A New York Appellate Court’s Recent Decision Reminds Us that the Faithless Servant Doctrine is Alive and Well in New York
On March 20, 2018, the Appellate Division of the Supreme Court of New York, First Department unanimously affirmed an arbitration award in favor of the legal recruiting firm Major, Lindsey & Africa, LLC (“Major Lindsey”) against a former employee, disgorging nearly $2 million in compensation paid to the former employee over the course of her four years with the firm based on claims that the former employee had stolen trade secrets and divulged confidential information to Major Lindsey’s competitors. In upholding the arbitration award, the First Department held that the decision to claw back all salary and commissions paid to the employee during her entire tenure with the company under a faithless servant theory of liability did not violate New York public policy. This decision represents the most recent sign that the faithless servant doctrine is alive and well in New York and provides a potentially powerful tool for employers that have been damaged by the actions of a disloyal employee.
The faithless servant doctrine, which is grounded in the law of agency, allows employers to claw back all compensation paid to an employee (whether in the form of salary, commissions and/or bonuses) upon a showing that the employee engaged in repeated acts of disloyal conduct during the course of his or her employment. The doctrine was first recognized by New York’s highest court in the late nineteenth century inMurray v. Beard, 102 N.Y. 505 (1886), in which the Court of Appeals instructed that “[a]n agent is held to uberrima fides [utmost fidelity] in his dealings with his principal, and if he acts adversely to his employer in any part of the transaction, or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of the employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.” Id. at 508. In 1977, the Court of Appeals further confirmed the doctrine’s place in New York law and clarified that forfeiture of compensation is required even when some or all of “the [employee’s] services were beneficial to the principal or [when] the principal suffered no provable damage as a result of the breach of fidelity by the agent.” Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-29 (1977); City of Binghamton v. Whalen, 141 A.D.3d 145, 147 (3d Dep’t 2016). In other words, a faithless servant can be forced to forfeit all compensation received during the period of the employee’s disloyalty, regardless of whether the employer could prove damages.
Generally, under New York law, the faithless servant doctrine has been applied in one of two situations: (1) where the employee’s misconduct and unfaithfulness substantially violates the contract of service such that it permeates the employee’s service in its most material and substantial part; or (2) where the employee’s misconduct rises to the level of a breach of a duty of loyalty or good faith. Disloyal acts that have found to be actionable under the doctrine include “act[s] directly against the employer’s interests – as in embezzlement, improperly competing with the current employer, or usurping business opportunities.” Pozner v. Fox Broad. Co., 2018 NY Slip Op. 28102 (Sup. Ct. N.Y. County Apr. 2, 2018).
In Major Lindsey v. Mahn, the arbitration award came on the heels of the arbitrator’s finding that the defendant had stolen confidential information and trade secrets, and shared confidential job postings with Major Lindsey’s competitors. While critics have opined that the doctrine is overly punitive and draconian, in upholding the arbitrator’s award, the First Department appears to have specifically addressed such arguments and rejected them. The First Department found that the $2.7 million arbitration award, which included disgorgement of more than four years’ worth of the disloyal employee’s past salary and commissions in the amount of $1.77 million plus over $900,000 in attorneys’ fees and costs, was not violative of New York public policy or punitive in nature. Id. (citations omitted).
By allowing for the claw back of all compensation paid to an employee during the period of his/her disloyalty, the faithless servant doctrine offers employers a more straightforward way to calculate their damages as compared to the more conventional commercial breach of contract, and tortious interference claims. A plaintiff asserting a claim for breach of contract or tortious interference must typically show the value of the harm inflicted as a result of the former employee’s unlawful conduct – which often may be hard to quantify and may present evidentiary complications particularly when the full extent of the wrongdoing may never be fully known. By contrast, under a faithless servant theory of liability, so long as the plaintiff can present adequate evidence of the disloyalty, and establish the period pervaded by the disloyal conduct, the plaintiff can seek to recover all compensation paid to the disloyal employee during that time (in addition to any lost profits that the disloyal employee obtained) even if the employer cannot establish damages suffered from the employee’s disloyal acts. Feiger, 41 N.Y.2d at 928-29. For example, in Beach v. Touradji Capital Management, LP, 144 A.D.3d 557 (1st Dep’t 2016), the First Department explained that the counterclaim plaintiff had stated a faithless servant claim and could seek to recover compensation paid to the disloyal former employees who formed a competing company, even if the counterclaim plaintiff could not show damages arising from its loss of investors. Id. at 563. Similarly, in Major Lindsey, the plaintiff may have suffered some damage to its good will as a result of the defendant’s sharing of trade secrets with its competitors. Rather than try to quantify that harm, the faithless servant doctrine allowed Major Lindsey to claw back four years’ worth of compensation.
This easier method of calculating damage was adopted by New York courts to deter employees/agents from self-dealing and acting against their employer’s interests. See Diamond v. Oreamuno, 24 N.Y.2d 494, 498 (1969) (“the function of [a breach of fiduciary duty] action, unlike an ordinary tort or contract case, is not merely to compensate the plaintiff for wrongs committed by the defendant but ... to prevent them, by removing from agents and trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others, or to which their agency or trust relates.”) (internal quotation marks, citations and emphasis omitted).
The First Department’s affirmance of the arbitration award in the Major Lindsey case is a clear win for employers and should serve as a reminder to litigators and employers of the potentially powerful faithless servant claim and meaningful remedies available to employers damaged by an employee’s disloyal acts. It should also serve as a warning and deterrent to employees engaged in disloyal conduct– as the penalty may be more than they bargained for.
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Business Litigation Bulletin is a newsletter of Tannenbaum Helpern Syracuse & Hirschtritt LLP’s Litigation and Dispute Resolution practice. It provides strategic perspectives on legal cases that impact the business community.
05.22.2018 | PUBLICATION: Business Litigation Bulletin | TOPICS: Litigation