Employer Awarded Over $800,000 In Damages After Employees Acted In Competition During Employment

On 5 October 2021, the Employment Court (“Court”) released its determination in Smith City (Southern) Limited (in Receivership) v Claxton [2021] NZEmpC 169, regarding two former employees, Jeremy Claxton (“Claxton”) and Nicholas Milne (“Milne”), who engaged in business activities that were in direct competition with their employer, Smith City (Southern) Limited (“Smiths City”), while employed.  
 
Considering the conduct of Claxton and Milne, the Court awarded damages to Smiths City totaling more than $800,000. 
 
Claxton
 
Claxton was employed in 2009 as the Flooring Manager at one of Smiths City’s Christchurch stores.  In his role, Claxton was responsible for two salespeople in the Flooring Department, as well as the “Laying Team”, who installed carpets for customers on behalf of Smiths City. 
 
The Court was quick to determine that, during his employment, Claxton had operated in competition with Smiths City, doing so in the following ways:

  • Can Do Flooring Limited (“Can Do Flooring”) developed and sold carpet, vinyl, tiles and ancillary flooring products.  From 2011, Claxton worked as a ‘consultant’ for Can Do Flooring, working out costings and quotes for work, attending to measuring the jobs and arranging installation.  He also assisted with invoicing and answering customer queries, on occasion following up with Can Do Flooring customers using his Smiths City email address.  Claxton set up a store account with Smiths City in the name of Can Do Flooring’s sole director, Ms Wilde.  Between 2011 and 2019, around 360 sales transactions were recorded through Ms Wilde’s store account where Claxton was named as the salesperson, totaling $397,000 plus GST.  Claxton invoiced Can Do Flooring for a ‘consultant’s fee’.  The Court noted that Claxton added GST to his invoices, despite not being registered for GST, and retained the additional 15 per cent he added to each invoice.
  • Gradually, Claxton began operating as a sole trader, purchasing, or arranging purchases, of carpet and flooring through other Smiths City customer account holders for himself.  To do so, Claxton used several customer accounts, including an account in the name of his mother-in-law and an account in the name of his father-in-law.  Using accounts in this way allowed Claxton access to lines of credit that Smiths City would not otherwise have allowed had Claxton been making these purchases as a bona fide customer.  This also allowed Claxton to circumvent Smiths City’s staff purchasing policy restrictions.
  • In 2017, Claxton incorporated his own company, Cando Creative Flooring Limited (“Creative Flooring”), undertaking flooring activities in direct competition with Smiths City.  Both Claxton and his wife were directors of Creative Flooring. 

The Court found that Claxton picked and chose customers from Smiths City to suit himself, and diverted Smiths City’s business on this basis.  Smiths City called 11 witnesses who gave evidence to the effect that Claxton had interposed himself, Can Do Flooring, or Creative Flooring, in transactions that the customer believed was with Smiths City.  The evidence indicated that quotes were sometimes given by Claxton to customers on Smiths City’s behalf, but the work was then undertaken and invoiced by Creative Flooring.  On other occasions, Claxton deliberately diverted the business away from Smiths City, or he would undercut Smiths City by providing a lower quote from Creative Flooring for the same work.  One customer gave evidence that she received a quote from Smiths City in an email from Claxton, signed by him as Smiths City’s Flooring Manager.  Subsequently, this customer then received an invoice from Creative Flooring.  The customer did not know anything about Creative Flooring, and called Claxton for clarification.  Claxton advised her that the transaction was “all good”, and that Creative Flooring was “another division of Smiths City”.  The Court also observed that, for a significant period of time, payments made to Claxton’s business were channeled into a bank account in his son’s name who was, at the time, a minor.
 
The Court was satisfied that Claxton undertook business in direct competition with Smiths City from about October 2011 right up until his employment ended in 2019 by way of resignation.
 
The Court accepted that Claxton had breached his employment agreement in:

  • establishing and maintaining a conflict of interest for a very long time;
  • competing with Smiths City in his arrangements with Can Do Flooring, himself as a sole trader, and Creative Flooring;
  • using Smiths City’s property to store his carpet and show it to customers;
  • influencing potential transactions with Smiths City’s customers by diverting them to himself for personal gain;
  • incorporating Creative Flooring and acting as its director; and
  • being a director of Cando Creative Installs (“Creative Installs”) alongside Milne, being a business that also directly competed with Smiths City.

In determining that Claxton had also breached his duty of fidelity to Smiths City, the Court accepted the conclusions in Rooney Earthmoving Ltd v McTague [2009] ERNZ 240, which related to a senior employee who was involved in establishing a competing business.  In Rooney Earthmoving, the Court observed that it was “no great extension of the duty of fidelity or trust and confidence to require that employee to report that conduct to the employer”
 
Here, the Court determined that Claxton, as a senior employee, had breached his duty of fidelity to Smiths City by:

  • failing to advise Smiths City before he began to compete with it that he intended to do so, and subsequently by not disclosing that he was competing with it;
  • failing to disclose Milne’s competing activities and his plan to establish a competing business.

The Court also determined that Claxton had breached his duty of fidelity immediately before his resignation in 2019 by emailing himself, from a Smiths City work computer, confidential information intended to be used for the benefit of Creative Flooring.  This confidential information included flooring installation targets, profitability spreadsheets, template flooring quotes, installers contracts and a pricelist.
 
Regarding remedies, Smiths City sought damages calculated as the revenue Claxton generated as a result of his competing activity less the costs he incurred in generating this revenue.  In Rooney Earthmoving, the Court made its assessment of damages by considering the revenue obtained by the employees less the plaintiff employer’s operating expenses, to reflect the net revenue that the employer would have obtained from the relevant transactions.  In this case, the Court determined that it would be artificial and impractical for Smiths City to calculate the costs it could have expected to incur had it undertaken the transactions that Claxton had diverted from it, particularly as Claxton himself was responsible for setting the margins on the sales to himself via other customer accounts.
 
In accepting Smiths City’s calculation of damages (being the revenue Claxton generated from his competing business less the costs he incurred in generating this revenue), the Court observed that what damages are appropriate “is a question of fact” and it may be necessary for the Court to “make the best assessment it can, being satisfied on the balance of probabilities that the conclusion as to loss is correct”.
 
Accordingly, the Court awarded damages against Claxton of $732,399.
 
Smiths City also made two claims for special damages. The first claim was to recover fees paid to licensed private investigators, totaling approximately $20,000.  This claim was unsuccessful, as the Court determined that the information gleaned from the private investigators was not compelling and as such it was not appropriate for these fees to form part of the damages awarded against Claxton (or Milne).
 
The second claim for special damages was for $110,000, relating to executive time spent investigating Claxton’s (and Milne’s) activities and preparing for the hearing.  A calculation was presented, breaking down executive time into charge out rates per hour and attributing to named executives the number of hours said to have been spent on the matter.  Despite this, the Court was not satisfied that the calculations provided were sufficient to establish this claim for special damages, as the calculations did not detail what those executives did, nor did they detail the connection between their conduct and Claxton’s breaches.
 
Claxton raised a counterclaim against Smiths City for alleged unpaid incentive payments, totaling $34,000 plus interest.  This was based on monthly incentive payments of $500 that were allegedly unpaid over 68 months.  However, when giving evidence, Claxton acknowledged that he had been paid these incentive payments.  Claxton also provided no evidence that he had met the performance targets for each of the months claimed to become entitled to the incentive payment.  The Court also noted that Claxton’s payslips all identified that he routinely received incentive payments.  Accordingly, this counterclaim failed.
 
Milne
 
Milne started work for Smiths City in 2009 as an apprentice floorcoverings installer.  In 2013, he was promoted to Flooring Installation Manager, and he reported to Claxton. When first employed, Milne signed a separate agreement with Smiths City (“trade agreement”), in addition to his individual employment agreement, which restricted the use of his trade skills outside working hours. 
 
Smiths City identified that, between 2016 and 2018, Milne received payments from Claxton for flooring jobs totaling $83,568.
 
Milne initially denied that he had been working in competition with Smiths City, and he claimed that the earlier payments from Claxton between 2016 and 2017 were not for carpet laying but other private transactions, including a shared interest in classic cars.  This explanation was rejected by the Court. 
 
The Court observed that, while employed by Smiths City, Milne worked for himself, eventually describing his business as “Tip Top Flooring” (“TT Flooring”), to undertake flooring installations for Claxton and Creative Flooring.  Milne invoiced Claxton/Creative Flooring for these services.  However, Milne admitted that many of the details in these invoices were inaccurate, with:

  • the business address being false;
  • the cellphone number being false;
  • GST was claimed, but Milne was not registered for GST; and
  • money due on some invoices was paid into bank accounts held in names other than his own (including that of his brother, his father-in-law, and his young son).

The Court determined that Milne had been operating in competition with Smiths City, which was in breach of his employment agreement and the trade agreement.  It was also determined that Milne was aware that Claxton was operating in competition with Smiths City from at least late 2015.
 
The Court identified that Milne had arranged for Smiths City’s employed installers to undertake work on behalf of Can Do Flooring and Creative Flooring during the working day.  The Court heard that, on more than one occasion, when Smiths City installers were working on floors supplied by Can Do Flooring the customer believed they were dealing with Smiths City, which could only have happened if Milne had directed the installers to work on jobs that were not for Smiths City’s benefit.  An example of this was where, on one occasion, a customer paid Can Do Flooring for carpet, but the installers who worked during the business day were wearing Smiths City staff t-shirts.
 
The Court concluded that Milne had breached his duty of fidelity by:

  • undertaking business in competition with Smiths City during his employment;
  • approaching existing Smiths City employees, while he was still employed, and inviting them to transfer to Creative Installs, the company Milne and Claxton had incorporated together to undertake flooring services.  Milne successfully solicited one employee from Smiths City, who resigned and began work with Creative Installs;
  • retaining Smiths City’s confidential information after his employment ended, in the form of profitability spreadsheets which identified the profitability of Smiths City’s flooring department and the costs associated with each installer; and
  • not reporting to Smiths City that Claxton was operating a business in competition with it.  The Court noted that this particular obligation arose as part of Milne’s senior position with Smith City.

As with Claxton, the Court accepted Smiths City’s calculation of damages, based on the revenue Milne generated through his competing activities, less the expenses that Milne had incurred in generating this revenue.
 
On this basis, the Court awarded damages against Milne of $83,568.
 
Milne raised a counterclaim against Smiths City for alleged underpayment of wages, totaling $22,427.20, on the basis that while his official start time was 7.30am, he often arrived at 7am, but he was not paid for these 30 mins.  The Court saw this counterclaim as an attempt by Milne to dampen the effect on him if Smiths City’s claims were to succeed.  The Court determined that there was no substance to this counterclaim, and it was dismissed.
 
Wider implications
 
While the conduct of Claxton and Milne was particularly egregious, and plainly in breach of their employment agreements, this determination includes pertinent observations that employers should be mindful of:

  • Scope of duty of fidelity: this determination reaffirmed the observations made by the Court in Rooney Earthmoving regarding the scope of the duty of fidelity, particularly for senior employees.  This determination reiterates that, for senior employees, the duty of fidelity includes the obligation to inform their employer of their intention to operate in competition, and to inform their employer of another employee’s competing activities/intention to compete should they become aware of it.
  • Calculation of damages: the Court confirmed that the calculation of damages resulting from an employee’s competing activities will be a question of fact, and it may be necessary for the Court to make the best assessment it can, being satisfied on the balance of probabilities that the conclusion as to loss is correct.
  • Claims for special damages: Special damages can be difficult to substantiate, and this determination indicates that claimants must be able to:
    • show that it would be appropriate for the invoices relating to the special damages to form part of the damages against the defendant; and
    • detail the hourly rates, time spent, specific attendances and the connection of the attendances to the employee’s breaches, when seeking special damages for executive time spent investigating the employee’s breaches and preparing for the hearing.

If you have any questions about the implications of this determination, or about the conduct of current or former employees, please feel free to contact us on 0800 339 002.

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