NY Employers Can Retroactively Fire For-Cause

A recent decision by the U.S. District Court for the Southern District of New York has injected new life into a doctrine that allows employers retroactively to “terminate” an employee for cause based on misconduct discovered after his or her termination or resignation.

The Kulick Decision

In Kulick v. Gamma Real Estate LLC, U.S. District Judge Mary Kay Vyskocil relied on the so-called “after-acquired evidence doctrine” to permit the defendant employer to treat an employee’s termination as a termination for cause after it uncovered evidence he spent the final month of his employment misappropriating the company’s resources and improperly soliciting its investors.

The after-acquired evidence doctrine is generally invoked by an employer seeking to “introduce evidence the employer collected after the discharged employee brings suit for wrongful discharge.” In practice, the doctrine grants employers greater leeway to investigate and bring forward employee misconduct the employee tried concealed before termination.

Yet the doctrine has, until now, been met with skepticism by courts. For example, the New York Supreme Court has called the practice of reclassifying terminations “disingenuous,” and in 2012 the Southern District of New York labeled the practice “nonsensical.”

That skepticism appears to be changing. The Kulick decision follows closely on the heels of a Delaware Chancery Court opinion in Metro Storage International LLC v. Harron, in which the court agreed with the defendant’s use of the after-acquired evidence doctrine to permit it to retroactively terminate a former employee for cause.

Judge Mary Kay Vyskocil relied on Metro Storage to reach the same outcome in Kulick. The court determined that former employee Kulick engaged in “unethical conduct in the performance of his duties,” including breaches of a confidentiality covenant, violations of employment policies, and misuse of company resources. The court concluded that there could be no doubt that “Defendants would have terminated Kulick had his misconduct been known from the time it began. Kulick cannot now reap the gains of his concealment.”

Practical Considerations of Kulick

In many executive agreements, the definition of “cause” can have a substantial impact on an executive’s right to severance and vested equity upon termination. For instance, in many such agreements, an executive is only entitled to severance if he is terminated without “cause.” Or, if an executive is terminated without cause, particularly after a change in control event, he may be entitled to accelerated vesting of equity in the company. There is no standard definition of cause, but it often includes terminations for willful violations of company policy, including the protection of confidential information of the company.

For employers, the Kulick decision highlights the importance of undertaking thorough investigations of allegations of executive misconduct. Often key evidence is not uncovered until after the former executive has left the company and their successors take over their responsibilities or employees feel more comfortable coming forward with evidence against the former executives.

Although the law is still unsettled, even if the executive’s agreement does not have a “claw back” provision for later-discovered evidence, the company may have the option of recharacterizing the basis for the termination and either denying severance and consideration offered by his agreement for a not-for-cause termination or seeking to claw back consideration that has already been paid to him. Also, in litigation with the executive, the company may have the option of presenting evidence discovered post-termination to support the position that the former executive engaged in conduct supporting a for-cause termination.

The decision also may have an impact on provisions in executive contracts related to the determination of whether there is cause to terminate. Cause definitions often require the employer to notify the employee of the misconduct constituting cause to terminate and provide the executive the opportunity to cure. If the executive satisfies his cure obligation at the time, but the company later determines that the executive engaged in other misconduct or that the cure evidence was not sufficient, it may be able to assert in negotiations, arbitration or litigation that it had cause to terminate.

Employers should be mindful that the Kulick and Metro Storage decisions are very recent developments in a landscape of jurisprudence that has generally not embraced the after-acquired evidence doctrine. Employers and employees should continue to monitor developments in this area of law and should consult with experienced executive employment counsel before relying on this doctrine.