Misappropriation of corporate opportunity is one of our favorite, most frequently blogged topics on New York Business Divorce. A special kind of breach of fiduciary duty, the corporate opportunity doctrine holds that “corporate fiduciaries and employees cannot . . . divert and exploit for their own benefit any opportunity that should be deemed an asset of the corporation.”
Recently, we’ve written about some rather egregious examples of corporate opportunity misappropriation: total theft of entire businesses through the secret formation of a new entity and clandestine transfer of all of the oldco’s assets to newco. For interested readers, here are links to recent articles on Ng v Asquared and O’Mahony v Whiston.
Far less frequently, because decisions involving it are quite rare, we’ve written about the doctrine of faithless servant in business divorce cases. Another special kind of breach of fiduciary duty rooted in agency law, the faithless servant doctrine holds that “[o]ne 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.
A key difference between the two common-law doctrines: misappropriation of corporate opportunity requires proof of actual damages. Faithless servant does not: it is an equitable forfeiture doctrine requiring a disloyal (i.e., “faithless”) agent to “disgorge” all compensation earned during the period of his or her disloyalty, even if the employer suffered no ascertainable damage from the agent’s disloyalty.
For the first time on this blog, the corporate opportunity and faithless servant doctrines converge in Owen v Hurlbut, 80 Misc 3d 1234(A) [Sup Ct, Monroe County Nov. 2, 2023]).
In Owen, Monroe County Surrogate and Acting Supreme Court Justice Christopher S. Ciaccio ruled that a shareholder’s scheme to misappropriate all the assets of an entity by transferring them to a secretly-formed, new entity provided the legal basis for disgorgement of three years – and more than one and a half million dollars – of the shareholder’s employment compensation under the faithless servant doctrine.
The Family Dispute
Owen emanates from a protracted legal dispute venued in Rochester’s Surrogate’s and Supreme Courts between Christine Owen (“Christine”) and her brother, Robert W. Hurlbut (“Bob”), over the estate and business empire founded by their father, Robert H. Hurlbut (“Robert”).
The family empire consisted of nearly a dozen nursing homes in the Rochester area under the Hurlbut name, each location held by a separate entity. At the time of Robert’s death in 2013, Christine and Bob were co-owners of each nursing home entity. But in 2016, Bob bought out Christine’s interest, becoming sole owner of each.
There were certain other family entities, however, to which Bob never acquired full ownership. One was ROHM Services Corporation (“ROHM”), an entity which provided the individual Hurlbut nursing homes (ROHM’s only client) a wide array of administrative and bookkeeping functions outlined by Christine in an affidavit. In exchange, the nursing homes paid ROHM management fees. Critically for the faithless servant claim, Bob served as President of ROHM, receiving a large annual salary for his services.
Initially, ROHM’s shares of stock were held by the Barbara Hurlbut Marital Trust (the “Marital Trust”), a trust Robert created in his will. Robert’s wife, Barbara Hurlbut (“Barbara”), was the lifetime income beneficiary and Christine and Bob co-equal, 50% residuary beneficiaries. In 2020, Barbara died and Christine and Bob became entitled to 50% of the assets of the Marital Trust, including the shares of ROHM.
The Misappropriation of ROHM’s Entire Business
As alleged in Christine’s amended complaint, shortly after Bob acquired Christine’s minority interests in the nursing homes, Bob embarked upon a scheme by which he “misappropriated the entire ongoing business of ROHM,” transferring it to a competing entity Bob owned, Hurlbut Health Consulting, LLC (“Hurlbut Health”).
The scheme went like this:
- In September 2017, without offering Christine or the Marital Trust (which then held ROMH’s shares) an interest or opportunity to participate, Bob secretly incorporated Hurlbut Health;
- Effective December 31, 2019, all of the employees of ROHM resigned;
- Effective January 1, 2020, Hurlbut Health hired the employees formerly employed by ROHM;
- Effective January 1, 2020, ROHM’s employee 401(k) plan was renamed the “Hurlbut Health Consulting, LLC 401(k) Plan”;
- In January 2020, all of the Hurlbut nursing home entities terminated their contracts with ROHM and entered into new contracts for the same services with Hurlbut Health;
- In May 2021, Hurlbut Health bought ROHM’s remaining physical assets for a nominal price; and
- In May 2022, Bob resigned as officer and director of ROHM, leaving ROHM without officers or directors.
Christine alleged that she did not learn of Bob’s scheme until he testified in a deposition in the Surrogate’s Court litigation that ROHM was “defunct” and that Hurlbut Health had “replaced” ROHM.
Christine sued Bob and Hurlbut Health derivatively on behalf of ROHM alleging a bevy of claims, including for Usurpation of Corporate Opportunity (the Third Cause of Action) and faithless servant (the Fourth Cause of Action).
Bob moved to dismiss the amended complaint. The Court converted the motion to summary judgment. Then Christine cross-moved for summary judgment on liability, including for misappropriation of corporate opportunity and faithless servant.
In his summary judgment decision, Justice Ciaccio made a number of interesting rulings. We’ll focus on just two.
The Corporate Opportunity and Faithless Servant Holdings
First, the Court granted Christine summary judgment on liability on “Christine[’s] claims that Bob simply took ROHM’s business without compensation,” writing:
Judgment is granted as to those causes of action premised on the misappropriation and/or underpayment of the assets of ROHM. It is undisputed that ROHM had value . . . and that Bob failed to pay anywhere near the value placed upon the business . . . . That he was under no obligation to pay market rates for ROHM’s services does not give rise to the conclusion that he was free to delay the destruction of ROHM and gradually eviscerate it of its value. Even giving Bob the benefit of every possible inference, the bottom line is that he paid very little for ROHM’s assets, and certainly nowhere near [ROHM’s] valuations. In no way was the transaction at arm’s length.
The extent of damages is best left to a trier of fact.
Second, the Court granted Christine summary judgment on liability and damages for faithless servant, writing:
It can be easily concluded — in fact the conclusion is inescapable — that rather than simply negotiating to pay the Marital Trust a reasonable amount of money for ROHM back when he purchased the skilled nursing facilities in 2016 . . ., Bob developed a plan to form a new company, Hurlbut Health, pay himself excessive compensation (so as to not have to distribute any money to the Trust), terminate the employees so that as president of the nursing homes he could hire them, take over the pension plan, and then appropriate [ROHM’s] trademark.
What ROHM lost in profits or diminished valuation as a result of these acts will be decided by the trier of fact, but it is held here that the series of repeated actions taken by Bob to diminish ROHM’s value to nothing constituted a breach of Bob’s fiduciary duty as president of ROHM . . . regardless of the extent of the damages.
Thus, partial summary judgment is granted on the Fourth Cause of Action, and Bob is ordered to disgorge his compensation for the period 2017-2019.
The Amount of Disgorgement
From 2017 to 2019, Bob received a total of $1,694,073 in compensation as President / employee of ROHM. The Court ordered him to forfeit / repay it all to ROHM. But, as the Court noted, “since the disgorged compensation goes back equally to the shareholders of ROHM, he of course receives back one-half.” In other words, insofar as a plaintiff alleges faithless servant derivatively on behalf of a close business entity, the resulting judgment is payable to the entity for distribution among the owners pro rata.
Owen is a fine example of clever use of the faithless servant doctrine in business divorce litigation.
Practitioners should sit up and take notice of the doctrine’s utility. Where actual damages may be questionable, difficult to prove, negligible, or even non-existent, the faithless servant doctrine can provide a powerful alternative remedy to secure meaningful financial redress. Where successful, forfeitures under the faithless servant doctrine may be hefty, draconian even, as the defendant learned firsthand in Owen.
Owen provides direct support for the proposition that upon a strong showing, courts in business divorce litigation may award judgment as a matter of law on a claim of faithless servant.
Nonetheless, despite Owen, faithless servant forfeitures are relatively uncommon, particularly in business divorce cases. If in our blogging travels we come across another example of a successful faithless servant judgment in a business divorce case, we’ll be sure to write about it.