Opinion ID: 783603
Heading Depth: 3
Heading Rank: 1

Heading: New York's Faithless Servant Doctrine

Text: 70 New York law with respect to disloyal or faithless performance of employment duties is grounded in the law of agency, and has developed for well over a century. See Murray v. Beard, 102 N.Y. 505, 7 N.E. 553 (1886). We apply this law to the relationship between Phansalkar and AW, as the district court did, notwithstanding the fact that Phansalkar was denominated a partner and is, in certain respects, dissimilar to the salaried or commission-compensated agents discussed below. 10 These dissimilarities do not alter the fact that Phansalkar was unquestionably an agent of AW, and therefore assumed an agent's duties. 71 Under New York law, an agent is obligated to be loyal to his employer and is `prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties.' Western Elec. Co. v. Brenner, 41 N.Y.2d 291, 295, 392 N.Y.S.2d 409, 360 N.E.2d 1091 (1977) (quoting Lamdin v. Broadway Surface Adver. Corp., 272 N.Y. 133, 138, 5 N.E.2d 66 (1936)). One who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary. Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928, 394 N.Y.S.2d 626, 363 N.E.2d 350 (1977) (citing Restatement (Second) of Agency (1958), § 469). Moreover, a principal is entitled to recover from his unfaithful agent any commission paid by the principal. Wechsler v. Bowman, 285 N.Y. 284, 292, 34 N.E.2d 322 (1941); see also Maritime Fish Prods., Inc. v. World-Wide Fish Prods., Inc., 100 A.D.2d 81, 474 N.Y.S.2d 281, 287 (1st Dep't 1984) (employer is entitled to the return of compensation paid employee during period of disloyalty). It does not make any difference that the services were beneficial to the principal, or that the principal suffered no provable damage as a result of the breach of fidelity by the agent. Feiger, 41 N.Y.2d at 928-29, 394 N.Y.S.2d 626, 363 N.E.2d 350. 72 As discussed above, the district court concluded that Phansalkar breached his duties of loyalty and good faith by failing to disclose (1) the Zip Options, (2) the Zip Shares, (3) the Osicom Fees, (4) the Osicom Options, (5) the offer of a Sync Board seat, and (6) the offer of an Entrada Networks Board seat. Based on these breaches, the district court determined that Phansalkar should be required to forfeit compensation, but only that compensation derived from transactions on which Phansalkar had worked and as to which he was disloyal. AW now challenges the district court's decision to limit Phansalkar's forfeiture. 73 In response, Phansalkar does not dispute the district court's findings that he breached his duties of loyalty and good faith. 11 Instead, he defends the district court's determination that New York law supports the limitation of a disloyal employee's forfeiture to compensation derived from transactions on which the employee worked and as to which the employee was disloyal. He also argues, in the alternative, that the district court erred in requiring any forfeiture. We address the latter contention first, and then turn to the question of whether the district court should have ordered Phansalkar to forfeit even more compensation than it did.
74 Phansalkar argues that his misconduct does not warrant the forfeiture of any compensation, because his misconduct was simply a failure to disclose, and because the district court made an explicit finding that he did not intend to defraud AW. Phansalkar asserts that all New York decisions that require forfeiture involve fraud or intentional wrongdoing by the employee. We reject this argument and find that Phansalkar's actions and omissions warrant forfeiture. 75 New York courts have used two different standards to determine whether an employee's misbehavior warrants forfeiture. Both standards derive from decisions of the New York Court of Appeals from the late nineteenth century. The Court of Appeals enunciated the first standard in 1885 in Turner v. Konwenhoven, where it stated in dictum that a disloyal employee forfeits promised compensation only when the misconduct and unfaithfulness... substantially violates the contract of service. 100 N.Y. 115, 120, 2 N.E. 637 (1885); see also Abramson v. Dry Goods Refolding Co., 166 N.Y.S. 771, 773 (1st Dep't App. Term 1917) (relying on Turner 's dictum and stating that an employee forfeits promised compensation only where his disloyalty permeates the employee's service in its most material and substantial part). Lower New York courts have followed Turner 's dictum and found agents' disloyalty to be substantial in a variety of circumstances. 12 They have found disloyalty not to be substantial only where the disloyalty consisted of a single act, or where the employer knew of and tolerated the behavior. 13 76 The New York Court of Appeals enunciated the second standard for determining whether an employee's misbehavior warrants forfeiture in 1886 in Murray v. Beard, where it stated: 77 An agent is held to uberrima fides 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. 78 102 N.Y. at 508, 7 N.E. 553. 79 We first highlighted this passage in Musico (as discussed further below) because it suggests that New York maintains a strict rule against limiting a faithless servant's forfeiture. We highlight it now because it also suggests that misconduct by an employee that rises to the level of a breach of a duty of loyalty or good faith is sufficient to warrant forfeiture. The New York Court of Appeals confirmed this suggestion in 1936 in Lamdin v. Broadway Surface Advertising Corp., where it held that an employee who fell below the standard required by the law of one acting as an agent or an employee of another forfeits salary due. 272 N.Y. at 138, 5 N.E.2d 66; see also Feiger, 41 N.Y.2d at 929, 394 N.Y.S.2d 626, 363 N.E.2d 350 (no forfeiture where employee was not guilty of any breach of fidelity). 80 Notwithstanding the existence of these two standards, New York courts have not reconciled any differences between them, or defined the circumstances, if any, in which one standard should apply rather than the other. Notably, the New York Court of Appeals has not mentioned its dictum in Turner, since it decided that case. We need not delve further into these questions, however, because we find that Phansalkar's behavior warrants forfeiture under both standards. 81 Phansalkar's misconduct warrants forfeiture under the standard enunciated in Turner, because Phansalkar's disloyalty was not limited to a single, isolated incident, but rather occurred repeatedly, in nearly every transaction on which he worked. Phansalkar breached his duties of loyalty and good faith with respect to his work with Zip, Osicom, Sync, and Entrada Networks. The only transaction for which Phansalkar had substantial responsibility and was completely loyal was the Sorrento transaction. Phansalkar's disloyalties lasted for many months, and persisted boldly through an opportunity to correct them in June 2000, when Phansalkar and Andersen discussed the various interests accumulated during Phansalkar's tenure. We conclude that where disloyalty occurs in four out five of an employee's primary areas of responsibility and continues over many months, it substantially violates the terms of an employee's service. 82 Our conclusion is also based in part on the fact that Phansalkar was one of five primary actors at AW and was entrusted with funds that were part of the firm's one reliable source of income. As Phansalkar was told when he joined the firm, AW required its partners and employees sitting on boards to report and contribute to the firm all Directors' Compensation and opportunities. The reason for this was that the partnership relied upon these funds to give the partnership a stable income that could be counted on through good times and bad, e.g., even when transactional business was scarce. Phansalkar thus breached a critical duty when he failed to disclose his receipt of this income and these opportunities, which belonged to AW. We find that Phansalkar's disloyalty permeate[d] [his] service in its most material and substantial part. Abramson, 166 N.Y.S. at 773. 14 83 Phansalkar's misconduct warrants forfeiture also under the standard enunciated in Murray and Lamdin, because Phansalkar unquestionably violated specific duties owed to AW. As discussed above, the district court found that Phansalkar breached his duties by failing to disclose six different interests or opportunities that he received as a representative of AW. 84 New York law is clear that an employee is prohibited from acting in any manner inconsistent with his agency or trust. Lamdin, 272 N.Y. at 138, 5 N.E.2d 66. [A]bsent an agreement otherwise, an employee who makes a profit or receives a benefit in connection with transactions conducted by him on behalf of his employer is under a duty to give such profit or benefit to his employer, whether or not it was received by the employee in violation of his duty of loyalty. Western Elec. Co., 41 N.Y.2d at 295, 392 N.Y.S.2d 409, 360 N.E.2d 1091 (citing Restatement (Second) of Agency §§ 388, 403 (1958)). When an employee violates this duty, [n]ot only must the employee or agent account to his principal for secret profits but he also forfeits his right to compensation for services rendered by him if he proves disloyal. Lamdin, 272 N.Y. at 138, 5 N.E.2d 66. 85 Here, Phansalkar acted in a manner inconsistent with his agency by withholding from AW cash, stocks, and other interests that belonged to AW and that should have been turned over to the firm, as a part of the firm's only reliable source of income. He also acted in a manner inconsistent with his agency by specifically declining Sync's offer to place an AW designee on its Board, without having told AW of the opportunity. In addition, he repeatedly violated his affirmative duty to give AW the Directors' Compensation he received on AW's behalf. These breaches are more than sufficient to warrant forfeiture. 86 Finally, we reject Phansalkar's argument that his misconduct does not warrant forfeiture because the district court found that he did not intend to defraud AW when he failed to disclose his Directors' Compensation and other benefits received. The district court made this finding in the context of rejecting AW's claim that Phansalkar's compensation agreement was voidable because of fraud; the court concluded that AW could not prove the requisite scienter for this claim because AW failed to show that Phansalkar took any affirmative steps to conceal the benefits he received. See Phansalkar II, at -91, 2001 WL 1524479 at . We find nothing in New York law to suggest that a specific intent to defraud is necessary to render misconduct sufficient to warrant forfeiture. See, e.g, Lamdin, 272 N.Y. at 137, 5 N.E.2d 66 (where employee advances his own interests by procuring due bills instead of cash and, in doing so, does harm to his employer's interest, misconduct is sufficient to warrant forfeiture, in the absence of the employer's acquiescence); cf. Beatty v. Guggenheim Exploration Co., 223 N.Y. 294, 305, 119 N.E. 575 (1918) (Crane, J., dissenting) (disagreeing with majority determination that disloyal employee could not recover compensation, and arguing that such a determination was improper because there was no showing that employee acted in bad faith or with malice). 87 The record shows that Phansalkar intended for AW not to receive certain income and benefits, and to that end he not only withheld information from AW but also declined the offer to AW of a Sync Board seat. The record also shows that Phansalkar intended to keep at least some of these benefits for himself — because he knowingly received and retained them without ever disclosing them to AW. In taking these actions, Phansalkar disregarded his affirmative duty to act in his employer's best interests. See Maritime Fish Prods., 474 N.Y.S.2d at 286. We find that Phansalkar acted with sufficient knowledge of his omissions, and their consequences, to warrant forfeiture under New York law. 88 We now turn to whether the district court should have limited Phansalkar's forfeiture as it did.
89 Early decisions by the New York Court of Appeals suggest that New York's law of forfeiture requires disloyal agents to forfeit all compensation, without limitation. More recent decisions by lower New York courts, however, have endorsed the principle that faithless servant forfeitures can be limited in specified circumstances. We first discussed this development in Musico, 764 F.2d at 113, and review it briefly here. 90 In Murray v. Beard, the New York Court of Appeals stated that a disloyal employee forfeit[s] any right to compensation for services. Murray, 102 N.Y. at 508, 7 N.E. 553 (1886) (emphasis added). The Court of Appeals applied this rule in that case to deny a timber broker's claim to commissions due for arranging a sale of timber, because the broker had undertaken competing obligations to different dealers. The Court of Appeals quoted Murray 's language fifty years later in Lamdin, and affirmed the dismissal of a suit by a disloyal employee for the balance of salary due to him. See Lamdin, 272 N.Y. at 138-39, 5 N.E.2d 66. Although the Lamdin decision stated that a disloyal agent forfeits any right to compensation, that statement was dictum, given that in Lamdin the employer had not sought forfeiture of salary already paid to the disloyal employee. 91 Since these decisions, New York's lower courts have endorsed limiting forfeiture to compensation paid during the time period of disloyalty. This limitation of forfeiture developed in the context of cases in which agency agreements apportioned compensation to periods of time. Musico, 764 F.2d at 113. 92 In Musico, this Court considered whether New York courts would relax the law on forfeiture even further, to allow an employee to keep compensation for the tasks he performed loyally, during the time period in which he was disloyal in other work. We held that New York law would permit such relaxation where: (1) the parties had agreed that the agent will be paid on a task-by-task basis ( e.g., a commission on each sale arranged by the agent), (2) the agent engaged in no misconduct at all with respect to certain tasks, and (3) the agent's disloyalty with respect to other tasks neither tainted nor interfered with the completion of the tasks as to which the agent was loyal. Id. at 114. We held that where these three criteria are met, a disloyal employee forfeits only compensation earned in connection with the specific tasks as to which he was disloyal; he retains compensation earned in connection with the specific tasks as to which he was loyal. In Musico the agents had entered into four separate contracts with the principal. We found that the agents' disloyalty affected only two of the four contracts. Accordingly, we held that the agents forfeited only compensation earned pursuant to the two contracts as to which the agents were disloyal. See id. 93 We noted in Musico that limitation of forfeiture by time period and by task reflected the position taken by the Restatement (Second) of Agency, §§ 469 and 456 (1958). 15 See Musico, 764 F.2d at 113. We highlighted the fact that the Restatement explicitly states that the only circumstance in which forfeiture can be limited to compensation for particular tasks is where the contract itself allocates compensation among tasks. See id.; Restatement (Second) of Agency § 469 (1958) (an agent who wilfully and deliberately breaches his contract of service is not entitled to compensation even for properly performed services for which no compensation is apportioned). Our holding in Musico adhered to the Restatement's limitation. 94 We subsequently reaffirmed Musico 's reasoning in Sequa. Sequa involved a consulting agreement that specified that the agent would receive a particular fee for each leveraged leasing transaction he completed (the agreement stated that the agent's fee for each transaction would be one-half percent of the purchase price of the capital asset, plus ten percent of the residual value of the asset when resold). See Sequa, 156 F.3d at 140. The agent consulted on over forty transactions under the contract during the time period at issue. The district court found that the agent was disloyal with respect to only one of those transactions, and ordered the agent to forfeit only his fee on that transaction. See id. at 146. We affirmed this decision. See id. at 147. 16 95 In affirming, we considered and rejected an argument that a disloyal agent's forfeiture should be even more limited. In Sequa, the agent argued that he should not be required to forfeit his entire fee on the one transaction as to which he was disloyal, because the disloyal act affected only a very small component of the transaction ( i.e., the disloyalty was limited to misstatement of a $29,000 expense, in the context of a very large transaction on which the agent earned a $900,000 fee). We rejected this argument, based on our concern that we should not relax New York's rule of forfeiture any further than we had done in Musico, in part because no New York state court had yet endorsed the relaxation we allowed in Musico. We pointed out that our Musico limitation thus had a tenuous posture, and hence that in Sequa we were being relatively generous to limit the agent's forfeiture to the fees from the one transaction as to which he was disloyal, rather than to require forfeiture of the fees from all transactions. Sequa, 156 F.3d at 147. 96 The New York Court of Appeals has never specifically delineated the appropriate limitations of forfeiture (if any) under the faithless servant doctrine. As noted above, New York's lower courts have limited forfeiture to the time period of disloyalty, but appear never to have been faced with the question whether forfeiture should further be limited to compensation for specific tasks as to which the agent was disloyal. 17 No reported New York state court decision has mentioned Musico or Sequa. Thus, as was the case at the time of our decision in Sequa, New York courts have given us no reason to retreat from, or to expand, our holding in Musico. 18