Staffing Firm’s Trade Secrets and Tortious Interference Claims Against Ex-Employees Rejected After Bench Trial (Part II of II)

Top Secret

The plaintiff staffing firm lost big in Instant Technology, LLC v. DeFazio, 2014 WL 1759184 (N.D. IL 2014).  The Northern District Court found for the defendants on the plaintiff’s non-compete counts (see prior post) as well as on its trade secrets, tortious interference and breach of fiduciary duty claims. 

Trade Secrets Analysis

The ex-employee defendants signed broad non-disclosure agreements that prevented them from divulging plaintiff’s business information to third parties.  In finding that the plaintiff failed to establish either valid trade secrets or that the defendants used the alleged secrets, the Court applied the key Illinois trade secrets rules:

–  a trade secrets plaintiff must establish (1) that it possessed trade secrets and (2) that the defendant misappropriated them;

– a trade secret is information not generally known to others.  The plaintiff must concretely identify the secret: it isn’t enough for the plaintiff to point to “broad areas of technology” and claim that something there “must be” secret;

– misappropriation means improper acquisition, unauthorized disclosure or unauthorized use.  See 765 ILCS 1065/2(b);

 – misappropriation by “improper acquisition” means theft, bribery, breach of or inducement of a breach of a confidential relationship or espionage through electronic means;

  – misappropriation by “unauthorized disclosure” or “unauthorized use” means the defendant used the alleged trade secrets or disclosed them to others for purposes other than serving the interests of the trade secrets owner;

where information is generally known to others who could benefit from using it, the information is not a trade secret

 (*18-19).

The staffing company failed to establish a protectable trade secret.  None of the client or candidate information the plaintiff was suing on was secret.  The Court found that client names, hiring needs as well as candidate identities and qualifications were publicly available (through phone or internet searches) and information that was freely given out by plaintiff’s clients.  This is because many of the plaintiff’s clients use multiple rival staffing firms simultaneously.

The Court also held that the plaintiff failed to show misappropriation by the defendants.  The trial testimony (18 witnesses testified at the bench trial) established that the defendants were authorized to store and transport plaintiff’s documents via thumb drives and that each defendant physically returned all of plaintiff’s documents and data.

Tortious Interference Analysis

The plaintiff also lost on its tortious interference with contract and prospective economic advantage claims.  Plaintiff alleged that certain defendants tortiously interfered with plaintiff’s client and candidate relationships.

In Illinois, to show tortious interference with contract, the plaintiff must establish: (1) the existence of valid and enforceable contract between plaintiff and third party; (2) defendant’s awareness of that contract; (3) defendant’s intentional and unjustified inducement of a breach of that contract; (4) breach of the contract by the third party; and (5) damages.  Tortious interference with prospective economic advantage has identical elements except the plaintiff must specify customers who actually contemplated entering into a business relationship with the plaintiff.

Since the non-compete lacked consideration and was unreasonable, the contract was unenforceable and so plaintiff’s  tortious interference with contract claim failed.   The plaintiff’s tortious interference with prospective economic advantage count also fell short since the plaintiff couldn’t identify a specific client that didn’t materialize due to defendants’ conduct.  The Court held that proof of a past customer relationship was insufficient to prove a reasonable expectation of a future business relationship.  (¶22).

Breach of Fiduciary Duty Claim

The Court also sided with the defendants on the plaintiff’s breach of fiduciary duty claim.  An Illinois employee can form a rival corporation and outfit it for business while employed by his former employer.  And where there is no valid post-employment restrictive covenant, an employee is free to compete with his ex-employer. 

Further, only a corporate “officer” can be liable for soliciting employees for a new, competing venture.  Job title is not enough to establish corporate officer status.  Instead, the court looks to whether the defendant performs “significant managerial and supervisory responsibilities for operation of the office”.  Here, one of the individual defendants – despite being Executive Vice President of plaintiff – had no managerial authority.  As a result, this defendant wasn’t a true corporate officer and couldn’t be liable for breach of fiduciary duty in soliciting the other defendants to join her in the new staffing firm.  (¶¶ 19-20).

Take-away: The case again illustrates the high evidence burden for a plaintiff to show the existence of a trade secret and its misappropriation.  It also underscores how difficult it is for a plaintiff to prove tortious interference without specifically pinpointing lost contracts or hoped-for business relationships.  The case also construes Illinois law to subject only a corporate officer – with management authority – to breach of fiduciary duty claims where that officer solicits employees of a corporation to join the officer in a competing venture.

Condo Association Sues Developer Based on False Statements In Sales Brochure and For Anemic Repair Reserves

In Henderson Square Condominium Association v. LAB Townhomes, LLC, 2014 IL App (1st) 130764, a condominium association sued the developer and contractor after unit owners discovered wide-ranging property defects in their units. (For Chicago readers: the project is near that nightmarish, multi-cornered Belmont-Lincoln-Ashland intersection on the North side).

The property’s construction was completed in 1996, the unit owners discovered the property defects in 2007-2008 and filed suit in 2011 – nearly 15 years after construction was finished and about 4 years after discovery of the defects.  The extent of the unit damage wasn’t revealed until a consultant hired by the association opened up the unit walls and ceilings. 

The association sued for breach of implied warranty of habitability, fraud, negligence, for violating the Chicago Municipal Code section (Section 13-72-030) governing real estate marketing misrepresentations.  The trial court dismissed all the claims as time-barred.  The association appealed.

Result: Trial court reversed.  Association’s claims reinstated

Rules/reasoning:

The basis for the reversal was the defendants’ possible fraudulent concealment of the association’s causes of action.  Code Section 13-214(a)and (b) provide a four-year limitations and 10-year repose period for construction-related claims, respectively.  The construction repose period can have harsh results: it means that no matter when a plaintiff discovers an injury, if more than 10 years have elapsed since construction was complete, the plaintiff’s claim is barred.

But Code section 13-214(e) provides that the repose period doesn’t apply where a defendant makes fraudulent misrepresentations or fraudulently conceals a plaintiff’s claim.  735 ILCS 5/13-214(e); ¶ 28.  When fraud is involved, the five-year limitations period set forth in Code Section 13-205 (735 ILCS 5/13-205) applies.  To demonstrate fraudulent concealment, a plaintiff must show silence coupled with deceptive conduct or the suppression of material facts.  ¶¶ 95-96. 

The Court found a question of fact as to whether there was active concealment based on (1) defendants’ marketing documents: a sales brochure that made specific statements concerning unit insulation; and (2) the anemic repair reserves earmarked by the developer for repairs.  The Court held that if the defendants didn’t inform the plaintiff that the units lacked insulation – as the plaintiff’s consultant found and noted in its report – and if the reserve levels weren’t large enough to meet anticipated future repairs, this could show fraudulent concealment sufficient to beat the repose period argument.  (¶¶ 98- 102).

The Court also sustained the association’s claims that were premised on Municipal Code.  Sections 13-72-030 and 13-72-100 of the Code provide a real estate buyer both with a private cause of action and damages remedy (including attorneys’ fees) where a seller makes misrepresentations in the course of marketing the sale of real estate; including condominiums.  The First District found that the association stated a cause of action under the Ordinance and rejected the defendants’ argument that the Ordinance claims were duplicative of the association’s fraud claims.  The Court found the Ordinance gave rise to a private right of action and provided an additional remedy to a common law fraud claim.  (¶¶112-113).

Validating the plaintiff’s breach of fiduciary duty claim, the Court looked to the Illinois Condominium Act (“Act”). Section 9.2 of the Act imposes a duty on a developer to adequately fund a reserve account for future improvements and repairs.  765 ILCS  605/9(c)(1), (2).  A “reasonable reserve” amount is a fact-based inquiry determined by (1) repair and replacement costs, and the (2) estimated remaining useful life of the property’s various structural, mechanical and energy components and its common elements.  (¶¶ 122-123, 129). 

The Court held that the question of whether the developer adequately funded the repairs reserve account wasn’t properly decided on a Section 2-615 motion.  And since the association properly pled that the developer breached fiduciary duties by failing to disclose known, latent defects in the property, the association stated a valid claim for breach of fiduciary duty (or at least one that survives a motion to dismiss).

Take-aways:

The Court found that a breach of fiduciary duty claim against a developer can survive almost 15 years after the developer’s last involvement with the property (the property was completed in 1996 and suit wasn’t filed until 2011).  The case also underscores the importance of adequately funding reserve accounts and demonstrates that claims premised on the City Ordinance sections governing false statements in real estate sales literature can be brought independently of common law fraud claims.  Henderson Square also illustrates the evidentiary showing a plaintiff must make to trigger the fraudulent concealment exception to the 10-year repose period applicable to construction claims.

IL First Dist. Examines Punitive Damage Standards In RE Fraud Suit

In K2 Development, LLC v. Braunstein, 2013 IL App (1st) 103672-U, the First District addressed Illinois law’s compensatory and punitive damages guideposts in a convoluted real estate fraud suit filed by an LLC against one of its two members.

The plaintiff LLC – through one of its members (a real estate novice) – sued the LLC’s other member – an experienced real estate developer – for fraud in connection with the defendant’s sale of an undeveloped piece of land to the plaintiff. 

The court awarded compensatory damages of nearly $400K and punitive damages of over $750K after a bench trial and the defendant appealed.

Held: Affirmed.

Rules/reasoning: The Court upheld the trial court’s damage awards based on the  evidence that the defendant orchestrated a fraudulent scheme and took advantage of his neophyte business partner (the other LLC member). 

In Illinois, compensatory damages are awarded as compensation, indemnity or restitution for a wrong or injury suffered by a plaintiff.  The purpose of compensatory damages is to make the injured party whole and restore him to his pre-loss condition. 

Compensatory damages are not designed to provide plaintiff with a windfall or profit.  Damage computations present a fact issue and a damage award will be overturned where the trial court ignores the evidence or the damage calculation is palpably erroneous.  ¶ 28 

The Court held that the trial court’s damage award based on defendant’s ill-gotten profits on the fraudulent deal coupled with the amount of asecret lien and easement defendant recorded/allowed to be recorded against the property had support in the record.  ¶¶ 28- 29

Punitive damages aim to (1) act as retribution against a defendant; and (2) deter the defendant and others from similar conduct.  The defendant’s conduct must be willful, outrageous and evince an “evil motive” or “reckless indifference” to others’ rights.  Punitive damages can be awarded in Illinois fraud actions; particularly where the false statements are made repeatedly and are particularly egregious. ¶¶ 32-34. 

Applying these rules, the Court held that punitive damages were appropriate based on the defendant’s continuing pattern of fraudulent conduct that saw   him make repeated misstatements and omissions. 

The K2 Court also rejected defendant’s claim that the $750K punitive damage award was unconstitutional.  The constitutional calculus for punitive damages includes (1) the degree of defendant’s “reprehensibility”, (2) disparity between actual or potential harm suffered by plaintiff and the punitive damage award, and (3) the difference between the punitive damages awarded and civil penalties authorized or imposed in comparable cases.  ¶ 37.

The Court addressed factors 1 and 2 above (factor (3) didn’t apply since there was no civil penalty for fraud or breach of fiduciary duty)).  In finding the defendant’s conduct reprehensible, the Court noted the defendant repeatedly made false statements to the plaintiff concerning the nature of property and the investment.  This showed a pattern of deceitful conduct. 

On the actual vs. punitive damage issue, the court noted that the punitives awarded ($750K) were about double the amount of the compensatory damages ($382K).  This 2:1 punitive:compensatory damages ratio clearly fell within reasonable damages bounds under Illinois law where anything more than a 4:1 punitive to actual damages ratio is “close to the line” (e.g. $400,000 punitive on a $100,000 actual damage award) of permissible punitives.  ¶¶ 41-42

Comments: A key factor in the Court’s damage analysis was that defendant owed and breached fiduciary duties to the plaintiff LLC’s other member.  

The disparity in business acumen between the parties clearly led the Court to affirm the trial court’s over $1M aggregate damage award for the plaintiff. 

K2 is particularly instructive on the “ratio issue”: how much a punitive damage can exceed an actual damage award without the court viewing it as excessive.  While there’s no bright-line rule, K2 suggests that anything higher than 4 to 1 can invoke elevated court scrutiny and a possible damage reduction.  

K2 also illustrates that a pattern of conduct – more than an isolated incident – will likely lead to a finding of reprehensible fraud and support a punitive damage award.