Canada: Unfair Competition By Fiduciaries Proves Costly

Copyright 2012, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Labour & Employment, March 2012

The Court of Appeal for Ontario (the Court) has released its decision in GasTOPS Ltd. v. Forsyth (GasTOPS). Writing for the unanimous Court, Justice Goudge upheld the trial judge's decision awarding over C$12-million in damages to GasTOPS for breach of fiduciary duty, breach of confidence and breach of the contracts of employment by four key employees who left GasTOPS to start a competing business. As only a few of the trial court's findings were appealed, the significance of the Court's decision is limited; however, it confirms that, in certain circumstances, the fiduciary duties of key employees can survive for periods as long as 10 years.

Facts

GasTOPS is a company that designs and develops computer software applicable to jet engine maintenance—"a highly specialized niche industry, with few clients, each of which generated significant revenues". In October 1996, four "key" employees resigned within days of one another. Within hours of their resignations, three of the former employees met with current GasTOPS employees and described their plans to start a new business focused on aviation maintenance software, in competition with GasTOPS.

Just over a week after the first two resignations were tendered, the four former key employees incorporated MxI, which soon hired a number of GasTOPS employees. As the Court noted, MxI's success and GasTOPS' corresponding damages were "immediate and significant". MxI was successful in marketing what it acknowledged was the fourth iteration of GasTOPS technology to GasTOPS' existing and prospective customers. In addition, it usurped a business opportunity GasTOPS had cultivated with the U.S. Navy, which accounted for 80% of MxI's income in its first three years of business.

GasTOPS brought an action against MxI and the four former key employees. After a 295-day trial, Justice Granger found MxI liable for breach of confidence and the former key employees liable for (i) breach of fiduciary duty; (ii) breach of confidence; and (iii) breach of contract for failing to provide GasTOPS with sufficient notice of resignation, which he assessed to be in the range of 10 to 12 months. GasTOPS was awarded damages equivalent to MxI's profits earned from its military contracts in its first 10 years of operation: over C$12-million, plus C$3-million in pre‑judgment interest and C$4.2-million in costs.

Key Employees as Fiduciaries

The appeal targeted only some of the trial judge's findings. One issue was his finding that two of the defendants, Cass and Vandenberg, were fiduciaries of GasTOPS. At the time they resigned their employment, neither employee was a member of GasTOPS' senior management team. However, Cass was GasTOPS' chief software developer and key technical product development person, and Vandenberg was project manager responsible for the company's most important client in the industrial system field. Both employees had access to GasTOPS' sensitive confidential information and were held at trial to be integral to GasTOPS' business.

The Court upheld the trial judge's decision that Cass and Vandenberg were fiduciaries because the appellants had failed to establish that the trial judge had made a legal error in his assessment of the facts. The Court noted that Justice Granger found the employees to be "crucial" to the direction and guidance of the company by virtue of their responsibilities, their key roles in product development, and the highly sensitive information that they possessed. In particular, they:

  • had a high degree of responsibility and worked with little, if any, supervision;
  • held important roles in the company;
  • had developed a "significant commercial component" of the company's business by using "sensitive technological information" which they helped to develop and which was "at the very core of GasTOPS' corporate identity"; and
  • had integral knowledge of and involvement in GasTOPS' products, including their design, development, and future.

In addition, by virtue of their employment, when they set up MxI, Cass and Vandenberg:

  • were "well aware of the business opportunities GasTOPS was pursuing" and its pitches to potential customers;
  • had "full knowledge" of GasTOPS' products; and
  • possessed GasTOPS' business plan for 1997 and its strategic plan to acquire the U.S. Navy as a customer.

This aspect of the decision confirms that courts will look beyond title and compensation when determining if an employee owes fiduciary duties and will consider all the facts and circumstances of the case in deciding if an employee is a fiduciary. When employees are functionally equivalent to senior management by being crucial to the direction and guidance of the company, they may owe fiduciary duties to their employer. This may be particularly so for highly specialized employees working in niche industries.

Assessing Damages to Ensure Fair Competition

Whether disgorgement of MxI's profits for 10 years was an appropriate remedy was a hotly contested issue. In light of the "particular circumstances of [the] case", the Court concluded that it was. In doing so, the Court confirmed that fiduciary duties and the obligation to protect confidential information can, in appropriate cases, extend for significant periods of time. In a passage that is sure to be cited in future decisions, the Court held that, in awarding damages for breaches of fiduciary duties, the "driving principle [is] to ensure fair competition".

While assessing the damages award, the Court reiterated that deference was owed to the trial judge's findings of fact and his assessment of the appropriate remedy for breach of confidence and fiduciary duty. The Court rejected the appellants' argument that the 10-year accounting period exceeded limits set by prior cases. It agreed that given the small and highly specialized market at issue, the confidential business and technical information misappropriated and used, and that the appellants marketed and sold what they described as the next generation of GasTOPS' products, "fair competition could not have been assured" by simply providing GasTOPS with one to two years of damages on the theory that if GasTOPS had one or two years within which to contact their customers and retain their loyalty this would have been sufficient.

The Court confirmed that the nature of the misappropriated confidential information is also important in assessing damages. Here, the confidential information was considered "very special indeed": the appellants possessed confidential business plans, information regarding customer needs, and technical information at the core of their former employer's products which took years to develop. Misusing this information allowed the appellants to market their products as "merely a seamless next step in the evolution of GasTOPS' products". Moreover, the measure of the applicable time period for the damages calculation had to take into account not simply how long it would have taken the departing employees to develop the newest iteration of the GasTOPS software but the many years that went into bringing the product to where it was when they left.

Proper Notice of Resignation

A controversial aspect of the trial decision was Justice Granger's determination that the former employees were required to provide GasTOPS with between 10 to 12 months' notice of their resignation. As this finding was not appealed, it did not need to be addressed by the Court. However, the Court said that, "we should not be taken to agree with the 10-12 months suggested by the trial judge or the factors he considered in reaching that period". Therefore, the question of whether such long employee notice periods would ever be required is an open one.

Conclusion

GasTOPS is a cautionary tale about the consequences of unfair competition by key employees. However, it is important to remember that the decision is driven by factual findings of wrongdoing—misappropriation of confidential information, usurping an important corporate opportunity—and deceit. In fact, given the trial judge's finding that the appellants' actions were "intended to destroy GasTOPS technology business", the result is not surprising. Courts have always been able to fashion equitable remedies, such as ordering a disgorgement of earnings that flow from misconduct, to make plaintiffs whole.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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