The New Jersey Supreme Court recently held that a court may order equitable disgorgement of an employee’s compensation when the employee has breached his or her duty of loyalty to his or her employer, even if the employer has not sustained economic loss as a consequence of that breach.

In Kaye v. Rosefielde, A-93-13, __ N.J. __ (2015), the plaintiff, consisting of several entities and their the controlling principal, hired an attorney, who served as the Chief Operating Officer and General Counsel for the two of the entities. During his tenure, the attorney earned a salary of $500,000, paid on a monthly basis.

After approximately two years, the controlling principal learned that the attorney, in his capacity as Chief Operating Officer and General Counsel, committed severe misconduct. Based on this conduct, the plaintiffs terminated the attorney and filed claims against him for breach of fiduciary duty and breach of duty of loyalty, among others. As part of their remedies, the plaintiffs sought equitabledisgorgement of the attorney’s compensation.

After a bench trial, the trial court found in favor of the plaintiffs on their claims, including those for the breaches of fiduciary duty and duty of loyalty. The trial court awarded compensatory damages, punitive damages, and legal fees, but denied the plaintiffs’ request for equitable disgorgement on the ground that the plaintiffs did not suffer any damages or loss as a result of the attorney’s disloyalty. The Appellate Court affirmed and the plaintiffs appealed, arguing that equitable disgorgement was improperly denied because a plaintiff need not show it sustained economic loss due to the employee’s disloyal conduct.

On appeal, the Supreme Court explained that equitable disgorgement, which has its roots in agency and contract principals, is appropriate even if the plaintiff cannot establish economic loss due to the employee’s disloyal conduct. Under agency principals, “[w]hen an employee abuses his or her position and breaches the duty of loyalty, he or she fails to meet the employer’s expectation of loyalty in the performance of the job duties for which he or she is paid.”[1] Under contract principals, “if the employee breaches the duty of loyalty at the heart of the employment relationship, he or she may be compelled to forego the compensation earned during the period of disloyalty.”[2] In other words, “compensation during a period in which the employee is disloyal is, in effect, unearned.”[3] The Court further found that equitable disgorgement provided a “valuable deterrent effect” and that failure to make available such a remedy would be “inconsistent with a basic premise of remedies available for breach of fiduciary duty.”[4]

Accordingly, the Supreme Court reversed and remanded the trial court’s finding, instructing it to determine whether the attorney’s conduct warranted equitable disgorgement. The Supreme Court set forth several illustrative factors to guide the trial court in its analysis and exercise of discretion, including:

  • The employee’s degree of responsibility and level of compensation;
  • The number of acts of disloyalty;
  • The extent to which those acts placed the employer’s business in jeopardy; and
  • The degree of planning to undermine the employer that is undertaken by the employee. [5]

The Court further instructed that, rather than issuing a wholesale disgorgement of compensation in every case, the trial court should issue disgorgement proportionate to the level of the employee’s misconduct. Thus, the trial court should calculate disgorgement based on how often the employee was paid, the pay period in which the disloyal acts occurred and the amount of compensation allocated to that pay period.

The Bottom Line. While employers no longer need to establish economic damages to obtain equitable disgorgement based on a breach of the duty of loyalty, employers still must establish: (1) how often the employee was paid; (2) the pay period in which the disloyal acts occurred; and (3) the amount of compensation allocated to that pay period. Absent such evidence, it is likely that a request for equitable disgorgement will be denied.