In Design Strategy, Inc. v. Davis (2006), the United States Court of Appeals for the Second Circuit clarified the forfeiture remedies available under the long-standing "faithless servant" doctrine in New York. Under this doctrine, generally an employee who breaches the duty of loyalty owed to his or her employer can be required to forfeit compensation earned in the period during which he or she was disloyal. In Design Strategy, the Second Circuit held, among other things, that an employee who breaches his fiduciary duty of loyalty to his employer in the performance of his duties and who receives both a regular salary and commissions: (i) must forfeit all regular salary earned during the period of disloyalty and (ii) is not required to forfeit any commissions earned where his disloyalty (a) did not arise in connection with any transaction from which the employee was entitled under the terms of an employment agreement to receive a commission and (b) did not "taint" or "interfere" with the completion of any sales in relation to which the employee received a commission.
Design Strategy, Inc. ("Design"), which provides trained personnel to companies that need technical support on projects requiring computer technology services, hired Marc Davis in 1987. Davis was hired to work as a Sales Representative and later as Sales Manager. Davis was an at-will employee with no written employment agreement. Davis was not subject to any restrictive covenants. From 1998 through February 2000, Davis earned an annual salary of $85,000. From 1997 through February 2000, Davis's commissions for sales of staffing services provided to Design's clients ranged from $73,119 to $512,333 per calendar year. Sometime in the summer of 1999, Davis learned of a corporate opportunity for Design which involved competing to be selected for participation in a $10 million computer technology project for a venture with Microsoft, Inc. ("Contentville Project"). Davis informed Marsh Newmark, the President and sole director and shareholder of Design, about the Contentville Project. From the time that Davis learned of the Contentville Project through mid-November 1999, Davis attempted to promote Design for the Contentville Project. Newmark was, however, reluctant to make the necessary initial capital investment to be selected for the Contentville Project. Sometime in mid-November 1999, Davis stopped endorsing Design for the Contentville Project. At the same time, Davis, while still employed by Design, unbeknownst to Design, started actively pursuing the Contentville Project for another company, Info Technologies Web Solutions ("IT Web"). In mid-December 1999, Microsoft awarded the Contentville Project to IT Web. On December 14, 1999, IT Web offered Davis a job, which he accepted in January 2000. Davis began working for IT Web in early February 2000.
In July 2002, Design commenced an action in the United States District Court for the Southern District of New York against Davis.1 Design asserted that Davis had, among other things, breached his fiduciary duty of loyalty in promoting IT Web for the Contentville Project while he was employed by Design. At the conclusion of a bench trial, the District Court determined, among other things, that Davis had violated his fiduciary duty of loyalty to Design. The District Court set the period of disloyalty from November 11, 1999 to December 9, 1999. The District Court then evaluated the appropriate forfeiture remedy for Davis's breach under the "faithless servant" doctrine in New York. The District Court recognized that the United States Court of Appeals for the Second Circuit had previously distinguished forfeiture cases involving an employee who drew a regular salary from forfeiture cases in which an employee drew a commission. Davis's compensation situation differed from prior Second Circuit forfeiture cases, however, because he received both a regular salary and commissions. As a result, the District Court applied the forfeiture remedies adopted by the Second Circuit in both types of forfeiture cases. The District Court concluded that Davis must disgorge the salary he earned during the period of disloyalty; Davis was not, however, required to forfeit commissions earned during this period of disloyalty. Davis had earned $6,538 salary, exclusive of commissions, during the period of disloyalty which he was ordered to forfeit.
On appeal, the Second Circuit affirmed the District Court's use of both types of forfeiture methods for Davis's breach of his fiduciary duty. The Second Circuit acknowledged that it had developed two distinct forfeiture methods under New York's "faithless servant" doctrine. In Phansalkar v. Andersen Weinroth (2003), the Second Circuit took a strict interpretation of the "faithless servant" doctrine. Phansalkar requires that a disloyal employee who is paid a regular salary (as opposed to commissions) must disgorge all compensation received from the date of the first disloyal act to his or her employer — including any compensation earned during this period related to tasks performed when the employee was not acting disloyal to his or her employer.2
The "transaction-by-transaction" forfeiture remedy adopted by the Second Circuit in 1985 applies when an individual is paid only by commissions (i.e., does not receive a regular salary). Under this approach, a disloyal employee will be required to disgorge only the commissions that were earned in connection with specific tasks as to which he or she was disloyal. Contrary to the forfeiture method in Phansalkar, the "transaction-by-transaction" approach permits an employee to retain commissions that were earned in connection with specific tasks that he or she performed loyally, provided that: (i) the parties had agreed that the employee would be paid on a task-by-task basis (i.e., a commission on each sale arranged by the employee), (ii) the employee did not engage in any misconduct with respect to certain tasks and (iii) the employee's disloyalty with respect to other tasks "neither tainted nor interfered with the completion of" the tasks which the employee performed loyally.3
As Davis received both a salary and commissions, the Second Circuit adopted the District Court's application of both of its previously established forfeiture methods to Davis's situation. The Second Circuit affirmed the District Court's conclusion that Davis did not have to disgorge commissions earned during the period that he was acting disloyal to Design. It noted that Davis's disloyalty did not arise in connection with any transaction for Design from which he was entitled under the terms of an employment agreement to receive a commission. The Second Circuit also stated that Davis's disloyalty did not "taint" or "interfere" with the completion of any sales relation to which he received commission. The Second Circuit agreed that Davis must forfeit $6,538 of his regular salary earned during the period of disloyalty.4