Duty of Loyalty
While many people are familiar with non-competition and non-solicitation agreements, the duty of loyalty and what it entails is less well known. Yet, there are important aspects to this duty which have substantial implications for employers and employees. For employers, the duty offers some measure of protection to guard the employer’s interests and help ensure that employees remain loyal even, in some instances, once they leave their position. For employees, being apprised of this duty is relevant to how they conduct themselves within the scope of their employment and when they are contemplating leaving their company or are slated for termination.
In general, the duty of loyalty requires that an employee act “solely for the benefit of the [employer] in all matters connected with [his or her] employment.” Riad v. 520 Michigan Avenue Associates, 2000 WL 680217, *3 (N.D.Ill.2000). It is important to note, however, that the duty of loyalty does not foreclose all activity on the part of an employee. For example, in accordance with the “preliminary stages” doctrine, this duty does not prohibit an employee from planning, forming, and outfitting a competing corporation while still working for the employer, so long as the employee does not engage in competition with the employer. Riad, 2000 WL at *3; Cooper Linse Hallman Capital Mgmt., Inc. v. Hallman, 368 Ill.App.3d 353, 856 N.E.2d 585, 589 (1st Dist. 2006); Adams v. Lockformer Co., 167 Ill.App.3d 93, 520 N.E.2d 1177, 1183 (1st Dist. 1988); Voss Engineering, Inc. v. Voss Industries, Inc., 134 Ill.App.3d 632, 635-636, 481 N.E.2d 63 (1st Dist. 1985); Lawter Int’l, Inc. v. Carroll, 116 Ill.App.3d 717, 451 N.E.2d 1338, 1349 (1st Dist. 1983) (defining preliminary activities to include obtaining financing, designing a production plant, and purchasing equipment and supplies); Xylem Dewatering Solutions, Inv. v. Szablewski, 2014 IL App (5th) 140080-U, 2014 WL 4443445, *6 (Ill. App. Ct. 5th Dist. 2014) (asking the employer’s customers and suppliers what they thought about the employee’s formation of a competitive business were merely preliminary activities). However, when an employee’s activities extend beyond “preliminary competitive activities” and the employee “commences business as a rival concern while still in his employer’s service” a court may find a violation of the duty of loyalty. Riad, 2000 WL at *3; See Corroon & Black of Illinois, Inc. v. Magner, 145 Ill.App.3d 151, 494 N.E.2d 785 (1st Dist. 1986); Foodcomm Int’l v. Barry, 328 F.3d 300, 303 (7th Cir. 2003) (employees who actively exploit their positions for their own benefit and hinder their employer’s ability to conduct business with its customer face liability for breach of fiduciary duty).
The following discussion should prove useful to employers in alerting them to their rights under Illinois law regarding the duty of loyalty and to employees by providing them with a list of problematic conduct which could result in substantial liability under the duty of loyalty doctrine.
A. CORPORATE OFFICERS
Corporate officers are held to a higher duty of loyalty standard than regular employees. Veco Corporation. v. Babcock, 243 Ill.App.3d 153, 160, 611 N.E.2d 1054, 1059 (1st Dist. 1993). Illinois courts have defined an officer as one who performs “significant managerial and supervisory responsibilities for the operation of the …office.” Everen Securities v. A.G. Edwards and Sons, Inc., 308 Ill.App.3d 268, 279, 719 N.E.2d 312 (3rd Dist. 1999). The duty of loyalty specifically prohibits corporate officers from (1) actively exploiting their positions within the corporation for their own personal benefit or (2) hindering the ability of a corporation to continue the business for which it was developed. Veco Corp., 243 Ill.App.3d at 160, Smith-Shrader Co. v. Smith, 136 Ill.App.3d 571, 577, 483 N.E.2d 283 (1st Dist. 1982); See Lawler v. North American Corp. of Illinois, 2012 IL 112530, 983 N.E.2d 414, 433 (Ill. 2012) (citing ABC Trans Nat. Transport, Inc. v. Aeronautics Forwarders, Inc., 62 Ill.App.3d 671, 379 N.E.2d 1228 (1st Dist. 1978)). Further, for corporate officers, the duty of loyalty imposes affirmative obligations to disclose information which falls within the scope of the fiduciary relationship and to refrain from profiting, without permission from the one who is owed the fiduciary duty, from property or information which is considered as belonging to the beneficiary. Graham v. Mimms, 111 Ill.App.3d 751, 761, 444 N.E.2d 549 (1st Dist. 1982).
Conduct which is likely to trigger liability for corporate officers under the duty of loyalty includes:
- using corporate assets to develop a new entity without compensating the corporation;1
- appropriating the office space of the corporation to help another corporation or business in which the officer has an interest;2
- taking advantage of a corporate opportunity3 without first disclosing it and tendering the opportunity to the corporate employer;4
- taking advantage of a corporate opportunity where an officer’s private interest would conflict with that of the corporation;5
- using corporate assets to usurp corporate opportunity for the officer’s own venture;6
- pre-termination solicitation of customers of the employer;7
- soliciting or contracting with fellow employees of the employer prior to terminating the employment relationship;8
- voting for and accepting bonuses without disclosure that the officer is leaving the corporation;9 and
- using the firm’s confidential information such as credit, billing or other financial information of the company or the company’s records for the benefit of the officer’s new venture.10
It is also important to note that resigning does not automatically relieve a former officer of a corporation from his or her duty of loyalty to that former corporation where transactions that were initiated during the tenure of the officer’s employment relationship are concerned. For those transactions which commenced during the officer’s employment or which were based upon information obtained during the course of the employment relationship, the corporate officer, even after he or she resigns or is terminated, cannot utilize essential information from those transactions or contact the parties involved without being subject to liability under the duty of loyalty doctrine. See Veco, supra, 243 Ill.App.3d at 161; Comedy Cottage, 145 Ill.App.3d at 360 (citing H. Vincent Allen & Associates, Inc. v. Weiss, 63 Ill.App.3d 285, 292, 379 N.E.2d 765, 770 (1st Dist. 1978)).
B. REGULAR EMPLOYEES
The duty of loyalty does not impose as many restrictions on employees who are not officers of a corporation. Under the more lenient standard for non-officer employees, Illinois law holds that once an employee leaves his position with an employer, he or she ceases to owe that employer a fiduciary duty. Jostens, Inc. v. Kauffman, 842 F.Supp. 352, 354 (C.D. Ill. 1994); Prudential Insurance Co. v. Semptrean, 171 Ill.App.3d 810, 816-817, 525 N.E.2d 1016, 1020 (1st Dist. 1988); Prudential Insurance Co. v. Van Matre, 158 Ill.App.3d 298, 312, 511 N.E.2d 740, 748-749 (5th Dist. 1987), app. den., 117 Ill.2d 553 (1987). Further, where there is no fraud, no contractual restrictive covenant, and there has been no improper taking of a customer list, former employees may, without fear of breaching the duty of loyalty, compete with their former employers and solicit former customers provided there is no evidence of this kind of activity prior to the employee’s termination of employment. Dowell v. Bitner, 273 Ill.App.3d 681, 691, 652 N.E.2d 1372, 1379 (4th Dist. 1995); Van Matre, 158 Ill.App.3d at 310.
In general, the duty of loyalty prohibits non-officer employees from:
- competing with the employer while still in the employ of that employer;11
- taking an employer’s customer list or soliciting customers away from the employer while still in the employ of that employer;12 and
- appropriating the employer’s personal property.13
C. EMPLOYER’S REMEDIES FOR EMPLOYEE’S BREACH OF DUTY OF LOYALTY
An employer has a wide array of remedies that it may seek in charging an employee or former employee with breach of the duty of loyalty. These remedies include:
- recovery of an employee’s total compensation paid during the time that the employee was breaching the fiduciary duty owed to the employer;14
- the imposition of a constructive trust to collect the profits reaped by the employee as a result of the breach of his or her fiduciary duty;15
- recovery of bonuses paid during the same period in which the employee breached his or her fiduciary duty;16
- the imposition of punitive damages if the breach was intentional and without just cause;17 and
- injunctive relief.18
The foregoing discussion is intended to make employers and employees aware of the duty of loyalty and to apprise them of some of the more serious implications of violating that duty.
ABOUT THE AUTHOR: David J. Morris is a Partner and Chair of the Corporate & Securities Group at Fox Swibel Levin & Carroll, LLP in Chicago. David concentrates his practice on mergers and acquisitions, private equity, venture capital, fund formation and general corporate matters, and serves as outside general counsel to start-up, emerging growth and middle market companies in a wide variety of industries.
1 Levy v. Markal Sales Corporation, 268 Ill.App.3d 355, 369, 643 N.E.2d 1206 (1st Dist. 1994).
2 Markal Sales, 268 Ill.App.3d at 369; Cf. Shlensky v. South Parkway Bldg. Corp., 19 Ill.2d 268, 166 N.E.2d 793 (1960).
3 Illinois courts have recognized that a corporate opportunity “exists when a proposed activity is reasonably incident to the corporation’s present or prospective business and is one in which the corporation has the capacity to engage.” Lindenhurst Drugs, Inc. v. Becker, 154 Ill.App.3d 61, 67, 506 N.E.2d 645, 650 (2d Dist. 1987); See Peterson Welding Supply Co. v. Croygas Products, Inc., 126 Ill.App.3d 759, 764, 467 N.E.2d 1068, 1072 (1st Dist. 1984); see also Kerrigan v. Unity Savings Association, 58 Ill.2d 20, 27-28 (1974).
4 Graham, supra, 11 Ill.App.3d at 765; Markal Sales, 268 Ill.App.3d at 366; Comedy Cottage, Inc. v. Berk, 145 Ill.App.3d 355, 359, 495 N.E.2d 1006 (1986).
5 Comedy Cottage, 145 Ill.App.3d at 359 (officer’s duty of loyalty to corporation includes obligation to disavow any corporate opportunity where officer’s private interest would conflict with those of corporation’s).
6 Graham, 111 Ill.App.3d at 763 (“a corporation’s fiduciary will not be permitted to usurp a business opportunity which was developed through the use of corporate assets.”).
7 Dowd & Dowd, Ltd. v. Gleason, 181 Ill.2d 460, 475 (1998); Dowd and Dowd, Ltd. v. Gleason, 816 N.E.2d 754, 761 (1st Dist. 2004); See Hill v. Names & Addresses, 212 Ill.App.3d 1065, 571 N.E.2d 1085 (1st Dist. 1991).
8 Radiac Abrasives, Inc. v. Diamond Tech., Inc., 177 Ill.App.3d 628, 633, 532 N.E.2d 428, 431 (2d Dist. 1988) (court found a breach of duty of loyalty by employee who contracted with fellow employees of employer during his employment tenure); Unichem Corp. v. Gurtler, 148 Ill.App.3d 284, 290-291, 498 N.E.2d 724, 728 (1st Dist. 1986) (court found breach of duty of loyalty where an officer solicited an employee to leave the employer and join a rival business in which the officer planned to join in the near future); Veco Corp., 243 Ill.App.3d at 163-164.
9 Gleason, 816 N.E.2d at 764.
10 Gleason, 816 N.E.2d at 765-766.
11 See Lawler, 983 N.E.2d at 433-434; Foodcomm, 328 F.3d at 304; Dowell, supra, 273 Ill.App.3d at 691; Aon Risk Services, Inc. of Illinois v. Shetzer, 2002 WL 1989466 at * 4-5 (N.D. Ill. 2002); Van Matre, 158 Ill.App.3d at 310-311.
12 See Lawler, 983 N.E.2d at 433-434; Foodcomm, 328 F.3d at 304, Dowell, 273 Ill.App.3d at 691; Jostens, supra, 842 F.Supp. 352 at 353; Van Matre, supra, 511 N.E.2d at 748.13 ABC Trans. Nat. Transport, Inc. v. Aeronautics Forwarders, Inc., 62 Ill.App.3d 671, 683, 379 N.E.2d 1228, 1237 (1st Dist. 1978).
14 See, Gleason, 816 N.E.2d at 772 (Illinois law allows for a complete forefeiture of compensation earned during the period covering the breach of the fiduciary duty); see also, Markal Sales, 268 Ill.App.3d at 373; Veco, 243 Ill.App.3d at 165; Vendo Co. v. Stoner, 58 Ill.2d 289, 305 (1974).
15 Lindenhurst Drugs, 154 Ill.App.3d at 71; Regnery v. Meyers, 287 Ill.App.3d 354, 679 N.E.2d 74 (1st Dist. 1997); Names & Addresses, Inc., 212 Ill.App.3d at 1083 (constructive trust may be imposed even when it more than compensates plaintiff for injury resulting from breach of loyalty because the right to recover from one who exploits his fiduciary position for his personal benefit is triggered by gain to agent rather than loss to principal); Veco, 243 Ill.App.3d at 153; See Gleason, 816 N.E.2d at 772.
16 See Gleason, 816 N.E.2d at 772.
17 See Hill, 511 N.E.2d at 1098; Gleason, 816 N.E.2d at 773; Markal Sales, 268 Ill.App.3d at 379.
18 See Superior Environmental Corp. v. Mangan, 247 F.Supp.2d 1001, 1003 (N.D.Ill. 2003). See e.g., Comedy Cottage, Inc., 145 Ill.App.3d at 361-362, 495 (appellate court upheld trial court’s order enjoining former employee from “interfering with [employer’s] possession [thereby] protecting corporation’s property interest in obtaining a lease of its place of business”).