In this Employment Issues column, Philip M. Berkowitz and María Cáceres-Boneau discuss issues to consider when your client’s controller appears to have made some critical errors that have caused substantial financial damage. How likely is it that your client can recover? What are the impediments to proceeding against the employee? And how wise, in any event, is it to move forward?

By Philip Berkowitz and María Cáceres-Boneau | January 08, 2020 at 12:50 PM

Your client’s controller appears to have made some critical errors that have caused substantial financial damage. The client feels that the controller’s conduct was at the very least negligent. While she does not appear to have engaged in intentional wrongdoing, she violated longstanding rules about transferring assets, failed to follow normal protocols, and cost the company millions of dollars. The company wants to recover against the controller, and also wants to send a strong message to employees that they need to be careful when they are in positions of trust.

How likely is it that your client can recover? What are the impediments to proceeding against the employee? And how wise, in any event, is it to move forward?

Employees working in positions of trust are not immune from errors in judgment that can cost their employer millions. And in the age of Internet fraud, they are subject to scams that can wipe out corporate assets with the click of a mouse.

New York’s labor laws have traditionally protected employees from having to reimburse their employers for losses they incur in the normal course of their duties. This makes sense, of course. These laws were designed to protect workers from liability from occurrences such as breakage (for example, in a restaurant) or industrial accidents or mishaps in which employees unintentionally cause expensive damage.

But what happens when the loss is in the millions? What happens when the employee who caused the damage is a professional in whom the employer has invested trust and confidence, and who simply should have known better? Shouldn’t these employees be held to a higher standard? Why should an employer have to absorb losses caused by individuals who failed to exercise due care in performing their job duties?

New York courts have been quite wary to allow such claims. A recent case is illustrative. In Charles H. Greenthal Management v. Waldes, Case No. 653211/2017, 2018 WL 987028 (Sup. Ct. NY County, Feb. 16, 2018), a real estate management company suffered damages due to an “a series of reckless, negligent and violate acts and omissions” by an employee, including succumbing to Internet fraud. The employee was plaintiff’s controller, who, as a result of a fraud, transferred $1.1 million, which was lost.

The employee also caused losses to the company by failing to file a certain report with the Department of Finance of the City of New York and paying real estate taxes from an incorrect account that resulting in the termination of a management contract. The employer sued, claiming that the controller’s actions were grossly negligent and reckless.

The court dismissed the claim, holding the lawsuit barred by §193 of the New York Labor Law, which prevents employers from taking deductions from employees’ wages if the deductions are not expressly authorized by that statute, which generally limits such deductions to those that would be beneficial to the employee, such as health insurance premiums.

The statute also prohibits employers from taking actions that would circumvent the Labor Law, and the court held (as have others) that suing the employee in such circumstances would be an unlawful effort to circumvent the statute. As the court put it in Barbagallo v. Marcum, 925 F. Supp. 2d 275, 298 (E.D.N.Y. 2013): “In New York, an employer cannot sue an employee for negligence or poor performance.” (Citing N.Y. Lab. L. §193).

Gross Negligence

What about a claim that goes beyond mere negligence? In Charter Oak Fire Ins. Co. v. Trio Realty Co., 2002 WL 123506 at *4 (S.D.N.Y. Jan. 31, 2002), the court noted that gross negligence, used interchangeably with willful negligence, differs “in kind, not only degree, from claims of ordinary negligence. It is conduct that evinces a reckless disregard for the rights of others or ‘smacks’ of intentional wrongdoing” (quoting Colnaghi, U.S.A. v. Jewelers Protection Services, Ltd., 81 N.Y.2d 821, 823-24 (1993)).

To try to put this in context: Recklessness, in the context of a gross negligence claim, is defined to mean an extreme departure from the standards of ordinary care, such that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Media Glow Digital v. Panasonic Corp. of N. Am., 2018 WL 6444934 at *7 (S.D.N.Y. Dec. 10, 2018).

Would demonstrating gross negligence or recklessness permit recovery in a lawsuit brought by an employer against its employee? The trial court in Charles H. Greenthal thought not, dismissing the claim despite allegations of gross negligence. It is worth noting, though, that the court did not engage in an analysis of whether the conduct at issue went beyond mere negligence.

Faithless Servant Doctrine

New York recognizes a faithless servant doctrine, under which an employee’s breach of his duty of loyalty to the employer may provide the employer a remedy in the form of the employee’s disgorgement of compensation received during that period. In Phansalkar v. Andersen Weinroth & Co., L.P., 344 F.3d 184) (2d Cir. 2003), the court held that this doctrine required the employee to forfeit compensation received after his first disloyal act, including previously paid salary, stock options (exercised and/or unrealized) and other investment opportunities.

The faithless servant doctrine is in the nature of a claim for breach of fiduciary duty. New York law recognizes that an employee-employer relationship is fiduciary, regardless of the employee’s rank and level of position. Courts have applied this doctrine, for example, to circumstances in which employees secretly compete with their employer, or divert funds to a competitor. E.g., Fairfield Fin. Mortg. Group v. Luca, 584 F. Supp. 2d 479, 485 (E.D.N.Y. 2008); Barbagallo v. Marcum, 925 F. Supp. 2d 275, 298 (E.D.N.Y. 2013).

An employee is “prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of duties.” Louis Capital Markets, L.P. v. REFCO Group Ltd., 801 N.Y.S.2d 490 (N.Y. Sup. Ct. 2005) (citations omitted).

Courts have allowed claims for breach of fiduciary duty where the employee engaged in fraud or there is intentional misconduct. See CC Industries v. Segal, 286 A.D.2d 234 (1st Dept. Aug. 9, 2001) (employee devised a schedule of creating fraudulent invoices and employer sought to recover $764,575 in damages); McDonnell v. Bradley, 109 A.D.3d 592 (2d Dept. Aug. 21, 2013) (breach of fiduciary duty claim based on employee diverting company profits to a separate account).

Outside the employment context, but where a fiduciary duty is not necessarily present, courts have nevertheless permitted fiduciary-breach claims to go forward. For example, New York courts do not generally regard the accountant-client relationship as a fiduciary one. Nevertheless, a breach of fiduciary duty claim may go forward against an accountant in special circumstances, e.g., “where the allegations include knowledge and concealment of illegal acts and diversions of funds and failure to withdraw in the face of a conflict of interest.” Elias v. Gettry Marcus CPA, P.C., 2018 WL 3117510 at *7 (S.D.N.Y. June 25, 2018).

Indemnity

It is also possible that the Company could proceed against the employee on a theory of indemnity. “Implied indemnity is a restitution concept which permits shifting the loss because to fail to do so would result in the unjust enrichment of one party at the expense of the other.” Mas v. Two Bridges Assocs., 75 N.Y.2d 680, 690 (1990) (citing McDermott v. City of N.Y., 50 N.Y.2d 211, 216-17 (1980)).

In McDermott, 50 N.Y.2d at 211, n.4, the court noted: “A classic indemnity claim exists, of course, in favor of a person who has been held vicariously liable for the tort of another. Thus, an employer who has who has been cast in damages, by virtue of respondent superior, may obtain indemnity from his employee …. In such case, of course, the underlying breach of duty is tortious in nature.”

In this context, Justice Cardozo observed in 1928: “The master who recovers over against the servant does not need to build his right upon any theory of subrogation to a cause of action once belonging to the victim of the injury. A sufficient basis for his recovery is the breach of an independent duty owing to himself. The servant owes the duty to the master to render faithful service, and must answer for the damage if the quality of the service is lower than the standard.” Schubert v. Schubert Wagon Co., 249 N.Y. 253 (1928).

But there may be no indemnity per se in a particular case, unless the employer has been held liable to a third party as a result of the employee’s negligence.

Is it Wise?

The client needs to consider that bringing such a claim may have several unintended and undesirable consequences:

• First, in any defense of the matter, the employee would likely argue that the Company’s processes were inadequate to detect the loss. This could draw attention to problems unrelated to the employee’s competence, and instead turn attention to the Company’s safeguards.
• Second, the employee could bring counter-claims, such as for extrajudicial defamation and possibly other claims.
• Third, bringing a lawsuit could breathe more life into the incident and result in greater publicity than the incident may already have received. This publicity could reflect badly on the Company. Social media could portray the Company as trying to blame its employee for problems with its own systems.

Conclusion

The only viable option for proceeding against an employee whose conduct appears to have been at the very least negligent and that resulted in damages to the employer is via a claim of fiduciary breach. The employer must demonstrate that the employee’s actions went well beyond mere negligence.

The employer must demonstrate that a reasonable person in the individual’s position would have clearly understood that he was acting in an egregious manner that evinced a reckless disregard for the rights of others. The conduct must be akin to intentional wrongdoing. It must represent an extreme departure from the standards of ordinary care, such that the danger was either known to the employee, or so obvious that he must have been aware of it.

Absent such a showing, the Labor Law appears to bar any action against employee bad actors.

Read the full article here:

https://www.law.com/newyorklawjournal/2020/01/08/employee-bad-actors-can-employers-recover/

Philip M. Berkowitz is a shareholder of Littler Mendelson and co-chair of the firm’s U.S. international employment law and financial services practices. María Cáceres-Boneau is an associate at the firm.

Reprinted with permission from the January 8, 2020 edition of the New York Law Journal©

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