When a LLC or closely-held corporation is thriving and everyone is doing well, there may not be friction or infighting. In good times, one rarely cares what the other shareholders or members are doing in their spare time. But, in our experience, things change when times get tough. During these times, some question a significant imbalance between the earnings of the parties. Some question when one LLC member or shareholder is spending far too much time on outside opportunities. These concerns can lead to friction or even litigation.
Litigation can happen when an opportunity presents itself to a shareholder or LLC member, which is then pursued personally or through a newly formed company to the exclusion of the original members or shareholders. I’ve even seen situations where a co-shareholder uses the company’s resources to secretly pursue an opportunity of a lifetime through another company. Inevitably, his or her co-shareholders sue to share in the profits of that new venture.
Clients often ask whether or not they can legally pursue such an opportunity. Legally meaning not violating any written agreement (or other statutory or common law) to existing co-shareholders or co-members. The answer to this question is not an easy one. In fact, due to the complication of the question, there is not enough space on here to answer it.
New Jersey Law
Generally speaking, an LLC member or shareholder of a New Jersey business must use caution when pursuing outside opportunities. First, there must be adherence to any relevant provisions of a written operating agreement or shareholder’s agreement. In the alternative, you must, in writing, get a waiver from your colleagues. Sometimes those agreements have a waiver of duties already built into the agreement. Therefore, it may expressly allow members or shareholders to pursue outside interests without restriction. But sometimes the agreement is silent.
The common law may be the source of a claim of a diversion of opportunity as well. A body of case law has developed which generally prohibits a person from taking a corporate opportunity that he learns of that is within the scope of a given business’ market segment or pursuits, for his own.
For many years, the state of the law in New Jersey was confused on this subject. Where the plaintiff was unable to prove that a diversion of company resources occurred to pursue that opportunity, or could not prove a direct financial loss to the business, some courts would not allow a recovery. Several years ago, however, the New Jersey Supreme Court decided on the issue. In Kaye v. Rosefielde, 223 N.J. 218 (2015), the Court ruled that where an opportunity is diverted, this violates a duty of loyalty and the offender may be required to disgorge his salary earned during any period of disloyalty, even when the company is unable to show a direct harm associated with the employee’s pursuit of the private opportunity.
Before you start another venture, call me. Also call with other shareholder or partnership questions.