In Claim for Breach of Employee’s Duty of Loyalty, New Jersey Supreme Court Allows Disgorgement of Salary Even Without Evidence of Economic Loss

Simon Cunningham [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrCorporate directors and officers owe the corporation certain fiduciary duties, meaning they are legally obligated to act solely in the corporation’s interest. The duty of loyalty requires officers and directors to act on behalf of the corporation without economic conflict. A breach of the duty of loyalty might consist of a transaction that benefits an individual employee over the corporation, or a corporate opportunity that the employee withholds for their own benefit. Remedies for a breach of the duty of loyalty may include economic damages and an equitable remedy known as disgorgement, by which the employee must give up any personal gains obtained from their breach. The New Jersey Supreme Court recently considered whether a court could award disgorgement to a corporation that did not suffer economic loss. Kaye v. Rosefielde, No. A-93 Sept. Term 2013, 073353, slip op. (N.J., Sep. 22, 2015).

The plaintiff in Kaye hired the defendant in 2002 as Chief Operating Officer (COO) of several companies. Under a formal employment agreement, the defendant received an annual salary of $500,000, paid in equal parts by a corporation and a limited liability company (LLC) controlled by the defendant. The defendant served as COO and General Counsel of both companies, which managed and sold timeshares in properties owned by those two companies and several others.

According to the court’s ruling, the plaintiff alleged multiple acts by the defendant that breached the duty of loyalty to the companies that employed him. In one case, the defendant created a separate LLC in 2003 to manage certain timeshare interests, but he did not follow the plaintiff’s instructions regarding the allocation of ownership interests. The defendant drafted the new LLC’s operating agreement in a way that increased his own ownership interest and that of a corporation he owned and controlled. In 2005, the plaintiff learned of some of the defendant’s acts and terminated his employment.

The plaintiff, both individually and on behalf of several companies, filed suit against the defendant, claiming breach of the duty of loyalty, fraud, and other causes of action. In addition to compensatory and punitive damages, he sought disgorgement of profits and other gains received by the defendant. After a bench trial lasting almost a month, the trial court declined to award disgorgement. It found that the plaintiff had not established actual damages resulting from the defendant’s breaches of fiduciary duty, citing a precedent holding that actual damages are a prerequisite for disgorgement, Cameco, Inc. v. Gedicke, 724 A.2d 783 (N.J. 1999). The Appellate Division affirmed the decision.

The New Jersey Supreme Court reversed the lower courts’ rulings, holding that disgorgement of salary could be available in some cases, even without economic loss. It noted that disgorgement, as an equitable remedy, is based on contract law principles. When an employee is disloyal, the court found, any pay they receive during that period of time “is, in effect, unearned.” Kaye, slip op. at 20. The court identified four factors trial courts should consider in deciding whether or not to award disgorgement, noting that the list is not exhaustive:

1. “the employee’s degree of responsibility and level of compensation”;
2. “the number of acts of disloyalty”;
3. the risk posed to the employer’s business by the employee’s acts; and
4. the extent to which the employee “plann[ed] to undermine the employer.” Id. at 26.

Business formation lawyer Samuel C. Berger offers fixed-fee legal-service packages to New York City and New Jersey business owners and entrepreneurs. We handle a wide range of legal issues for our clients, including general transactional matters, contracts, business formation, and dissolution. Contact us online or at (212) 380-8117 today to schedule a confidential consultation with a skilled and experienced advocate.

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Person Assuming Management of Family Business Does Not Assume Liability for Predecessor’s Business Torts, According to New York Court, New York & New Jersey Business Lawyer Blog, September 26, 2013

Corporate Directors, Even Though Acting in Subjective Good Faith, May Breach Fiduciary Duties to the Corporation, According to Delaware Court, New York & New Jersey Business Lawyer Blog, December 28, 2012

Photo credit: Simon Cunningham [CC BY 2.0], via Flickr.