Start-up Penalized for Deferring Employee Compensation on Employee’s Advice

A startup employee advised his employer that it could withhold his and others’ wages until it secured future funding. The employee was a lawyer and drew up contracts to reflect this agreement. The employee later left the company on bad terms and demanded arbitration to recover his back wages. An arbitrator ruled for the employee, determining that the company had violated the Illinois Wage Payment and Collection Act because it had withheld wages beyond the statutorily allowed time period. The company later sued the employee, arguing that it was the employee’s own advice that led to the company’s liability. The district court granted the employee’s motion to dismiss, and the company appealed. The appellate panel affirmed the decision of the district court, finding that the company’s CEO had failed to show that the employee owed her a duty, and that the company had failed to show that the employee’s advice was the proximate cause of its actions.

UFT is a commercial finance company founded by Joanne Marlowe in 2008. Richard Fisher worked as a consultant with UFT from February 2013 to September 2013 and then became employed by UFT as its chief legal officer in October 2013. While he was employed at UFT, Fisher was the sole source of legal counsel to UFT and Marlowe regarding the company’s operations. Fisher also drafted the employment agreements between UFT and its employees, including both Marlowe’s and his own. The employment agreements included mandatory arbitration clauses.

During this time period, UFT’s revenues were inconsistent. The company therefore failed to pay Marlowe, Fisher, and all other employees their agreed salaries when they were due. Fisher and other employees continued to work at the company because they believed in its potential. At various times, Fisher recommended and drafted “supplemental agreements” allowing for the accrual of wages owed to various employees who could not be paid on schedule due to UFT’s revenue shortfalls.

Fisher entered into one of these agreements for his own compensation in January 2016. Fisher’s agreement stated that he was owed $330,000, which was to be paid in full from any subsequent first closing of any permanent equity/debt placement by UFT in an amount greater than US $1,000,000, if not paid earlier from any other source. Fisher did not advise UFT to consult independent counsel when drafting his own supplemental and employment agreements. Fisher also advised Marlowe against the purchase of Directors and Officers liability insurance.

In August 2016, Fisher left UFT on bad terms after negotiations with Marlowe over his contract renewal broke down. In January 2018, Fisher demanded arbitration before the American Arbitration Association to recover his unpaid wages. In January 2019 an arbitrator found that Fisher’s wages had been illegally withheld throughout his employment because the Illinois Wage Payment and Collection Act imposes strict time limits on when wages must be paid. The arbitrator held UFT and Marlowe jointly and severally liable to Fisher for unpaid wages and statutory penalties totaling $864,976. The arbitrator also held UFT liable for an additional $366,460 because Fisher did not receive written contract notice of his contract nonrenewal, which entitled Fisher to be paid for another three-year contract term, whether earned or not.

Here is the Court’s full opinion.

UFT and Marlow did not pay the arbitration award. Instead, they filed suit against Fisher in Illinois state court alleging that Fisher’s own legal malpractice caused them to take the actions that triggered their liability to him under the arbitration award. Fisher removed the case to federal court based on diversity of citizenship. The district court granted Fisher’s Rule 12(b)(6) motion to dismiss, finding that any malpractice related to Fisher’s original employment agreement was barred by Illinois’ statute of repose; that Fisher owed no duty to Marlowe because he formed no attorney-client relationship with her personally; that the plaintiffs did not successfully plead that Fisher’s legal advice caused them to use the supplemental agreements, refuse independent counsel, or forgo D&O insurance; and that the plaintiffs had not alleged any damages stemming from contracts with any employee other than Fisher. The plaintiffs then appealed.

The appellate panel began by noting that the plaintiffs challenged only whether Fisher owed a duty to Marlowe and whether they needed to show proximate cause as to the supplemental agreements. The panel first addressed Fisher’s duty to Marlowe. The panel stated that even if it assumed that Marlowe was Fisher’s client regarding Marlowe’s own supplemental agreement and the D&O insurance decision, the plaintiffs had failed to plead any plausible malpractice claims arising from those matters.

Next, the panel addressed the issue of proximate cause. The panel stated that the plaintiffs were misreading the arbitrator’s decision and that the arbitrator had not found that Fisher’s supplemental agreement was an illegal deferred compensation agreement. The panel stated that the arbitrator had found that the intent and effect of the agreement was merely to confirm UFT’s accrued payment obligation to Fisher, and that the agreement did not disclaim any right to payment. The panel stated that the plaintiffs needed to have pled facts plausibly showing that if Fisher had not recommended the supplemental agreements, they would have taken a different course of action that would have avoided their liability to Fisher. Because the plaintiffs failed to do so, the panel held that their claims were foreclosed. The panel, therefore, affirmed the decision of the district court.

You can review the Court’s full opinion here.

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