Opinion ID: 783603
Heading Depth: 2
Heading Rank: 2

Heading: Forfeiture of Compensation

Text: 68 The pivotal question on appeal is whether the district court ordered Phansalkar to forfeit too little of the compensation awarded to him by AW in 1999 and 2000. If it did, and if Phansalkar should have been ordered to forfeit his interest in MCEL, we must reverse the district court's judgment of over four million dollars in Phansalkar's favor. In reviewing this question, we recognize that the district court faced a formidable task in grappling with this sprawling litigation. We also commend the court for its concerted effort to adjudicate even-handedly the parties' overlapping claims. We find, however, that Phansalkar was ordered to forfeit too little. 69 We reverse because our prediction with respect to the direction of New York law is different from that made by the lower court. We conclude that New York's faithless servant doctrine should be interpreted to require Phansalkar to forfeit all compensation awarded to him after October 15, 1999, the date his disloyalty began, including any interest in MCEL. Because Phansalkar loses his right to the MCEL Shares, he cannot challenge AW's retention of them. It is thus unnecessary to consider the issues raised by both parties with regard to Phansalkar's conversion claim.
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
97 The district court limited Phansalkar's forfeiture based on its interpretation of our decisions in Musico and Sequa. The court summarized its view of Musico and Sequa as follows: [T]ransaction-by-transaction apportionment of forfeiture is appropriate where (1) an employee did not engage in a `wide-ranging scheme' to defraud his employer, and (2) the incidents of disloyalty `did not extend to or taint all the dealings between the parties.' Phansalkar II, at , 2001 WL 1524479 at  (citations omitted) (quoting the district court decision in Sequa, 1996 WL 745448, at , and Musico, 764 F.2d at 114, respectively). 98 The district court's approach goes farther than either Musico or Sequa in limiting forfeiture. In light of our concern that even our Musico rule should now be considered tenuous, we believe that we should not relax the law of forfeiture any more than we did in Musico. 99 With one exception, 19 the only reported decisions applying transaction-by-transaction limitation of forfeiture are Musico and Sequa. In each of these two cases, there was an agreement (or several agreements) that the agent would be paid only a defined amount for his completion of each of several specific tasks or transactions; transaction-by-transaction forfeiture has not been applied in the absence of such an agreement. It thus has not been applied in cases in which the employee is paid a salary, or receives compensation derived from transactions on which he did not work. The existing limitation has the advantage of drawing a clear line, and of not embroiling courts in deciding how much general compensation should be forfeited, where the general compensation was awarded while the agent was acting disloyally in some, but not all, of his work. We adhere to this limitation. 100 As described above, Phansalkar's 1999 compensation agreement with AW specified that he would be paid $250,000 in salary, and that he would be given Partner Allocations, the value and nature of which were to be determined later, solely at the discretion of Andersen and Weinroth. Phansalkar's 2000 compensation agreement specified that he would be given Partner Allocations, but not a salary. Neither agreement specified that Phansalkar would be paid a particular fee or receive a particular benefit for each transaction he completed. The opportunities that Phansalkar received in 1999 and 2000 to make certain investments were left entirely to the discretion of Andersen and Weinroth. 101 The compensation Phansalkar actually received in 1999 and 2000 was derived from (1) transactions for which he had substantial responsibility, (2) transactions for which he had limited responsibility, and (3) transactions for which he had no responsibility. For instance, in 1999, Andersen and Weinroth decided to pay Phansalkar Partner Allocations for the Zip and Osicom transactions, for which he had substantial responsibility, and the Treasure Master transaction, for which he had no responsibility. In 2000, Andersen and Weinroth gave Phansalkar the opportunity to invest on favorable terms in Sorrento, for which he had substantial responsibility, in MCEL, for which he had limited responsibility, and in Headway, which was not even an AW transaction. 102 We believe that forfeiture cannot appropriately be limited to only some transactions in these circumstances, where the agreement calls for general compensation, and does not limit compensation to specific amounts paid for the completion of specific tasks.
103 Pursuant to the principles articulated above, Phansalkar is required to forfeit all compensation awarded to him after October 15, 1999, the date upon which he received but did not report his Zip Options, and thus the date upon which his disloyalty began. 104 Phansalkar's forfeiture should include, in addition to the forfeiture already ordered by the district court, (1) the portion of Phansalkar's $250,000 salary paid from October 15, 1999 to the end of 1999, (2) his interest in Treasure Master received in December 1999 as part of his share of the 1999 Partner Allocations, and (3) his interests in, and any benefits received from, his MCEL and Headway investments, which he made in 2000.
105 In reaching our decision that Phansalkar must forfeit his interests in his MCEL and Headway investments, we reject his final argument regarding forfeiture. Phansalkar contends that the investment benefits he received, or should have received, from the opportunities to invest in MCEL and Headway, are not compensation for the purposes of New York's faithless servant doctrine, because Phansalkar was required to risk his own capital to receive those benefits. Phansalkar further contends that, because those investment benefits are not compensation, they cannot be subject to forfeiture. 106 No New York court has decided whether a disloyal employee should forfeit benefits received from investment opportunities provided at a discounted price by his employer. Cf. McDougal v. Apple Bank for Sav., 200 A.D.2d 418, 606 N.Y.S.2d 215, 216 (1st Dep't 1994) (raising, but not deciding, question of whether the rule regarding a faithless employee's forfeiture of compensation applies to plaintiff's rights under the option agreements (citation omitted)). The district court found that Phansalkar's investment benefits were compensation, because the investments were offered to him in [c]onnection with his [s]ervice at AW, Phansalkar II, at , 2001 WL 1524479 at , at a discounted price, id. at , 2001 WL 1524479 at . The district court drew upon decisions holding that investment opportunities and the benefits of those opportunities may be considered compensation for the purpose of federal taxation and securities law. See, e.g., Comm'r of Internal Revenue v. Lo Bue, 351 U.S. 243, 247, 76 S.Ct. 800, 100 L.Ed. 1142 (1956) (employee realized taxable gain when he received and then exercised nontransferable stock options to purchase common stock in employer's company at below market price); United States v. Ostrander, 999 F.2d 27, 30-31 (2d Cir.1993) (opportunity to purchase securities, if regarded as a benefit by the recipient, can be thing of value or compensation for purposes of federal securities laws). 107 We agree with the district court that, for the purposes of New York's faithless servant doctrine, investment opportunities — like Phansalkar's opportunities to invest in MCEL and Headway — are a form of compensation. When an employer makes an investment opportunity available to an employee to reward him for his work and to give him an incentive to continue working for the employer, that opportunity and any benefit realized should be subject to forfeiture like any other form of compensation. The fact that an employee must use his own capital to take advantage of such an opportunity does not require a different conclusion. 108 The effect of ordering Phansalkar to forfeit his interest in MCEL is slightly different from the effect of ordering Phansalkar to forfeit his interest in Headway. This is because AW withheld (or withdrew) the MCEL Shares from Phansalkar before he realized any value from those Shares. In contrast, AW delivered 44,000 shares of Headway stock to Phansalkar, and he then sold those shares for a profit. Thus, with respect to MCEL, there is no need to quantify the investment benefit provided to Phansalkar. Because AW has maintained control over the MCEL Shares, Phansalkar simply forfeits any right to them. 20 With respect to Headway, there is a need to quantify the investment benefit provided. The profit Phansalkar made when he sold the Headway shares appears to be the appropriate measure of the benefit provided. However, because this point was not fully developed below, we remand to the district court on this issue. 21 B. AW's Stock Options in Phansalkar's Name 109 The final issue on appeal is how to treat the stock options that Phansalkar received as Directors' Compensation, which belong to AW, but are still in Phansalkar's name. As discussed above, AW sued Phansalkar for failing to disclose these options, on theories of breach of contract and breach of fiduciary duty. The district court held that, with respect to the two sets of options which belong to AW and as to which Phansalkar acted disloyally (the 40,000 Zip Options and the 35,000 Osicom Options), AW is entitled only to the money realized when the options are exercised. 22 The court declined to grant AW any specific remedy, such as being given the right to direct the exercise of the options at a particular point in time, because it found that AW's right to the options was not prejudiced by Phansalkar's disloyalty. 110 The lower court reasoned, implicitly if not explicitly, that because AW could not prove that it had the right to decide when options held in the name of a current employee could be exercised, AW should not be given that power over options held in the name of a former employee. The court apparently believed that such a remedy would place AW in a better position with respect to Phansalkar than it was with respect to a current employee. The court thus declined to formulate any remedy for the Zip and Osicom Options, and held that AW would simply remain the holder of a contingent right to the economic value of those options once they are realized. Phansalkar III, at -61, 2002 WL 1402297 at -19. 111 We vacate the district court's finding that AW is in the same position today with respect to the Zip and Osicom Options as it would have been had Phansalkar fulfilled his duties as an employee. The district court made this determination without first considering whether AW's ability to control stock options held in the name of a former employee was any different than its ability to control stock options held in the name of a current employee. We find that the district court should have engaged in further fact finding as to the existence of a policy that would have permitted AW to control the Zip and Osicom Options (if AW had known about them), once Phansalkar informed AW of his intent to leave the firm, or after he actually left. If such a policy existed, and Phansalkar's disloyalty prevented or frustrated AW's ability to assert its rights under that policy, then the district court must find that AW was harmed by Phansalkar's disloyalty and consider what remedy is appropriate to redress that harm. 23 On remand, the district court may consider any failure or delay on AW's part to demand that Phansalkar exercise the options, or to supply Phansalkar with any capital necessary for him to do so. It may also take note of any restrictions on Phansalkar's ability to exercise the options.