The Latest from the Court of Appeal on Departing Employees and Their Fiduciary Duties

The decision of the Ontario Court of Appeal in GasTOPS Ltd. v. Forsyth, et al., released on March 1, 2012, is a useful reminder of the extent to which the court will express serious disapproval of breaches of fiduciary duty by departing employees.

This particular case involves facts which appear to reflect unusually egregious conduct. 

GasTOPS Ltd. was in the business of developing computer software products that assessed machinery conditions for maintenance purposes for operators of gas turbine engines.  It was an industry leader in the area.  Its primary market was that of military aviation, particularly for the Canadian Armed Forces, but its business grew to include the commercial industrial market as well.  Its industry was a highly specialized niche one with a small number of customers each generating substantial revenues.  At the time of the events in question, it was pursuing an important opportunity with the US Navy.

If a former employer can demonstrate that it took a substantial period of time for it to get back on its feet, departing fiduciaries may well be held to account for their former employer’s lost profits for that entire period of time.

The four individual Defendants had been employees of GasTOPS for periods ranging from three to nine years as of October, 1996.  They were effectively the designers of the core programs within the family of GasTOPS’ products.  They knew of GasTOPS’ business opportunities, and they were completely familiar with its products.  They were aware of GasTOPS’ strategic plan to acquire the US Navy as a customer as well as GasTOPS’ business plan generally.  The trial judge found that they were privy to GasTOPS’ customers’ and potential customers’ requirements and had thorough knowledge of its sensitive technological information. 

The trial judge found that about five months before resigning from GasTOPS, two of them had attended a seminar on starting a software company.  In October, 1996, they gave two weeks’ notice of their resignation.  The other two resigned three days later with the same length of notice.  Within hours, they were meeting with GasTOPS’ employees and describing their plans to set up their own business focused on aviation maintenance software.  Shortly afterwards, a number of other GasTOPS employees left to join them in their new company. 

They set up a new company, MxI Technologies Ltd., and immediately pursued every existing and potential GasTOPS’ customer including the Canadian Armed Forces and the US Navy.  Using the confidential business information obtained while at GasTOPS to develop their marketing strategy and their technology, they offered GasTOPS’ customers a virtually seamless transition to MxI and its products.  They actually portrayed themselves as a “spin off” of GasTOPS and indicated that their product was the next iteration of the product that they had developed at GasTOPS. 

MxI was successful in obtaining US Navy contracts which, over the first three years of its existence, provided 80% of its income. 

As for GasTOPS, its expert’s evidence at trial estimated its lost and foregone profit at about $13 million over a 10-year period. 

GasTOPS sued for an injunction to stop the Defendants from pursuing this course of action.  The injunction was not granted.  GasTOPS also sought damages. 

The case took seven years to complete.  The trial occupied almost 300 days over a span of 3 ½ years.  It involved 70,000 pages of exhibits.  Written submissions occupied more than 3,000 pages and took a further year and half to complete.  The Reasons for Judgment took another two years and consisted of 668 pages. In the result, the four individuals and MxI were ordered to pay damages of over $12 million together with pre-judgment interest of about $3 million and costs of over $4 million. 

Damages were awarded on the basis of three conclusions reached by the trial judge.  Firstly, he found that all of the individual Defendants owed a fiduciary duty to GasTOPS and breached it mainly in the way they left their jobs and continued to act after doing so.  In particular, they left knowing that other employees would follow with devastating effects on GasTOPS, they solicited customers of GasTOPS, and they used its confidential information to compete unfairly with it.  Secondly, they misused confidential information to advance their own business interests in breach of their duty of confidence to GasTOPS.  Thirdly, they breached their contracts of employment by leaving without giving reasonable notice.

Two of the individual Defendants appealed the finding that they owed fiduciary duties.  That appeal was rejected without great deal of difficulty.  All of the Defendants appealed the finding that each was jointly and severally liable for the amount of the damages.  The quantification of damages was also an issue.  These grounds for appeal were dismissed as well. 

On the quantification of damages, the trial judge awarded lost profits for a 10-year period.  Although the Defendants argued that this remedy was not fair or proportional, the Court of Appeal would not interfere with it.  The Court of Appeal accepted the trial judge’s finding that the damage suffered by GasTOPS as a result of the Defendants’ conduct lasted 10 years.

The Defendants argued that in cases of breach of fiduciary duty, the time limit in assessing damages usually averages between one and two years, with five years as a maximum.  The Court of Appeal pointed out that these cases relate to a fiduciary’s duty not to compete until an employer has had a chance to contact customers and try to retain them.  The principle behind the analysis is the ensuring of fair competition.  In this case, the unfair competition stemmed from much more than attempts to attract GasTOPS’ customers.  The court took into account the fact that this was a small and specialized market with highly confidential technical information that was appropriated and used by the Defendants in their new business.  The Court of Appeal decided that the trial judge was correct in assessing damages on the basis of how long GasTOPS actually suffered from the Defendants’ actions.  The same analysis was used in addressing the time limit for the misuse of confidential information. 

It follows from this analysis that earlier cases limiting the extent to which damages would be awarded against departing employees to one or two years can no longer be accepted as a rule of thumb.  If a former employer can demonstrate that it took a substantial period of time for it to get back on its feet, departing fiduciaries may well be held to account for their former employer’s lost profits for that entire period of time.  Alternatively, they may be required to disgorge their new company’s profits for that period of time. 

One other interesting point relates to the trial judge’s observations concerning the amount of notice that the individual Defendants should have given to GasTOPS of their intention to resign.  Clearly, two weeks was totally inadequate.  The trial judge commented that if they had provided 10-12 months’ notice, GasTOPS probably would have been able to make arrangements to replace them and have their new employees become familiar with the GasTOPS’ products and compete with MxI in the market.  In the view of the trial judge, the effect of their breach of fiduciary duty to GasTOPS would have been lessened greatly.

The Court of Appeal was careful to observe that it “should not be taken to agree with the 10-12 months suggested by the trial judge”.  While the Court of Appeal did not offer any alternative analysis on the point, it is worth noting that the day that the senior employee might be required to provide his employer with a very substantial period of notice of resignation may not be far off in the future.

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