In many previous issues of A Potpourri, we have discussed the fiduciary duties that officers and directors owe to their corporation. Generally, Illinois courts have held that, pursuant to the principles of agency law, non-officer employees also have certain fiduciary duties to their Illinois employers even in the absence of a restrictive covenant. Two recent cases provide further guidance regarding the duties non-officer employees owe their employers.
In the case of Midwest Ink Company v. Graphic Ink Systems, the plaintiff, Midwest Ink Company (“Midwest”), was a manufacturer and seller of ink products to commercial printers in Illinois and Wisconsin. In August 1994, the defendant, Dave Scott (“Scott”), entered into an oral, at-will employment agreement with Midwest in which Scott agreed to be employed by Midwest as a commissioned salesman.
In February 1995, pursuant to Scott’s request, Midwest amended its oral employment agreement with Scott. As part of the amended agreement, Midwest provided Scott with health insurance, a company car, including payment of car insurance and maintenance costs, and worker’s compensation insurance. In addition, Midwest financed the cost of establishing a manufacturing plant and an office for Scott in Wisconsin.
In January 1998, Scott’s wife, Toni Scott, formed a corporation by the name of Graphic Ink Systems (“Graphic”). Graphic sold and manufactured ink products that competed directly with Midwest’s products. Thereafter, Midwest noticed Scott’s sales began to decline. Upon further investigation, Midwest learned Scott had been selling Graphic’s ink products to Midwest’s customers. Midwest proceeded to terminate Scott and filed suit alleging Scott breached his fiduciary duty to Midwest.
In entering judgment for Midwest, the court rejected Scott’s argument that he was an independent contractor who owed no duty to Midwest. The court found that Scott was clearly an employee and thus owed certain fiduciary duties to Midwest. Scott’s fiduciary duties prevented him from: (1) actively exploiting his position with Midwest for his own personal gain, or (2) from hindering the ability of Midwest to conduct the business in which it was engaged. In particular, the court found Scott had a duty of loyalty to Midwest preventing him from acting inconsistently with Midwest’s trust by soliciting his Midwest customers for himself, enticing co-workers to leave their employment with Midwest, or taking Midwest’s property for his use.
The court then found Scott breached his fiduciary duty to Midwest because he was only authorized to sell Midwest’s products from his Wisconsin office; Midwest suffered considerable monetary losses after Scott began to sell products for Graphic; Graphic’s list of customers was identical to that of Midwest; and Scott used information provided by Midwest for the benefit of Graphic. Scott’s breach of his duties entitled Midwest to recover the total compensation paid to Scott during the time he breached his fiduciary duties.
Midwest Ink demonstrates that, even in the absence of a restrictive covenant, an employer has a claim for breach of fiduciary duty against an employee who engages in disloyal activities during the course of his employment. Such duties, however, are subject to the “preliminary stages” exception, which allows an employee to set up a competitive business while still working for his employer, as long as the employee does not begin any competitive activities before termination of the employment relationship, as illustrated in the next case.
In Radiac Abrasives, Inc. v. Diamond Technology, Inc., Radiac Abrasives, Inc. (“Radiac”) filed suit for breach of fiduciary duties against several former employees who formed a rival corporation. During their employment, Peter Mertens, Wesley Lindquist, and Bernard Brady (“Defendants”) discussed their dissatisfaction with Radiac and the possibility of forming a competing company, Diamond Technology, Inc. (“Diamond”). Thereafter, and prior to resigning, Defendants sold certain used Radiac equipment and machinery to a third party and then repurchased some of the machinery for use by Diamond. In addition, the Defendants leased a building; entered negotiations to obtain financing for Diamond; began test marketing Diamond wheel products; started manufacturing; sold some products to Radiac customers; and spent time at Radiac making or engraving products for sales by and for benefit of Diamond.
The court in Radiac Abrasives held that, absent a restrictive covenant, an employee has the right to enter into competition upon leaving his employment. Prior to leaving his employment, an employee may form a rival corporation and provide it with the necessary resources to begin business. It is only when the employee goes beyond preliminary competitive activities, such as, soliciting customers for such rival business and beginning business as a competitor, that the employee breaches his fiduciary duty to his employer. While the court in Radiac Abrasives found that some of Defendants’ actions may have constituted a breach of Defendants’ fiduciary duties, such as the selling of equipment to a third party with the intent to repurchase the equipment later, most of the activities were preliminary steps to the formation of Diamond and would not form the basis of a claim for breach of fiduciary duty.
Illinois law allows employers to bind employees to restrictive covenants that prevent employees from soliciting customers or revealing or using confidential information for a period of time after employment ends. To be enforceable, however, the restrictive covenants must, among other things, be designed to protect a legitimate business interest, rather than simply to prevent competition, and be reasonable.
The cases discussed in this article demonstrate the applications and limitations of claims for breach of fiduciary duties against non-officer, “at-will” employees, who are not bound by restrictive covenants. If you have any questions relating to the fiduciary duties of non-officer employees and what activities might constitute a breach of such duties, please contact a member of the firm.