On September 22, the New Jersey Supreme Court unanimously gave the green light to awards of the remedy of equitable disgorgement, even in the absence of economic loss, as a fair and practical response to an employee’s disloyal conduct. The Court also noted that the fear of disgorgement should serve to as a deterrent to employee misconduct. Bruce Kaye v. Alan P. Rosefielde (A-93-13) (073353), New Jersey Supreme Court.

The Facts of the Case

Bruce Kaye hired attorney Alan Rosefielde as a full-time, salaried employee after using him as outside counsel. Rosefielde served as Chief Operating Officer and General Counsel for some of Kaye’s timeshare businesses. Kaye terminated Rosefielde’s employment based on discovery of unauthorized self-dealing and other actions by Rosefielde that exposed Kaye’s companies to potential liability, and as result of dissatisfaction with Rosefielde’s job performance. Kaye sued Rosefielde for breach of fiduciary duty, fraud, legal malpractice, unlicensed practice of law and breach of the duty of loyalty. After a lengthy bench trial, Rosefielde’s egregious conduct was found to breach his duty of loyalty, among other claims. The trial court awarded compensatory and punitive damages, as well as legal fees. However, the court did not order disgorgement of Rosefielde’s salary as an equitable remedy because the breach of loyalty did not result in any actual damage to the employer’s companiesThe Appellate Division affirmed.

Upon review of the limited question of whether a court may award the remedy of disgorgement of a disloyal employee’s salary to an employer who has sustained no economic damage, the New Jersey Supreme Court recognized that the remedy of equitable disgorgement has only rarely been discussed in appellate decisions. Writing for the unanimous court, Justice Anne Patterson stated that:

“[t]he disgorgement remedy is consonant with the purpose of a breach of the duty of loyalty claim: to secure the loyalty that the employer is entitled to expect when he or she hires and compensates an employee.…[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….[r]equiring an employer to demonstrate a that it has sustained economic loss ‘is inconsistent with a basic premise of remedies available for breach of fiduciary duty’”. (Opinion, Page 24/25).

As one example, the New Jersey Supreme Court cited to the determination that Rosefielde had engaged in multiple inappropriate sexual advances towards toward co-workers as a basis for disgorgement of Rosefielde’s salary – without requiring the employer to demonstrate that litigation resulted from the misconduct, or that any other economic loss resulted from the inappropriate behavior.

What type of conduct may justify an award of disgorgement of salary?   Examples of the misconduct constituting breach of duty of loyalty in the Kaye case included: unauthorized business transactions that provided a personal financial benefit to the employee; billing the employer for non-business expenses during a Las Vegas trip (a hotel suite shared with three adult film stars); sexual advances towards female co-workers; a fraudulent application to a health insurer to obtain employee coverage for independent contractors; and retaliation against another employee who refused to participated in a self-dealing scheme.

In terms of application of the Kaye decision to unfair competition claims, employers will presumably no longer need to demonstrate economic loss to recoup salary for employee misconduct such as theft of confidential information or customers, use of employer time and resources to set up a competitive activity, misdirecting business opportunities to a potential new employer or failing to fully perform duties or responsibilities while anticipating a jump to a new employer.

How much salary can be recouped?

The New Jersey Supreme Court remanded for a determination on disgorgement, and instructed the trial court to apportion the employee’s compensation by focusing on time periods during which the employee committed acts of disloyalty, and to consider the following factors: 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; the degree of planning to undermine the employer that is undertaken by an employee; and other factors that may guide a court in the exercise of its discretion to impose an equitable remedy.

The Court also directed that the trial court should order disgorgement for monthly pay periods in which the Rosefielde committed acts of disloyalty because he was paid his salary on a monthly basis.

While the Court did caution that the trial court should not order a wholesale disgorgement before conducting the analysis cited above, it did include a footnote in the Kaye decision allowing for disgorgement of the employee’s entire salary if there is a determination that the employee was disloyal during all pay periods. (Opinion, fn.8).

The Takeaway

Employers should include breach of duty of loyalty claims when suing for “on the job” misconduct, especially for highly paid employees.   Such claims may very well have the deterrent effect intended by the New Jersey Supreme Court by allowing employers to recoup salaries without having to show economic loss. Deterrence may be especially relevant with regard to claims of unfair competition, as subsequent employers will likely not able to offer enforceable indemnification guaranties for disgorgement awards.