co. v. Ferrario, 2006 WL 2546814 (E.D. Mo.  Aug. 31, 2006) (discussing duty of loyalty only in context of deferential standard of review of arbitration award); Healthcare Service of the Ozarks, Inc. v. Copeland, 198 S.W.3d 604, 610, n.3 (Mo. 2006) (en banc) (contrasting non-compete agreements with duty of loyalty); In re McGregory, 340 B.R. 915, 920 (8th Cir. 2006) (examining duty of loyalty in context of conflict of interests).

[xxvi]   Synergetics, Inc, 477 F.3d at 953-54.

[xxvii]   Id. at 954, 957-59.

[xxviii]   Id. at 959.

[xxix]   Id.

[xxx]   Mo App’d Jury Instruct (Civil) 23.14 (6th ed. 2007).