“Faithless Servants” Beware – Part II

Illustrative Cases

In Phansalkar v. Andersen Weinroth & Co, L.P., Phansalkar, an investment banker and employee of Anderson Weinroth & Co., was found in breach of his duties of loyalty and good faith to his employer, for failing to disclose his receipt of various benefits (i.e. stock options, stock shares, fees, and business opportunities), which he had received from other companies in consideration for serving on their boards. Under the terms of his employment contract, such benefits belonged to the defendant’s employer. 

At first, the Federal District Court limited the employee’s forfeiture to compensation directly derived from transactions in which the employee breached his duties, and declined to apply the Faithless Servant Doctrine to profits made on stock options offered to the defendant by his employer. However, on appeal, the Second Circuit held that the employee must forfeit all compensation he received after the date of his first breach of duty—the clawback could not be limited to certain transactions since he was paid a general salary and not specific amounts for specific tasks. Furthermore, the Second Circuit held that the employee must forfeit any profits and interest generated by the stock options, despite investing his own capital, because they were offered to him in connection with his employment as compensation.  The Court explained that:   “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.”  

And in Consolidated Edison Co. v. Zebler, Zebler, an employee of Con Edison, was found to have accepted bribes in a kickback scheme over a 26-month period, in exchange for providing favorable treatment to a construction contractor, including approving inflated invoices that overcharged his employer and expediting payments to the contractor. Despite the employee’s argument that only his compensation directly related to the kickback scheme should be forfeited, the Court held that, the “faithless servant doctrine strictly requires salaried employees, such as Mr. Zebler, to forfeit 100% of their compensation… this requirement is consistent with the policy rationale behind the forfeiture rule, which is to prevent breaches of fiduciary duty by removing from agents and trustees all inducements to attempt dealing for their own benefit in matters which they have undertaken for others, or to which their agency or trust relates… Accordingly, as a salaried employee not paid on a task-by-task basis, Mr. Zebler must forfeit all of [his salary] received during the 26-month period of his disloyalty, even though he claims to be acting disloyal only 15% of the time.”   The Faithless Servant Doctrine is intended to be a deterrent against employee and fiduciary disloyalty, even in cases where no actual damages are incurred or crimes committed, and as such serves as a useful common law tool for employers and principals applicable to a wide range of contexts and circumstances. 

Contrasting New York’s Faithless Servant Doctrine with the Mandatory Victims Restitution Act 18 USCS § 3663A, a criminal statute under which Consolidated Edison also sought restitution, the Court noted: “The faithless servant doctrine does not consider criminal culpability, nor does it require the Court to value the loss of honest services. Under the faithless servant doctrine, the act of being disloyal to one's employer is itself sufficient grounds for disgorging all compensation received during the period of disloyalty, and does not depend on actual harm to the employer.”