The faithless servant rule is grounded in the law of agency and provides a tool that employers can use to try to claw back all compensation paid to a former employee upon demonstrating that the employee repeatedly engaged in disloyal and unfaithful conduct during the term of his or her employment. The theory underlying the doctrine is quite simple: one who has acted unfaithfully or in bad faith in an employment context should not be entitled to retain his or her compensation.
The faithless servant doctrine was first recognized by the New York Court of Appeals in Murray v. Bear.1 New York’s highest court found 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 employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.”2
Over 90 years after Murray was decided, the Court of Appeals affirmed the doctrine’s survival in New York and held that forfeiture of compensation is compulsory 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.”3 Under the Court’s analysis, a faithless employee can be ordered to forfeit all compensation paid during the entire course of the employee’s disloyalty, irrespective of the employer’s ability to prove concrete damages or harm.
The faithless servant doctrine has been applied in New York to two scenarios: (1) where the employee’s disloyalty and wrongdoing so substantially violated his employment duties such that it saturated the employee’s work on the most material and critical level; and (2) where the employee’s unfaithful conduct constituted a breach of the duty of loyalty. Actionable misconduct under a faithless servant theory can take many forms such as fraudulent misconduct, gross negligence, embezzlement, misappropriating trade secrets, behavior detrimental to the company, or misstating a company’s financial position.
Although critics of the faithless servant doctrine have characterized it as overly punitive, the First Department obviously feels differently. In Mahn v. Mayor, Lindsey & Africa, LLC,4 it upheld an arbitrator’s award totaling $2.7 million, which included disgorgement of over four years of prior salary and commissions paid to the employee in the amount of $1.77 million and over $900,000 in attorneys’ fees and costs. The arbitrator had found that, in addition to the former employee having stolen trade secrets, she had intentionally shared confidential job postings with certain of MLA’s direct competitors. The Court specifically held that the award was not punitive in nature and did not violate New York’s public policy.
By forcing disgorgement of all compensation paid to an employee during the course of his or her misconduct, the faithless servant doctrine provides employers with a more clear-cut and calculable basis for damages than breach of contract and tortious interference claims. Such claims require that a plaintiff demonstrate the monetary value of the damages suffered from the prior employee’s misconduct. This requirement can often be difficult to satisfy since the actual scope and degree of the misconduct may not yet be entirely clear.
Under the faithless servant doctrine, by contrast, as long as the plaintiff can make a sufficient showing of disloyalty by the former employee during his or her employment, the plaintiff can seek recovery of all compensation paid to the employee over the course of such employment. Disgorgement may be required even if the employer suffered no damages from the employee’s disloyalty because one of the primary purposes of this doctrine is to remove all incentive for a servant, i.e., employee, to be faithless. The penalty for violating the doctrine is harsh and can be draconian to some: the employee must forfeit all compensation earned since the first date of employment even though the employee’s services may have otherwise benefitted the employer and even if the employer suffered no damages.
In Beach v. Touradji Capital Management, LP,5 for example, the court held that the faithless servant doctrine could be used to recover the compensation paid to disloyal employees who formed a competing company regardless of whether the counterclaim plaintiff could prove damages occurring from its loss of investors. Beach confirmed the faithless servant doctrine’s place as a potent weapon for employers faced with an employee engaged in disloyalty during his or her employment. As in Beach, the plaintiff in Major Lindsey may have sustained some harm to its good will from the defendant’s disclosure of trade secrets to its competitors. Rather than attempt to calculate the value of that harm, the faithless servant doctrine provided MLA with a tool to claw back all compensation paid to the former employee during her four years of employment.
In Salus Capital Partners, LLC v. Moser6, a limited liability company (LLC) petitioned to confirm an arbitration award against its former Chief Executive Officer (CEO). The LLC’s claim arose out of the CEO’s use of corporate funds for personal purposes. The CEO moved for partial vacatur of the award. The CEO contended that the damages award requiring him to disgorge several months of compensation should be vacated as an improper application of the faithless service doctrine. The CEO argued that the total award of $2.6 million was disproportionate to the amount in controversy since the CEO only misused $200,000 of corporate funds. The court disagreed with the CEO’s position, and upheld the arbitration award.
The affirmation of the Major Lindsey arbitration award by the First Department and the Southern District of New York’s decision in Salus are obvious wins for employers and should serve as a reminder that the powerful faithless servant doctrine is alive and well in New York. They should also serve as warnings to potentially disloyal employees: the penalty for future misconduct may be much more than they “bargained for.”
However, there are instances when the employer will not fully recover under the faithless servant doctrine. The Second Circuit has carved out a limited exception where compensation is expressly allocated among discrete tasks, such as commissions. In such cases, the employee may keep compensation derived from any transactions that were separate from and untainted by the disloyalty. Specifically, apportionment is available when:
(1) the parties 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.7
Of course, there are instances when employers have been unsuccessful involving the faithless servant doctrine in New York courts. For example, employers have been unsuccessful when they were not able to provide enough evidence of when and how the former employee acted as a faithless servant. For example, in the 2020 case, Babbitt v. Koeppel Nissan, Inc., the plaintiff worked for the defendant as a finance manager. The Defendants’ cross-claim that the plaintiff was a faithless servant failed because the defendants failed to provide any detail beyond conclusory allegations such as “The Plaintiff’s disloyalty permeated her services in its most material and substantial part.”8
Additionally, in Stefanovic v. Old Heidelberg Corp.,9 the defendants alleged in a cross-claim that the Plaintiffs, former restaurant personnel, had forfeited compensation paid to them during the periods of employment in which they altered the tips on customers’ receipts. The defendants alleged that plaintiffs were employed by the restaurant and harmed its interests by changing the gratuity amount on customer receipts to give themselves a higher tip. As a result of the plaintiffs’ actions, the defendant stated a claim under the faithless servant. However, the defendants did not provide any specific instances of receipt altering by the plaintiff. Therefore, the defendants’ counterclaim was dismissed.
The court found in Leary v. Al-Mubaraki10 that the defendant’s counterclaims fail to state a claim under the “faithless servant doctrine.” The defendant did not prevail because he could not specifically allege how the plaintiff’s alleged disloyalty substantially affected his job performance. The defendant alleged only that between 2014 and 2017 the plaintiff’s work performance suffered significantly, leading to underperformance by his clients’ securities portfolios and causing his division to not be profitable. However, the defendant omits any facts concerning how its clients’ portfolios underperformed. The Court stated it could just as easily infer that any such portfolio underperformance or lack of profitability was caused by external market forces.
Even though the faithless servant doctrine is alive and well in New York, employers need to recognize that, unless they can prove to the court that an employee acted as a faithless servant and the employee’s actions impacted the employer’s business, the employer will not prevail as mere allegations will not suffice in New York courts.
1 Murray v. Bear. 102 N.Y. 505 (1886).
2 Id. at 508.
3 Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-929 (1977).
4 159 A.D.3d 546 (App. Div. 2018).
5 Beach v. Touradji Capital Management, LP, 144 A.D.3d 557 (1st Dep’t 2016).
6 Salus Capital Partners, LLC v. Moser, 289 F. Supp. 3d 468 (S.D.N.Y. 2018).
8 Babbitt v. Koeppel Nissan, Inc., 2020 WL 3183895, (E.D.N.Y. June 15, 2020).
9 Stefanovic v. Old Heidelberg Corp., 2019 WL 3745657, at 4 (S.D.N.Y. Aug. 8, 2019).
10 Leary v. Al-Mubaraki, 2019 WL 4805849, at (S.D.N.Y. Sept. 30, 2019).
Richard B. Friedman
Richard Friedman PLLC
200 Park Avenue Suite 1700
New York, NY 10166
Connect with me on Linkedin