Faithless Servant in Business Divorce Cases

April 03, 2023

Litigants assert with growing frequency “faithless servant” claims in business divorce cases. New York’s faithless servant doctrine, and the legal standards governing faithless servant claims, emanate from two ancient decisions that continue to crop up in the case law.

Ancient Roots

In Turner v Kouwenhoven (100 NY 115 [1885]), New York’s highest court ruled that where an agent engages in “misconduct and unfaithfulness which substantially violates the contract of service,” he can recover “nothing for the part of the term past, nor for the future” as compensation.

In Murray v Beard (102 NY 505 [1886]), the same Court ruled:

An agent is held to uberrima fides in his dealings with his principal; and if he acts adversely to his employer in any part of the transaction, or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of the employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.

Recent Expression

In its most recent faithless servant case, the Court of Appeals wrote, “One who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary,” from the first act of disloyalty (Feiger v Iral Jewelry, Ltd., 41 NY2d 928 [1977]).

Relationship to, and Differences from, Breach of Fiduciary Duty

Faithless servant is a variation of a claim of common-law breach of fiduciary duty. But the claims are notably distinct in at least two important ways.

First, faithless servant is considered an equitable forfeiture doctrine. For the successful plaintiff, financial recovery consists of disgorgement of the disloyal agent’s compensation, including salary, commissions, fringe benefits, and other compensation, rather than restitution of the plaintiff’s actual pecuniary losses. In other words, if the defendant loses, he forfeits his earnings, rather than repay the plaintiff’s losses. The result can be harsh: under the case law, the agent forfeits all compensation during the period of disloyalty: “there is no requirement under the faithless servant doctrine that an apportionment be performed so as to exclude those portions of salary where no disloyalty was found” (Paramount Painting Group, LLC v Nichtberger, 212 AD3d 533 [1st Dept 2023]).

Second, under the law of faithless servant, a plaintiff may be entitled to recover disgorgement of compensation even if the plaintiff did not suffer actual pecuniary damages. So held the Court in Feiger, ruling that, in a faithless servant claim, it is irrelevant whether “the services were beneficial to the principal, or that the principal suffered no provable damage as a result of the breach of fidelity by the agent.”

The CARCO Faithless Servant Case

Because of the power of potential disgorgement without the need to prove actual damages, faithless servant is an exceedingly powerful remedy. When I was a young associate, I had the good fortune of successfully litigating on behalf of a plaintiff in federal court a claim for faithless servant based upon an employee’s business record falsification resulting in a hefty money judgment after a two-week bench trial (read here), an appeal to the U.S. Court of Appeals for the Second Circuit (read here), a partial remand and subsequent damages award (read here), and another appeal and cross-appeal to the Second Circuit (read here), followed by a settlement.

Mistake, Misapprehension, or Neglect Not Enough

But faithless servant has its limits. As the Turner Court wrote so many years ago, disgorgement is reserved for “[f]lagrant acts of dishonesty or crime which seriously affect the master’s interest,” and mere “mistake, misapprehension or neglect” do not justify forfeiture.

The White Case

Perhaps without consciously doing so, a recent decision from Albany County Commercial Division Justice Richard M. Platkin ratifies Turner’s “mistake, misapprehension or neglect” defense to a claim of faithless servant. In White Mgt. Corp. v Aley (77 Misc3d 1235(A) [Sup Ct, Albany County Feb. 9, 2023]), Justice Platkin granted summary judgment dismissing overlapping claims for breach of fiduciary duty and faithless servant brought by two entities against a former officer, director, and minority shareholder for alleged dissemination to a competitor of financial information about the businesses.

The Businesses and Owners

My last article was about a father / son dispute. This week’s article is about a father / son-in-law dispute. David White (“David”), through various entities, acquired a portfolio of roughly 30 upstate New York restaurants. One of David’s companies, M & W Foods, Inc. (“M & W”), owned 11 Dunkin’ Donuts (“Dunkin’”) franchises. Another, Plattsburgh Taco, Inc. (“Plattsburgh Taco”), owned a Taco Bell.

Around 2000, David’s son-in-law, Ray Aley (“Ray”), began to manage the restaurants owned by M & W, eventually becoming vice president and minority shareholder of M & W and employee, director, and minority shareholder of Plattsburgh Taco.

Separately, and without David’s involvement, Ray formed Aley Restaurant Management, Inc. (“ARM”), which eventually acquired seven Dunkin’ franchises apart from the M & W portfolio.

Around 2017, Ray and his wife (David’s daughter), Cheryl, decided to relocate to Colorado. Ray and Cheryl (also a shareholder of M & W) sought to divest themselves of their assets in New York, including their interests in M & W and ARM.

The Proposed Transactions, the Inadvertent Financial Disclosure, and the Sale

Initially, David, Ray, and Cheryl hired a business broker who procured a potential purchaser, Ever Santana (“Santana”), for the 18 Dunkin’ franchises collectively owned by M & W and ARM.

As negotiations proceeded, according to Ray’s affidavit, “family hostilities dramatically increased,” and David blocked the transaction with Santana, insisting that Ray and Cheryl instead sell their equity interests and Dunkin’ franchises to him. Ray and Cheryl began negotiating a potential deal with David, but because Ray and Cheryl were “not optimistic that the deal with David would work,” Ray continued to negotiate with Santana for a potential divestiture of ARM’s Dunkin’ franchises as a fall back.

According to Ray, ARM’s financial information had always been stored on M & W’s servers with M & W’s own financial data as part of a single integrated system. In connection with Ray’s negotiations with Santana, Ray emailed Santana certain financial information related to ARM. Ray alleged that he attempted to redact / remove non-ARM related information from the spreadsheet, but learned later he did not succeed, resulting in Santana receiving certain sensitive financial information related to M & W and Plattsburgh Taco.

Notwithstanding the inadvertent financial disclosure, Ray and Cheryl eventually sold their M & W equity interests and all of ARM’s Dunkin’ franchises to David.

The Litigation and Summary Judgment Motions

After closing the deal, David sued Ray on behalf of M & W and Plattsburgh Taco based solely upon Ray’s financial dissemination alleging in his second amended complaint claims for breach of fiduciary duty, faithless servant, and accounting, among others.

Both sides moved for summary judgment, Ray seeking dismissal, David seeking judgment on liability. You can read the opening briefs here and here.

The Decision

Justice Platkin dismissed David’s complaint in its entirety, focusing most of his attention on the fiduciary duty claims.

The Court ruled that Ray’s dissemination of financial information to Santana was part of “legitimate efforts to explore whether Santana was interested in purchasing the seven Dunkin’ restaurants owned by ARM” and “did not pertain to the restaurants owned by M & W or Plattsburgh Taco.”

Apparently because Ray previously offered ARM’s seven Dunkin’ franchises to David’s entities, the Court ruled that the “sale of ARM’s restaurants was not a corporate opportunity of plaintiffs, and defendant’s activities on behalf of ARM were not in inherent conflict with the duties he owed to M & W and Plattsburgh Taco as a fiduciary.”

Next, the Court ruled that the “proof further shows that the dissemination of M & W and Plattsburgh Taco’s financial information was inadvertent, a product of the fact that both ARM and [David’s] Companies maintained their financial information” on the same system, “together with [Ray]’s failure to redact [M & W and Plattsburgh Taco’s] financial information before sending the emails to Santana.”

The Court found “no evidence that [Ray] disclosed plaintiffs’ information to advance any personal interest beyond his legitimate desire to ensure the sale of ARM’s restaurants in the event the transaction with [David] did not close.”

Finally, the Court ruled that “the record conclusively demonstrates that plaintiffs have not sustained any loss from the disclosure to Santana.” “There simply is no evidence,” ruled the Court, “of any damages or injury to plaintiffs or any benefit to defendant.” The Court found that Ray’s disclosure to Santana “did not prevent the transaction” between David, Ray, and Cheryl “from being consummated,” and ultimately, “ARM’s seven Dunkin’ restaurants were transferred to M & W, and [David] acquired the Aleys’ entire interest in M & W.”

As a result, the Court dismissed the fiduciary duty claims.

Analyzing faithless servant under essentially the same framework as fiduciary duty, the Court found “no grounds by which to conclude that [Ray] was dishonest or otherwise breached his fiduciary obligation to plaintiffs so as to warrant the forfeiture of earned compensation.”

The Court concluded its opinion by dismissing the accounting claims, ruling that plaintiffs failed to demonstrate any “circumstances giving rise to a duty to account.”

Commentary on White

Based upon my understanding of the case law, the absence of any provable damage in White was not in and of itself an impediment to disgorgement of Ray’s compensation (see e.g. Panos v Mid Hudson Med. Group, P.C., 204 AD3d 1016 [2d Dept 2022] [“It makes no difference” for a faithless servant claim if the plaintiff “suffered no provable damage”] [quotations omitted]).

But David’s faithless servant claims foundered on a more basic level: his inability to prove liability. As an appeals court held exactly two weeks after Justice Platkin issued White, whether a defendant “engaged in disloyal conduct sufficient to warrant the disgorgement of his salary” generally presents “material issues of fact” requiring a trial (Bax v InterEnergy Holdings, 213 AD3d 598 [1st Dept 2023]).

But I think it’s fair to say that a faithless servant claim requires something more than a fiduciary breach – it requires, at a minimum, some proof of active disloyalty in a material aspect of the agent’s duties. Under Turner, the doctrine requires “misconduct and unfaithfulness which substantially violates the contract of service.” Justice Platkin’s holding that David failed to raise a triable issue as to any actual wrongful intent, the record instead demonstrating no more than “inadvertent” conduct, defeated the faithless servant claims.

Like Turner itself, White now stands for the proposition that even if a defendant commits a technical fiduciary breach, mere “mistake, misapprehension or neglect” do not justify forfeiture in faithless servant cases.