Clawing Back All Compensation From the “Faithless Servant” Under New York Law

Clawing Back All Compensation From the “Faithless Servant” Under New York Law by Richard Friedman

In a terse opinion, the Appellate Division of the Supreme Court of New York, First Department recently unanimously affirmed an arbitration award in favor of legal recruiting firm Major, Lindsey & Africa, LLC (“MLA”) pursuant to which MLA was awarded almost $1.8 million in compensation paid to a former employee during her four-year tenure at the firm as well as over $900,000 in attorneys’ fees and costs on the grounds that the former employee had stolen trade secrets from the firm and had disclosed confidential information to certain of MLA’s competitors. Mahn v. Major, Lindsey & Africa, LLC, 2018 N.Y. Slip Op. 01888 (March 20, 2018). Applying the faithless servant theory of liability, the First Department found that the decision to claw back all salary and commissions paid to the employee during her four-year tenure with the firm did not violate New York’s public policy. The decision is the most recent confirmation that the faithless servant doctrine remains a viable basis for liability in New York and offers a potentially powerful tool for employers to use against employees who have been unfaithful even where, as discussed below, the employer cannot prove damages

The faithless servant rule is grounded in the law of agency and provides a tool that employers can use 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, 102 N.Y. 505 (1886). 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.” Id. at 508. 

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.” Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-929 (1977). 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 substantially violated his employment contract 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. 

The Major Lindsey arbitration decision was based on the arbitrator’s finding 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. Although critics of the faithless servant doctrine have characterized it as overly punitive, the First Department obviously feels differently. It upheld the 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 Court specifically held that such 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. South Pierre Assocs. v. Meyers, 12 Misc.3d 955, 960-61 (Civ. Ct. N.Y. 2006). 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, 144 A.D.3d 557 (1st Dep’t 2016), 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. Like Beach, in Major Lindsey, the plaintiff 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. 

The affirmation of the Major Lindsey arbitration award by the First Department is an obvious win for employers and should serve as a reminder that the powerful faithless servant doctrine is alive and well in New York. In addition, the case should serve as a warning to potentially disloyal employees: the penalty for future misconduct may be much more than they “bargained for.” 

Richard B. Friedman
Richard Friedman PLLC

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