'Faithless Servant' Must Surrender All Income

The Second Circuit, in a rare venture into the realm of damages resulting from a breach of the duty of loyalty, has ruled that a “faithless servant” must surrender all income, including investment opportunities, after the date the disloyal acts began. Phansalkar v. Andersen Weinroth & Co., 2003 WL 22130902 (2d Cir. 9/16/03) (Jacobs and Straub, Cir. Judges and Wood, D.J., sitting by designation).

Rohit Phansalkar was employed as a nominal partner in the merchant-banking firm of Andersen Weinroth. As such, Phansalkar was paid a salary and received options and warrants, and “carried interest” in certain of the firm's investments. Phasalkar sat on various boards as the company's representative, was awarded stocks and options, and was paid director's fees. Under company policy, all director compensation belonged to the firm and therefore Phasalkar was obligated to disclose this compensation and turn it over. He did not do this. In turn, Phansalkar alleged that Andersen Weinroth converted his interests in various deals that he worked on for them.

Firm Brings Action

The firm brought an action for breach of contract, breach of fiduciary duty, and conversion. Phansalkar countersued, alleging conversion of his stock. Following a bench trial, Judge Shira Sheindlin awarded Phansalkar $4.4 million on his conversion claim and ruled in favor of Andersen Weinroth on certain of its claims, limiting its damages to the compensation earned by Phansalkar on those matters in which he was found to be disloyal.

Second Circuit Rules

The Second Circuit began its analysis by noting that New York law on disloyal or faithless servants is grounded in the law of agency. The court took issue with Judge Scheindlin's decision that Phansalkar, who was found to be disloyal on six separate matters, was obligated to forfeit compensation only on those matters in which he was disloyal. The court noted that New York has two parallel lines of authority when determining whether forfeiture is required: in one, forfeiture is required where the misconduct substantially violates the employment contract, and in the second where the employee fails to disclose an interest that would influence his or her dealings on the employer's interests. Under either standard, the Second Circuit concluded that Phansalkar was obligated to forfeit all of his income.

In support of its conclusion, the court noted that Phansalkar was disloyal in almost every transaction on which he worked for Andersen Weinroth, and his disloyalty lasted over a substantial period. The court also found that the policy of turning over director income was important, as this was the only regular income for the partnership. The court rejected Phansalkar's claim that there was no intent to defraud, ruling that such intent was not required to render misconduct sufficient to warrant forfeiture.

The court distinguished those cases in which courts have limited forfeiture to monies gained on the specific transactions in which the employee was disloyal. The Second Circuit concluded that such transaction-specific forfeiture applied where the employee was paid on a task-by-task basis such as a commissioned salesperson, the employee was loyal with respect to certain tasks, and the disloyalty with respect to other tasks did not interfere with the employee's completion of his or her job duties. The court also pointed to the RESTATEMENT (Second) of Agency, which provides that the only circumstance in which forfeiture can be limited is where the contract itself allocates compensation among tasks. Here, the court concluded that Phansalkar's compensation was not task-based, and therefore forfeiture could not be so limited.

Forfeiture of Investments

One question of first impression addressed by the court was whether benefits received from investment opportunities must also be forfeited. The court concluded that any such benefit must also be forfeited. “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 Second Circuit, in a rare venture into the realm of damages resulting from a breach of the duty of loyalty, has ruled that a “faithless servant” must surrender all income, including investment opportunities, after the date the disloyal acts began. Phansalkar v. Andersen Weinroth & Co., 2003 WL 22130902 (2d Cir. 9/16/03) (Jacobs and Straub, Cir. Judges and Wood, D.J., sitting by designation).

Rohit Phansalkar was employed as a nominal partner in the merchant-banking firm of Andersen Weinroth. As such, Phansalkar was paid a salary and received options and warrants, and “carried interest” in certain of the firm's investments. Phasalkar sat on various boards as the company's representative, was awarded stocks and options, and was paid director's fees. Under company policy, all director compensation belonged to the firm and therefore Phasalkar was obligated to disclose this compensation and turn it over. He did not do this. In turn, Phansalkar alleged that Andersen Weinroth converted his interests in various deals that he worked on for them.

Firm Brings Action

The firm brought an action for breach of contract, breach of fiduciary duty, and conversion. Phansalkar countersued, alleging conversion of his stock. Following a bench trial, Judge Shira Sheindlin awarded Phansalkar $4.4 million on his conversion claim and ruled in favor of Andersen Weinroth on certain of its claims, limiting its damages to the compensation earned by Phansalkar on those matters in which he was found to be disloyal.

Second Circuit Rules

The Second Circuit began its analysis by noting that New York law on disloyal or faithless servants is grounded in the law of agency. The court took issue with Judge Scheindlin's decision that Phansalkar, who was found to be disloyal on six separate matters, was obligated to forfeit compensation only on those matters in which he was disloyal. The court noted that New York has two parallel lines of authority when determining whether forfeiture is required: in one, forfeiture is required where the misconduct substantially violates the employment contract, and in the second where the employee fails to disclose an interest that would influence his or her dealings on the employer's interests. Under either standard, the Second Circuit concluded that Phansalkar was obligated to forfeit all of his income.

In support of its conclusion, the court noted that Phansalkar was disloyal in almost every transaction on which he worked for Andersen Weinroth, and his disloyalty lasted over a substantial period. The court also found that the policy of turning over director income was important, as this was the only regular income for the partnership. The court rejected Phansalkar's claim that there was no intent to defraud, ruling that such intent was not required to render misconduct sufficient to warrant forfeiture.

The court distinguished those cases in which courts have limited forfeiture to monies gained on the specific transactions in which the employee was disloyal. The Second Circuit concluded that such transaction-specific forfeiture applied where the employee was paid on a task-by-task basis such as a commissioned salesperson, the employee was loyal with respect to certain tasks, and the disloyalty with respect to other tasks did not interfere with the employee's completion of his or her job duties. The court also pointed to the RESTATEMENT (Second) of Agency, which provides that the only circumstance in which forfeiture can be limited is where the contract itself allocates compensation among tasks. Here, the court concluded that Phansalkar's compensation was not task-based, and therefore forfeiture could not be so limited.

Forfeiture of Investments

One question of first impression addressed by the court was whether benefits received from investment opportunities must also be forfeited. The court concluded that any such benefit must also be forfeited. “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.”