False Info in Employee Time Records Can Support Common Law Fraud Claim – IL Fed Court

Some key questions the Court grapples with in Laba v. CTA, 2016 WL 147656 (N.D.Ill. 2016) are whether an employee who sleeps on the job or runs personal errands on company time opens himself up to a breach of fiduciary or fraud claim by his employer.  The Court answered “no” (fiduciary duty claim) and “maybe” (fraud claim) in an employment dispute involving the Chicago Transit Authority (CTA).

Some former CTA employees sued the embattled transit agency for invasion of privacy and illegal search and seizure after learning the CTA implanted Global Positioning System (“GPS”) technology on the plaintiffs’ work-issued cell phones. An audit of those phones revealed the plaintiffs’ regularly engaged in personal frolics during work hours.

The CTA removed the case to Federal court and filed various state law counterclaims to recoup money it paid to the ex-employees including claims for breach of fiduciary duty, fraud and conversion. The Northern District granted in part and denied in part the plaintiff’s motion to dismiss the CTA’s counterclaims.

Breach of Fiduciary Duty

Sustaining the CTA’s breach of fiduciary duty claim against the ex-employees’ motion to dismiss, the Court looked to black-letter Illinois law for guidance.  To state a breach of fiduciary duty claim in Illinois, a plaintiff must allege (1) the existence of a fiduciary duty, (2) breach of that duty, and (3) breach of the duty proximately caused damages.  The employer-employee relationship is one the law recognizes as a fiduciary one.

While the extent of an employee’s duty to his employer varies depending on whether the employee is a corporate officer, the law is clear that employees owe duties of loyalty to their employers.  Where an employee engages in self-dealing or misappropriates employer property or funds for the employee’s personal use, it can give rise to a fiduciary suit by the employer.

Here, the Court found that the employees’ conduct, while irresponsible and possibly negligent, didn’t rise to the level of disloyalty under the law.  The Court made it clear that under-par job performance doesn’t equate to conduct that can support a breach of fiduciary duty claim. (**6-7).

Fraudulent Misrepresentation

The Court upheld the CTA’s fraudulent misrepresentation claim – premised on the allegation that the plaintiffs lied to the CTA about the hours they were working in order to induce the CTA to pay them.  Under Illinois law, a fraud plaintiff must show (1) a false statement of material fact, (2) known or believed to be false by the party making the statement, (3) with the intent to induce the statement’s recipient to act, (4) action by the recipient in reliance on the truth of the statement, and (5) damage resulting from that reliance.

Under the Federal pleading rules, a fraud claimant must plead the “who, what, where when and how” of the fraud but the allegation of a defendant’s intent or knowledge can be alleged generally.

Here, the Court found that the CTA sufficiently alleged a fraudulent scheme by the employees to misrepresent the hours they worked in exchange for their paychecks.  This was enough, under Illinois fraud law, to survive the employees’ motion to dismiss.  See FRCP 9(b); (*7).

Take-aways:

1/ While an employee owes an employer fiduciary duties of loyalty, his sub-par job performance doesn’t equate to a breach of fiduciary duty.  There must be self-dealing or intentional conduct by the employee for him to be vulnerable to an employer’s fiduciary duty suit;

2/ An employee misrepresenting hours work can underlie a common law fraud claim if the employer can show it paid in reliance on the truth of the employee’s hour reporting;

 

 

 

Seventh Circuit Files: Court Voids LLC Member’s Attempt to Pre-empt LLC’s Suit Against That Member

In Carhart v. Carhart – Halaska International, LLC, (http://law.justia.com/cases/federal/appellate-courts/ca7/14-2968/14-2968-2015-06-08.html) the plaintiff LLC member tried to shield himself from a lawsuit filed against him by the LLC by (1) taking an assignment of a third-party’s claim against the LLC; (2) getting and then registering a default judgment against the LLC; (3) seizing the LLC’s lone asset: its lawsuit against the plaintiff; and (4) buying the lawsuit for $10K.  This four-step progression allowed the plaintiff to extinguish the LLC’s claim against him.

Plaintiff was co-owner of the defendant LLC.  After a third-party sued the LLC in Minnesota Federal court (the “Minnesota Federal Case”), Plaintiff paid the third-party $150,000 for an assignment of that case.  Plaintiff then obtained a $240K default judgment against the LLC.

Meanwhile, the LLC, through its other owner, sued the plaintiff in Wisconsin State Court (the “Wisconsin State Case”) for breach of fiduciary duty in connection with plaintiff’s alleged plundering of the LLC.  While the Wisconsin State Case was pending, Plaintiff registered the Minnesota judgment against the LLC in Wisconsin Federal court.

Plaintiff, now a judgment creditor of the LLC, filed suit in Wisconsin Federal Court (the “Wisconsin Federal Case”) to execute on the $240K judgment against the LLC.  The Wisconsin District Court allowed the plaintiff to seize the LLC’s lone asset – the Wisconsin State Case (the LLC’s breach of fiduciary duty claim against plaintiff) – for $10,000.  This immunized the plaintiff from liability in the Wisconsin State Case as there was no longer a claim for the LLC to pursue against the plaintiff.  The LLC appealed.

The Seventh Circuit voided the sale of the Wisconsin State Case finding the sale price disproportionately low.

Under Wisconsin law, a chose in action is normally considered intangible property that can be assigned and seized to satisfy a judgment.  However, the amount paid for a chose in action must not be so low as to shock the conscience of the court.

In this case, the court branded the plaintiff a “troll of sorts”: it noted the plaintiff buying the LLC’s claim (the Wisconsin State Case) at a steep discount: the defendant paid $150,000 for an assignment of a third-party claim against the LLC and then paid only $10,000 for the LLC’s breach of fiduciary duty claim against plaintiff.

The court found that under Wisconsin law, the $10,000 the plaintiff paid for the LLC’s claim against him was conscience-shockingly low compared to the dollar value of the LLC’s claim.  The plaintiff did not purchase the LLC’s lawsuit in good faith.  The Seventh Circuit reversed the District Court’s validation of plaintiff’s $10K purchase so the LLC could pursue its breach of fiduciary duty claim against the plaintiff in the Wisconsin State Case.

Take-aways:

This seems like the right result.  The court guarded against a litigant essentially buying his way out of a lawsuit (at least it had the appearance of this) by paying a mere fraction of what the suit was possibly worth.  

The case serves as an example of a court looking beneath the surface of a what looks like a routine judgment enforcement tool (seizing assets of a judgment debtor) and adjusting the equities between the parties.  By voiding the sale, the LLC will now have an opportunity to pursue its breach of fiduciary duty claim against the plaintiff in state court. 

Company Exec Who Bilked His Employer Hit With Multi-Million Salary Forfeiture Judgment

expensereport03The First District affirmed an almost $10M bench trial judgment in favor of a publishing company against one of its former officers in ICD v. Gittlitz, 2014 IL App (1st) 133277.

The defendant engaged in a multi-year course of fraudulent conduct against his employer by issuing bogus expense reports and writing himself  company checks for “advances” that he wasn’t entitled to.  After lodging criminal embezzlement charges, the plaintiff brought civil claims.

The plaintiff sued for compensatory and punitive damages under breach of fiduciary duty and fraud theories.  It also asserted a specific performance claim seeking the defendant’s turn over of his stock shares.

The defendant countered that the plaintiff gave up much of its claims by signing an earlier written release (the “Release”) after the plaintiff first encountered the defendants’ fraudulent conduct. The defendant also claimed the plaintiff was unjustly enriched by retaining certain profits the defendant claimed he was owed.

The trial court found for the plaintiff on all claims and rejected the defenses and counterclaims.

Upholding the hefty money judgment, which included a $2M punitive damage award, the Court answered some important questions on the proper measure of damages for a corporate officer’s breach of fiduciary duty and the circumstances that justify voiding a written release of claims.

The court synthesized this patchwork of legal principles during its analysis:

Corporate shareholders owe fiduciary duties of loyalty to both the corporation and the other shareholders;

– Where an agent breaches a fiduciary duty to a principal, the damage award is within the court’s equitable discretion;

The complete forfeiture of salary during the time the fiduciary was breaching his duty to the corporation is a proper damage measure in cases of intentional misconduct;

– The purpose of the salary forfeiture remedy is to deprive the wrongdoer of his gains from his breach of duty and to deter disloyalty;

-Punitive damages are also awarded at the court’s discretion and can only be nullified if they are the result of passion, partiality or corruption;

A 3:1 ratio (punitive damages to compensatory damages) is recognized as an acceptable (“not excessive”) figure;

– When parties who stand in a fiduciary relationship to each other sign a release that settles or gives up potential claims, the release can be undone if one party withholds material facts surrounding the signing of the release;

– A release will not include claims that weren’t in the parties’ contemplation

(¶¶ 54-77).

The defendant’s several-year campaign of blatant fraud as evidenced in part by the defendant’s guilty plea in the criminal case justified the court ordering the defendant’s wholesale forfeiture of his salary during the operative time span (about $7M).

The court also held that the $2M in punitive damages bore a reasonable relationship to the $1.2M in phony checks cashed by the defendant. The punitive award fell below a 2:1 ratio and so was acceptable under the law.

The court ruled that the Release was voidable by the plaintiff since two corporate shareholders testified that they signed the Release based on the plaintiff’s promise that his fraud against the company was brief.

The court also affirmed summary judgment on the specific performance claim through which the plaintiff sought to compel performance stock repurchase provisions of a shareholders agreement.

The court rejected the defendant’s election of remedies doctrine noting that it only applies to prevent double recovery where a plaintiff seeks inconsistent remedies for the same cause of action.

Normally, a plaintiff can’t recover damages for breach of contract and also obtain specific performance of that same contract. He must choose on or the other. Here, though, election of remedies didn’t apply: plaintiff’s money damages were predicated on the defendant’s fraudulent conduct while the specific performance order related solely to the stock repurchase agreement. ¶¶ 78-80.

Take-aways:

(1) Complete forfeiture of an executive’s compensation is a proper damage remedy where the executive intentionally violates fiduciary duties to the corporation;

(2) A release won’t encompass claims that weren’t in the parties’ contemplation – especially where one party is a fiduciary who hoodwinks the other;

(3) A 3:1 punitive damage:actual damage ratio is generally acceptable and won’t be overturned as excessive.