What if an employer has incurred no economic loss as a result of an employee's breach of his duty of loyalty? Is the disloyal employee to retain compensation earned while he committed acts of misconduct because his employer fortuitously sustained no actual loss?

This is a recurring issue in employment law governed by the New Jersey Supreme Court's decision in Kaye LLC v. Rosefielde, a decision of which all practitioners should be aware. In Kaye the New Jersey Supreme Court reaffirmed, after a misreading of a prior Supreme Court case by the trial court and the Appellate Division, that a court's equitable power, with its attendant broad discretion to fashion remedies that are fair and practical, includes the power to order disgorgement of an employee's compensation as a remedy for a breach of loyalty in an appropriate case even if the employer suffered no economic loss.

Defendant Rosefielde was an attorney hired by the plaintiff as outside counsel and then as an employee for his timeshare business, essentially serving as general counsel at an annual salary of $500,000. According to the court's opinion, Rosefielde acted on the behalf of his own interests and exposed his employer to liability. He improved his position in a new venture by deliberately misallocating an interest to himself in the operating agreement without his employer's knowledge and also diverting another employee's interest to himself. The employee misrepresented the nature of papers to secure his employer's signature on documents prepared for Rosefielde's self-benefit and not the employer's interest. Rosefielde forged signatures of defaulting time share mortgagors on quitclaim deeds, and fraudulently obtained health insurance for independent contractors, claiming they were full-time employees of a dormant company. Rosefielde billed his employer $4,000 for hotel expenses incurred on a trip to Las Vegas where he had shared the room with three adult film stars. The defendant also made several inappropriate sexual advances to coworkers, subjecting his employer to liability for sexual harassment claims, the court noted.

When exposed, Rosefielde was terminated and sued by his employer. The trial court held that Rosefielde had breached his duty of loyalty and his fiduciary duty, and committed legal malpractice and civil fraud; the court found his conduct “egregious” and labeled the lawyer “an unfaithful servant.” While the trial court rescinded defendant's interests in the several entities he had fraudulently acquired, and awarded compensatory and punitive damages, as well as legal fees, the judge declined to order the equitable disgorgement of Rosefielde's salary because the breaches did not cause economic damage to his employer. The trial court relied on Cameco v. Gedicke, a 1999 New Jersey Supreme Court case, believing that that decision authorized disgorgement of a disloyal employee's compensation only if the court found the “employee's breach proximately caused the requested damages.” Without economic loss, the Kaye trial judge held, there could be no disgorgement. The Appellate Division affirmed on this issue, finding the trial court's legal analysis to be “unassailable,” and remanded on others. The Supreme Court granted certification only on the “remedy of disgorgement of a disloyal employee's salary to an employer that has sustained no economic damage.”

Plaintiff argued before the Supreme Court that without the remedy of equitable disgorgement, an employer who suffers no damage at the hands of a disloyal employee has no meaningful recovery. The Supreme Court reviewed its decision in Cameco where it had enumerated the factors necessary to prove breach of a duty of loyalty by an employee. The Kaye court, however, did not read Cameco to preclude a recovery where there is no economic loss: “Cameco clearly stands for the principle that disgorgement is available as a remedy, even when there is no finding of economic loss to the employer.” Justice Anne Patterson, writing for a unanimous court, also looked to the Restatements (Second and Third) of Agency and concluded that the equitable remedy of disgorgement is derived from principles of contract law. An employee should return compensation that, if he has breached his duty of loyalty, is essentially unearned compensation.

Justice Patterson noted that disgorgement is consistent with the purpose of punishment for a violation of a duty of loyalty. Disgorgement also serves a valuable deterrent effect so that agents understand that “adverse consequences will follow a breach of fiduciary duty” in all cases. The court therefore reaffirmed that equitable disgorgement was available as a remedy and identified several criteria to guide a trial court: the employee's responsibility and level of compensation; the number of acts of disloyalty and the extent to which such acts jeopardized the employer's business; and the level of planning to undermine the employer. Other factors may be relevant, and the Kaye opinion specifically refers back to the Cameco opinion for a further identification of factors for a court to consider, such as possible direct competition by the employee with the employer; aiding the employer's direct competitors; participating in a plan to destroy the employer's business; or secretly depriving the employer of an economic opportunity.

The disgorgement itself would be appropriate, “depending on the circumstances,” and a trial court should differentiate between periods of non-loyalty and periods of loyalty. The trial court should only “claw back” compensation generated for pay periods in which the employee acted in violation of the duty of loyalty.

The Kaye court therefore reversed the Appellate Division with respect to the remedy of equitable disgorgement and remanded the matter to the trial court for proceedings in accordance with its holding.

We support the decision and the Supreme Court's interest in bringing clarity to this issue. Economically harmed or not, an employer who is victimized by a dishonorable employee should have the right to recapture compensation paid during the time of the employee's disloyalty. A dishonest employee should not be allowed to go unpunished because of the fortuity of his employer's lack of loss. The integrity of our marketplace demands a full panoply of remedies for judges when confronting an unfaithful servant.

Board members John Connell and Carl Poplar recused from this editorial.