A recent decision by the U.S. Bankruptcy Court for the District of Utah[1] is a cautionary tale for senior-level employees that are considering leaving their employment and taking employees and business to a competitor. It is also a primer for an employer who has to pursue its claim against the departing employee in bankruptcy court. The wrongdoing employee is not only potentially liable under theories of breach of fiduciary duty, tortious interference and violation of whatever employment agreements are in place, but the offending former employee may also face a discharge objection in bankruptcy court.
After becoming dissatisfied with his employment, in-house counsel to First American Title Insurance Co. took steps to form a new company, including by leasing new space and communicating with First American employees about coming with him to the new company, all of which he concealed from First American. After he resigned from First American, 26 First American employees joined the former in-house attorney at his new company, taking customers with them.
During discovery, First American obtained the attorney’s emails written after his resignation, which included statements such as, “They are idiots…. Instead, they threaten lawsuits and file a lawsuit, which only unifies us here at Northwest Title.… We have some of the best employment law specialists in the state representing us. We are in good hands and not worrying about it....” The attorney admitted in these emails that he “fully expected [to get sued] going in…; and that “they [First American] suck as a company.”
As he admittedly expected, First American sued the attorney in federal court. But contrary to his dismissal of First American’s ability to prevail, First American obtained a jury verdict and judgment against the attorney for (1) $500,000 for beach of his employment agreements; (2) $600,000 for breach of fiduciary duty with a finding of “clear and convincing evidence that his breach of fiduciary duty was willful and malicious, or in knowing and reckless indifference toward, and disregard of, the rights of First American”; and (3) $525,000 for tortious interference with contracts with a finding of “clear and convincing evidence that such tortious interference was willful and malicious, or in knowing and reckless indifference toward, and disregard of, the rights of First American.” The verdicts were upheld on appeal.
The attorney then filed for relief under chapter 7 of the Bankruptcy Code to discharge his obligation under the judgment. First American filed an adversary proceeding to contest the discharge, and the bankruptcy court held that the debt was nondischargeable under § 523(a)(6), which provides that a debtor may not discharge a debt incurred for a “willful and malicious injury by the debtor to another entity.” Several aspects of the bankruptcy court’s ruling are informative.
Claim Preclusion Applied to the District Court’s Decision
Because common parties and facts were involved in both the district court case and the adversary proceeding, the doctrine of issue preclusion applied, binding the bankruptcy court to the “findings of fact and law made in the District Court Litigation, and as affirmed by the Tenth Circuit Court of Appeals.”[2] Thus, the issues of the damages were already decided by the district court judgment.[3] And even if the damages were separated by claims, the bankruptcy court held that if all of the damages arise from willful and malicious injury, then all of the damage award is non-dischargeable regardless of the underlying cause of action.[4]
Claim Preclusion Does Not Apply to a Ruling that Does Not Track the Language of § 523(a)(6)
Section 523(a)(6) requires a finding that the debt arises from a “willful and malicious injury….” But the jury verdict in the district court action tracked the state statutory language for the punitive-damages claim, finding that the conduct was “willful and malicious” or with “knowing and reckless indifference.” The reckless indifference language and the requirement that the bankruptcy court find the conduct both “willful” and “malicious” precluded an automatic finding of liability under § 523(a)(6) based on the district court ruling.[5] Counsel representing a plaintiff in an action involving claims that could be nondischargeable should consider crafting jury instructions, verdict forms, and proposed findings of fact and conclusions of law to track the language of § 523(a)(6) to avoid further litigation in a future bankruptcy proceeding.
The District Court’s Finding of Fact Had Preclusive Effect on Whether the Attorney’s Conduct Was Willful and Malicious
The bankruptcy court ultimately found that the attorney’s conduct was willful and malicious largely, if not wholly, based on the findings of the district court.[6] Thus, even if the language of the judgment is not sufficient by itself to have a preclusive effect as to a ruling on nondischargeability under § 523(a)(6), findings of fact or special verdict form findings are preclusive as to any findings of fact contained therein. Accordingly, plaintiff’s counsel should consider drafting these with a later nondischargeabilty proceeding in mind.
The court closed with a lesson for others who might consider the path chosen by former in-house counsel:
There is nothing per se malicious about the Debtor wanting to create a better career opportunity for himself and others. However, the Debtor’s otherwise appropriate motivations crossed the line into malicious conduct when his business plan evolved into what was essentially a surprise attack on the operations of First American that involved intentionally concealing the formation of Norwest Title, poaching First American’s essential employees and significant customers, and setting up offices in locations that were in direct competition with First American. The Debtor’s actions are particularly problematic, and support the Court’s finding of an intent to injure, given that the Debtor's formation of Northwest Title occurred when he was concurrently acting as First American’s legal counsel. As such, the Debtor knew he had a fiduciary duty to avoid self-dealing and to act in the best interests of First American. As described above, the Debtor's conduct in this regard was wholly contrary to this duty, and the Debtor knew that his actions would injure First American.[7]
The fact that the ex-employee here was an attorney exacerbated his exposure. For example, as noted above, the court found that the attorney’s actions “were particularly problematic” because he was acting as First American’s legal counsel while simultaneously setting up a competing business. Similarly, the attorney tried to argue advice of counsel as a defense or to show lack of malicious intent. But the court held that “because the Debtor is an attorney with more than twenty years of experience in the title industry, it was not reasonable for him to accept what he heard second-hand … as the definitive word on the enforceability of the Equity Employment Agreement.”[8]
Senior employees — particularly in-house counsel — should understand that violations of an employment agreement can expose them to liability and that bankruptcy might not discharge that liability. Employers pursuing former employees that have violated an employment agreement should consider drafting jury instructions, verdict forms, findings of facts and trial briefs to take advantage of issue preclusion from a trial court to limit further ligation in a later bankruptcy proceeding.
[1] In re Smith (First American Title v. Smith), 2019 Bankr. LEXIS 2064 (Bankr. D. Utah July 10, 2019).
[2] Id. at *40.
[3] Id. at *43.
[4] Id. at *46.
[5] Id.
[6] Id. at *53.
[7] Id. at *80-81.
[8] Id. at *74.