Does your business partner owe you anything? We’re not talking about money, although that may be an ultimate outcome, we’re talking about how they treat you. Do they owe you any duty to be fair or to bring business opportunities to your company? Whether you are a shareholder in a small, closely held corporation or a member in a limited liability company, the answer to this question is yes, with some exceptions.
Every small business owner, again, whether be it a corporation or limited liability company, has a fiduciary relationship with the other business owners. What is a fiduciary relationship? A person who is a fiduciary is someone charged with a legal and/or ethical relationship of trust with one or more other persons. A fiduciary duty, in turn, is the highest standard of care that can be imposed on someone. A fiduciary is required to be loyal to the beneficiaries of that duty and there must be no conflict of interest between the fiduciary and beneficiaries. The fiduciary cannot profit personally from his position as a fiduciary.
Since each shareholder or limited liability company member owes each other a fiduciary duty the responsibility is reciprocal. Therefore, as a small business owner, you owe a fiduciary duty to your other partners whether you own 60% of the company or 5% of the company and they also owe you a reciprocal fiduciary duty.
The fiduciary duty has several components. One such component is a duty of care. Those in charge of running a business are required to understand the business and to exercise ordinary care in its operation. There is s Business Judgment rule which operates to give wide protection to the decisions made when running a business as long as they are made in good faith. Engaging in grossly negligent or reckless conduct, intentional misconduct or a knowing violation of law will constitute a breach of the duty of care.
Another component of the fiduciary duty is the duty of loyalty. This is the most fundamental aspect of the fiduciary duty and under the duty of loyalty the other business owners cannot solicit the company’s customers or otherwise compete with the company for their own benefit. How many times have you heard the story of your friend whose business partner went out and started a competing business, stealing many of the customers of your friend’s business? It happens frequently and, while New Jersey favors open competition, even that has limits. All may be fair in love and war, but not in business. If your partner has used business assets, either information, personnel or resources to engage in a competitive business, they have breached that duty of loyalty.
In many instances you may already be engaged in one business and have an idea to enter into a new line of business and want to bring in a partner. This can create issues later if the two businesses are similar or share one or more lines of business, but you can protect yourself with proper planning in the beginning. Business owners can make an agreement among themselves that allows for competition with the business by one or more owners, even if that other business would be a direct competitor, however, that agreement needs to be in writing and as specific as possible about what competition is permitted and what is not.
Accordingly, when starting a new business with others or bringing in new owners to your existing business, you need to carefully examine all possible scenarios and proper up front planning can avoid substantial legal woes later.