The Balles v. Babcock Power Inc. decision sheds light on whether sexual misconduct constitutes “cause” and provides go-forward guidance to all parties drafting and negotiating (or re-negotiating) “for cause” language in employment and compensation agreements.

In the spring of 2017, before the emergence of the #MeToo movement, the case of Balles v. Babcock Power Inc. was decided in Massachusetts. The case involved a company’s “for cause” termination of an executive upon learning of his sexual conduct with a subordinate. The judge ultimately sided with Eric N. Balles on the issue of “cause” under the stockholder agreement, and ordered the employer to return his stock and pay all dividends.

In light of Balles v. Babcock Power Inc., neither employers nor employees should assume that societal norms supersede contractual rights and obligations. Employers and employees should review the “for cause” language of their various employment and compensation agreements and, if appropriate and possible, negotiate or re-negotiate terms – because those are the terms to which they will be held.

It was undisputed that Babcock Power Inc. terminated executive Ballesafter learning of his sexual conduct with a subordinate, and the steps he took to keep his conduct hidden.  The employer also terminated “for cause,” which allowed the employer to re-purchase Balles’ stock for the nominal price of $0.001 per share, and to decline paying Balles any severance.  In response, Balles filed suit for declaratory judgment and breach of contract.

In the jury-waived portion of the trial, the trial court judge found for the employer on its breach of fiduciary duty claim.  On that basis, the judge assessed against Balles an equitable forfeiture of past compensation – that which was paid to him during the period of his disloyalty – and denied him severance because of his material breach of the employment agreement.

On the other hand, however, the judge found for Balles on the issue of “cause” under the stockholder agreement, and ordered the employer to return his stock and pay all dividends.  The employer appealed this order and direct appellate review was granted.

Guidance from the Court

Ultimately, guidance was provided regarding the following: (1) the standard of judicial review of an employer’s determination of “cause”; (2) the meaning of “fraud”; (3) the meaning of “gross insubordination”; (4) when an employer may ignore a contractually provided opportunity to correct (cure), and what constitutes correction in a circumstance such as this; and (5) the application of fiduciary duty defenses to stockholder agreement claims.

Standard of Judicial Review Applied to An Employer’s Decision Regarding Cause

Parties to a contract may, within limits, agree to a standard of judicial review that is deferential to one party (usually the employer).  However, saying that a decision as to cause “may only be made by the [employer]” does not guarantee such deference. Rather, if the parties want to provide an enforceable deferential standard of judicial review, they would be wise to say so explicitly.

The Meaning of “Fraud”

If “fraud” is a ground for termination for cause, the common law definition of fraud applies unless otherwise defined by the parties. Under the common law definition, fraud requires both fraudulent intent and actual harm.  In this case, the steps taken by Balles to keep his conduct hidden did not meet the common law definition.  His mistakenly submitted false reimbursement request, for example, was submitted with no intent to defraud or harm the employer.  Additionally, Balles’ career advocacy on behalf of the subordinate – in which he engaged in without disclosing his sexual conduct with her – was also without fraudulent intent or harm. To the contrary, the Superior Court held that the subordinate fully earned her salary and benefits by “her obvious verbal and managerial skills, intelligence, maturity, and motivation…”

The Meaning of “Gross Insubordination”

As with “fraud” as a ground for termination for cause, where the parties do not provide a definition, the common law definition of “gross insubordination” will be applied. Under the common law, an employee merely failing to abide by an employer’s policies does not constitute “gross insubordination” (versus mere insubordination). Rather, under the common law, “gross insubordination” is generally defined as “willful disregard of a direct order.”  In this case, Balles never disobeyed a direct order, therefore his conduct did not constitute “gross” insubordination.

What Constitutes Correction and What Constitutes Futility?

When required by an agreement, an employer must provide the employee with an opportunity to correct his/her conduct, and an employer acts at its peril if it fails to do so under the “narrow” theory of futility.  By asserting that the correction required the impossible – undoing the breach, rather than remedying its effects – the employer in Balles read the correction opportunity out of the agreement and thus violated its agreement with Balles. Furthermore, correction was, indeed, found to be possible in the Balles case. Correction would have been satisfied by financial penalty – such as that imposed by the trial court – or even termination, if termination was required to protect workplace culture. However, to insist that such a termination would be for “cause,” would make the correction opportunity “for naught.”

Application of Fiduciary Duty Defenses

Despite the language of the employment agreement, “the rights of stockholders arising under contract, as here, are governed solely by [that] contract.” Balles was entitled to his rights under the stockholder agreement regardless of breaches of fiduciary duties as an employee.