U.S. District Court Judge William Young’s recent decision in Talentburst, Inc. v. Collabera, Inc. is worth study. Talentburst is the former employer of Raj Pallerla. While employed by Talentburst, Pallerla signed a noncompete agreement with Talentburst. He then resigned and went to work for Collabera, Inc. For ease of reading I’ll refer to these three parties as Former Employer, New Employer and Employee.
When the Former Employer discovered that its Employee had gone to work for New Employer, it pursued an unorthodox legal strategy: rather than sue the employee for breach of the noncompete agreement, it sued only the new employer, alleging that the New Employer had “aided and abetted” a breach of fiduciary duty by the Employee. It also claimed that by hiring the Employee the New Employer “interfered” with the noncompete contract. The case was filed in Massachusetts Superior Court, but the Former Employer was able to “remove” it to federal court (based on diversity jurisdiction). To the Former Employer’s misfortune, the case was drawn by Judge Young, who was almost certain to give the case closer scrutiny than it would have received in state court.
The Former Employer filed a motion to dismiss, which is usually a long shot. However, Judge Young allowed the motion and dismissed the suit on the basis of the complaint alone. In his decision Judge Young reasoned that the Employee, who was a non-managerial “worker bee,” did not owe a fiduciary duty to his employer. The New Employer could not have interfered with a non-existent fiduciary duty, and therefore this claim failed.
As to the tortious interference claim, the judge zeroed in on the requirement of “improper means or motive.” Mere advancement of one’s economic interests is not, however, “improper,” and since the Former Employer couldn’t make anything more than a “generalized” allegation of improperness, this claim failed as well.
I have a few observations about this case.
First, in addition to Massachusetts appellate precedent, Judge Young relied heavily on “unpublished” Superior Court decisions (using Westlaw citations when available). I can’t think of a federal district court decision that has made as much use of Massachusetts trial court decisions as this one. However, Judge Young is a former Massachusetts trial court judge, and he often expresses his great respect for that court. The use of state court decisions is also a function of the Business Litigation Session, which has produced many more written decisions than other sessions of the trial court.
Second, Judge Young rejected the Former Employer’s argument that it was not required to make anything more than a generalized allegation of improper means/motive at the pleading stage, holding the plaintiff to the higher pleading standard established by the Supreme Court in the Bell Atlantic v. Twombly decision in 2007. As noted in this post, this standard has now been adopted by the Massachusetts Superior Court as well. Although Twombly was an antitrust case, this is another example of its broad application, extending here so far as to bar a state tort claim; before Twombly, this case likely would have survived dismissal. It probably would have survived dismissal if it had remained in state court.
Third, and lastly, what the plaintiff/Former Employer had in mind when it sued the New Employer but not its Former Employee (against whom it appears it had the stronger claim) continues to elude me, but the strategy clearly back-fired in a major way.
Bottom line: This case is important precedent in the area of employee breaches of fiduciary duty, by reason of its careful legal analysis and the gravitas of the judge who authored it. I expect the case to become part of every business lawyer’s legal arsenal when issues of employee fiduciary duty are raised.
Further to my post below, commenting on whether the enforceability of noncompete agreements in Massachusetts has been a major factor in Silicon Valley’s relatively greater success in attracting high tech start-ups, a review of recent Massachusetts noncompete cases shows how difficult it has become to enforce these agreements in Massachusetts. Judges appear to be leaning over backwards to deny preliminary injunction motions (which is where the real action lies in these cases). Here is a quick summary of several recent state court cases.
In Bank of America v. Verille, decided by Superior Court Judge Thomas A Connors in Norfolk County in August, the Court denied BoA a preliminary injunction to enforce a non-soliciation agreement (a close relative of noncompete agreements), on the grounds that the customers that followed the former employee to his new job signed affidavits to the effect that they were not solicited by him. To put this in context, many years ago I saw a Superior Court judge state from the bench that the line between “soliciting” a customer and the customer “following” an employee is so fine that she would presume that a customer had been solicited, even in the face of affidavits from the customer stating it had not been solicited. I doubt that this judge would draw the same inference today.
In addition, in the Verille case the judge questions whether the “goodwill” (that is, the “relationship”) with these customers belongs to BoA or to the former employee, a defense to noncompetes that has definitely gained tranction in Massachusetts in recent years, after being viewed as having dubious credibility many times in the past, except in instances where the employee had pre-existing relationships with the customers (not the case here).
In Edwards v. Athena Capital, decided by Judge D. Lloyd MacDonald in Suffolk Superior Court in August, Edwards brought suit to enjoin the enforcement of his noncompete agreement with Athena, his former employer. In other words, rather than wait for Athena to sue him, he forced the issue by bringing suit first. Judge MacDonald ruled in favor of Edwards, holding that the noncompete was overbroad (it overstated the areas in which the former employee could not compete, and was of unlimited duration). In the past, the Massachusetts courts have been willing to “redline” agreements of this sort to make them acceptable (for example, rewrite the time period), but here the Court ruled against Athena based, in large part, on Edwards’ overbreadth argument.
In Boston Software Systems v. Doherty, decided by Judge Gants in the Business Litigation Session in April 2007, the Court refused to impose a preliminary injunction upon a former employee of Boston Software that had entered into a noncompete agreement. Judge Gants questioned whether the “good will” at issue belonged to the employee or the former employer (the employee had returned to her pre-Boston Software employer after being terminated by Boston Software). He also found that Boston Software would likely be able to prove any damages at trial, and therefore was unable to prove the irreparable harm necessary for a preliminary injunction. The defendant “stole the thunder” of Boston Software by representing to the Court that she would not deal with any of Boston Software’s former customers during the one year noncompete period, would work outside Boston Software’s market area during that year, and would not utilize any of Boston Software’s confidential information. The Court accepted these representations, and included them in its Order.
Going back a little farther, to October 2006, Judge Allen Van Gestel, in the Suffolk County Business Litigation Session, denied the employer a preliminary injunction against its former salesperson/employee in Tyler Technologies, Inc. v. Reidy. In that case the noncompete agreement misidentified Reidy, the former employee, as a consultant, when in fact he was an employee. This error (admittedly somewhat bizarre), doomed the effort to obtain an injunction for reasons explained in the decision. Tyler’s argument that it was clear from the context and the relationship that the parties intended Reidy to be bound by the agreement, whether it referred to him as a “consultant” or an “employee” held no water. Judge Van Gestel defended his ruling by stating that “in reading the agreement so strictly the Court may seem to be overreaching,” but this was the former employer’s agreement, “for which it is wholly responsible.”
In Advanced Cable Ties v. Hewes, decided by Judge Jeffrey A. Locke, sitting in Worcester County in October 2006, the employer sought to enforce a noncompete agreement against its former employee, Hewes, relying on Hewes’ knowledge of the former employer’s trade secrets to justify enforcement. The judge could find no flaw in the agreement itself (it was reasonable in geographic scope and duration), and found that Hewes had been given access to proprietary manufacturing information. However, pointing to extenuating circumstances (Hewes’ new employer competed with only 10% of the former employers’ product line, and Hewes had changed jobs in order to work near a sick and elderly parent), the judge refused to bar Hewes from the competing employment. Instead, he issued an order that Hewes not work on the competing product line for the duration of the one year noncompete period.
It seems clear that, although there is no statute in Massachusetts prohibiting the enforcement of noncompete agreements (as there is in California), Massachusetts Superior Court judges have gotten the message: these agreements are to be enforced only where the contract is clear and enforceable, and where the equities demand it. Maybe someone whispered in their ears – exercise some discretion in these cases, or the legislature may ensure that you have no discretion at all.
Fiduciary Duty. As a recent case shows, the answer is: it depends.
Assume that you are the attorney for a closely-held corporation (a privately held corporation with a small number of active shareholders), and you have interacted with and provided corporate legal advice to the shareholders over the years. Even though you did not represent them personally, the shareholders placed their trust and confidence in you. A dispute then arises between one of the shareholders (who has a minority position) and the corporation. Can you represent the corporation in this dispute, or do you have a fiduciary duty to the minority shareholder that presents a conflict of interest, and precludes you from the representation?
An article by Massachusetts Bar Counsel written in 2003, Closely Held Conflicts, reviews the case law on this issue (which has developed mostly in the context of motions to disqualify counsel), and sends a clear warning that attorneys who have represented a closely held corporation most likely do owe a fiduciary duty to the shareholders.
However, a recent decision by Superior Court Judge Francis R. Fecteau draws an important distinction to keep in mind when this issue arises. In that case, Bensetler v. Data Plus, Judge Fecteau found that attorneys who represented a closely held corporation did not have a fiduciary duty to a minority shareholder with whom they had never interacted. Thus, at least according to this case, there is no per se rule on this issue, and depending on the level of interaction, there may be circumstances under which an attorney who has represented a close corporation may represent the corporation in a suit adverse to a minority shareholder.
UPDATE: Here is a link to Superior Court Judge’s Christine Roach’s Memorandum of Findings and Ruling, dated October 8, 2008, ruling for the defendants following a bench trial.
Noncompete Agreements. Plaintiffs seeking to enforce noncompete agreements by means of preliminary injunctions have been up against it as of late. In Payson’s Trucking v. Yeskevicz (pdf file) Judge Peter Agnes denied the plaintiff’s motion, which was brought against a contracting party (as opposed to an employee), on the grounds (among others) that the agreement was too vague as to its geographic reach and in the identification of the plaintiff’s actual customers.
In Merchant Business Solutions v. Arst (pdf file) Judge Richard Connon denied a preliminary injunction against a former sales employee on the grounds that the geographical limits were too broad and that the plaintiff was seeking protection from ordinary competition (among other reasons). Both cases are worth reviewing, since the impression one takes away is that the pendulum has swung (yet again) in the direction away from enforcement of these agreements. A plaintiff simply needs better facts than the parties had here in order to obtain a preliminary injunction to enforce a noncompete agreement.
Derivative Shareholder Suits. When it turns out a company has made an operational mistake it can expect two lawsuits. The ubiquitous and much publicized class action and the less well-known derivative shareholder suit. The latter seeks damages on behalf of the corporation from the officers and directors who allegedly were involved in the wrongdoing. Often the two suits are coordinated by plaintiffs’ counsel,hoping that a squeeze play will bring the corporation to the settlement table that much sooner.
The standard response to the derivative suit is for the corporation to appoint a special litigation committee (SLC) to investigate the claims and recommend whether the suit should go forward or not. Without going into too much detail, this recommendation and the corporation’s decision implicate the so-called “business judgment rule” (read more about this rule here). Not surprisingly, the SLC typically recommends against bringing any claims against the officers/directors, and the plaintiff then accuses the SLC of bias in favor of the officers and board members. Therefore, it is of paramount importance that the SLC not only be independent, but that it not demonstrate any signs of bias in favor of the individuals whom it is investigating.
These issues are highlighted in Massachusetts Superior Court Judge John Agostini’s recent decision in Blake v. Friendly Ice Cream Corp. Judge Agostini held that the recommendation of the SLC appointed by the Friendly’s Board did not act independently, and ordered that the derivative case go forward. This case is an unusually extensive analysis of the law relating to special litigation committees and derivitive suits. For a discussion of some of the interesting and unusual facts underlying the case that do not appear in the decision, click here.
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Freeze-Out of Minority Shareholders. Majority shareholders in a close corporation cannot “freeze- out” a minority shareholder, that much is clear. The Supreme Judicial Court established the close corporation/fiduciary duty doctrine in 1975 in the case of Donahue v. Rodd Electrotype Co. Exactly what constitute a freeze-out is less clear than some might hope. However, the doctrine seems not yet to have reached its outermost limits.
In Brodie v. Jordan, the Appeals Court held that the majority had engaged in a freeze-out of the widow of a minority shareholder when the majority denied her a corporate office, rejected her request for financial and operating information, and stonewalled her efforts to obtain an appraisal of her stock. Of greatest interest in this case is the remedy the court provided to Mrs. Brodie: the Appeals Court affirmed the trial judge’s order that the majority purchase her shares at a price based upon an appraisal value provided by a court-appointed expert. As a dissenting judge noted, this is the first time an appellate court in Massachusetts has ordered such a remedy, thereby venturing, as the dissenting judge noted, “onto uncharted waters.”
. . . of your company, that is.
OK, here the facts, minus the legal jargon.
You’re a businessman with a successful company. You meet someone that wants to go into business with you in a related area. You start a new company, making sure that you hold a majority interest (52.5%). Your new “partner” gets 37.5%, and the rest of the stock goes to a couple of employees. Although your partner is a minority shareholder he’s running the business, so you make him president of the company.
Almost ten years go by, and although the company is making money you’re unhappy with your partner. He’s bad at finances, and tensions arise over bookkeeping and other business issues.
Eventually you reach your boiling point, and one morning you fire your minority partner.
Simple enough you think. After all, you own a majority of the company, what’s stopping you from doing this?
In O’Connor v. U. S. Art Co., a recent case decided by Judge Allen Van Gestel in the Suffolk County Business Law Session, the minority shareholder was awarded $218,000 in damages based on these facts. The judgment was against the other three shareholders, personally.
Here’s the rub: in Massachusetts, shareholders in “close” corporations (nonpublic companies with a small number of shareholders) owe each other a fiduciary duty. You can’t fire a minority shareholder unless you have a “legitimate business purpose,” and there is no “less harmful alternative.” Harmful to the minority shareholder, that is.
In the U.S. Art case Judge Van Gestel found that the majority shareholders could have hired a bookkeeper, among other possible solutions. In other words, even assuming there was a problem, they could have solved the problem without firing the guy.
What’s interesting about this case? Nowhere in the 11 page decision did Judge Van Gestel indicate that the minority shareholder had invested any money when U.S. Art was formed. Usually, the rationale behind cases like this is that the minority shareholder invested in the company, expecting to earn a living from the company, only to find him or herself fired, and out both the investment and the job. That appears not to have been the case here.
What could the majority shareholder have done to avoid this outcome? Easy: enter into an agreement when the business was formed, permitting termination, either at will or for cause. If that wasn’t feasible, take proper steps before terminating the minority shareholder. In the U.S. Art case the Judge described the majority’s actions as “ham- handed.” It doesn’t take a Supreme Court Justice to see that the Judge thought the majority shareholders behaved offensively, and that this contributed to the result.
If you’re interested in further details on this case you can read the full decision here.
Minority Shareholders/Fiduciary Duty. Massmanian v. Duboise, decided in September by Judge Ralph Gants in the Suffolk County Business Litigation Session, proves once again that when a party to litigation angers a judge, they can be forced to pay a high price.
In this case the plaintiff Massmanian was a 30% minority shareholder and employee in North/Win. After he filed suit accusing the majority shareholders of diverting North/Win’s profits and assets to another company (a serious breach of fiduciary duty, if true), North/Win terminated Massmanian for insubordination and neglecting his duties. Massmanian then asked the court to issue a preliminary injunction reinstating him. In opposing this motion, North/Win, and its lawyers made some serious strategic errors:
- First, they demanded that all North/Win employees sign a Confidentiality Agreement which (among other things) barred employees from disclosing “matters related to the lawsuit Massmanian has filed against the company, even in a legal proceeding.” This Agreement was demanded upon pain of termination, and one employee was terminated for failing to sign it. The court characterized this as “heavy-handed overreaching” and an improper attempt to prevent employees from testifying in the case.
- Second, when asked about the Confidentiality Agreement North/Win’s lawyers made false statements to the Court.
The upshot of all this was one very angry judge, who lambasted North/Win and its lawyers, and went on to describe North/Win’s actions as a “triple freeze-out,” (1) denying Massmanian lifetime employment, (2) giving North/Win the right to trigger its option to purchase Massmanian’s shares and (3) denying him access to information relevant to his status as a minority shareholder. The judge took the highly unusual step of ordering North/Win to reinstate Massmanian and enjoining North/Win from terminating his employment.
This case illustrates extremely bad judgment by North/Win (and possibly its lawyers, if they approved the Confidentiality Agreement), and North/Win is paying the price for it.