When a party has an obligation to act in the best interest of another, such as attorney/client or principal/agent, it’s known as a fiduciary duty. If the fiduciary fails to act in accordance with that duty, it is called a breach of fiduciary duty. When a fiduciary breaches his duty to a party, that party (the principal) can sue for damages.
What Is Disgorgement?
One of the remedies for a claim of breach of fiduciary duty is profit “disgorgement.” That’s where the injured principal seeks to obtain the fiduciary’s ill-gained profits that were caused by the breach. Disgorgement tries to make whole those harmed financially by returning ill-gotten funds to the injured party. This type of civil remedy seeks to prevent unjust enrichment by the fiduciary.
An action for disgorgement of a fiduciary’s wrongful gains is sometimes known as seeking recovery of “secret profits,” which consist of the benefits a fiduciary acquires from the party in excess of the fiduciary’s agreed compensation.
A recent California Court of Appeals case discusses the recovery of secret profits by disgorgement and what’s required to succeed on such a claim.
Background
In 2009, the International Congress for Joint Reconstruction, Inc. (Congress)— a group of nationally known orthopedic surgeons—retained Mark Sacaris, part owner of the Center for Healthcare Education and Research to help them produce medical education conferences on joint-reconstruction surgery. The parties didn’t have a written contract, and there was no discussion of compensation.
Sacaris and his company (together “Fiduciary”) provided all of the services Congress needed. He unilaterally set rates for these services, adding a markup on labor costs to create a profit for Center and indirectly for himself. He used Congress’s money accounts to pay Center’s invoices without notifying Congress’ board members of what it was being charged. Without informing the Congress’ board Sacaris subsequently increased the scope of Center’s services to include developing Congress’s websites and broadcasting live surgeries to Congress conferences (even though Center employees lacked the required experience). Congress was overbilled for web development and was left without a working website.
This provided Sacaris with additional sources of profit, but he didn’t disclose his interest in these arrangements to Congress.
Fiduciary organized and ran conferences for Congress from 2009 until 2016. Fiduciary employees, including Sacaris, billed for their services by the hour. Fiduciary would increase the employees’ hourly rates by between 17 – 20% to reimburse Fiduciary for its overhead expenses. He would add an additional markup of up to 80% of the employees’ hourly rates to create a profit for that company, and indirectly, for Sacaris—which he didn’t disclose to Congress.
In 2013, Sacaris was made a chief operating officer of Congress and a nonvoting member of its board of directors. The change in Sacaris’ official role at Congress had no impact on his billing practices. He continued his practices of inflating invoices to Congress and pocketing the surplus.
The Lawsuit
When Sacaris told Congress’ board that he was owed $2 million, they ended the relationship with Fiduciary. Center filed an action to recover what it thought it was owed by Congress under their agreement. In turn, Congress filed a cross-action against Fiduciary claiming that they’d secretly profited from their relationship with Congress. Congress sought, among other remedies, disgorgement of the profits Fiduciary received in breaching of their fiduciary duties.
At trial, Congress identified several ways in which Fiduciary had allegedly breached their duties to Congress and sought disgorgement of the undisclosed profits recovered through each form of misconduct. The trial court found in favor of Center on its breach of contract claim and awarded $2.2 million. However, the trial court did find that Fiduciary breached their fiduciary duties by failing to disclose the amounts they were charging Congress for web development and their lack of necessary experience. The trial court awarded Congress $800,000 on this claim, finding Congress succeeded in proving it was overbilled by this amount for web development, but denied Congress recovery on its other claims. The net result was a loss for Congress of roughly $1.41 million.
Congress Appeals the Decision
On appeal, Congress argued that the trial court erred in determining that it couldn’t recover disgorgement of Fiduciary’s profits from their undisclosed charges for management services without proof the breach of fiduciary duties caused Congress to suffer monetary damages.
Congress argued that once the trial court found Fiduciary breached their fiduciary duties to Congress, it erred when it held Congress was required to present evidence it suffered monetary loss from the breach to recover. Congress argued that when a principal seeks disgorgement of a fiduciary’s secret profits, the appropriate measure of the damages resulting from the breach of fiduciary duties is the amount of the fiduciary’s wrongfully-acquired profits. Congress contended that once it established that Fiduciary breached their fiduciary duties and the amount by which Fiduciary directly and indirectly profited from the breach, the court was required to provide a remedy.
The Court of Appeals’ Decision
Administrative Presiding Justice Judith McConnell, along with Justices Patricia Benke and Joan Irion concurring, wrote that a claimant pursuing a cause of action for breach of fiduciary duties has the right to elect the kind of relief they seek. The available relief includes damages or any of a “variety of equitable remedies,” including disgorgement of profits. The trial court erred when it held Congress couldn’t recover on its cross-claim for breach of fiduciary duties without evidence that it suffered economic harm from the breach. Because Congress was seeking the equitable remedy of disgorgement of secret profits—rather than the legal remedy of compensatory damages—it wasn’t required to show it suffered pecuniary harm to establish a right to disgorgement of the profits Fiduciary earned from their misconduct.
“The aim of these equitable remedies is to enforce the high standards of conduct to which a fiduciary must be held,” Justice McConnell wrote.
“The emphasis is on the wrongdoer’s enrichment, not the victim’s loss,” the Court said, citing an earlier decision.
The Court of Appeals found that there was no agreement as to the amount of Sacaris’ (or Center’s) compensation. Sacaris, on behalf of Center, nevertheless made up Center’s rates and compensated Center without disclosure to Congress’ board. This course of conduct breached the duties of loyalty and full disclosure, the Court held..
Thus, once Congress demonstrated that Fiduciary breached their fiduciary duties, to establish a right to recover in disgorgement, it had the burden of producing evidence “‘permitting at least a reasonable approximation’” of their wrongful gain, Justice McConnell held.
The burden then shifts to the fiduciary to provide evidence of costs, expenses, and other deductions to show the actual or net benefit he received. The residual risk of uncertainty in calculating net profit is assigned to the wrongdoer, the Court of Appeals said.
A principal seeking disgorgement of a fiduciary’s wrongful gains is not required to prove it suffered economic damage from the breach in order to recover. Thus, the Court of Appeals found that Congress wasn’t required to show it suffered monetary harm to establish a right to Fiduciary’s profits from their undisclosed charges for event management services. That portion of the judgment was reversed.
Center for Healthcare Education & Research v. International Congress for Joint Reconstruction, Inc., 2020 Cal. App. LEXIS 1133 *; 2020 WL 7021312 (Cal. App. 4th November 30, 2020).