Lindabury, McCormick, Estabrook & Cooper, P.C. Firm News & Events
Because of the fiduciary duties owed by business owners to each other, whether they are shareholders in a closely held corporation, members in a limited company, or partners in a general or limited partnership, a business owner generally is prohibited from competing with the company. This general prohibition can be modified by an agreement among the owners, but in the absence of such an agreement the prohibition stands.
Failure to do so is referred to as the diversion of corporate opportunities. An owner of a closely held business has a duty to bring to the company any business opportunity that the company would normally expect to seek to pursue. The opportunity must be presented to the company and cannot be pursued individually unless the company decides not to pursue that opportunity.
As with the prohibition on competition, the requirement to present all opportunities to the company can be altered by contract. Pursuant to N.J.S.A. 14A:3-1, a corporation can renounce its interest in, or expectancy of the opportunity to pursue, specific opportunities. One manner in which corporate opportunities can be relinquished is to insert the pertinent language in the Certificate of Incorporation. When starting a new business, if there is any thought that one or more owners might want the right to pursue competing opportunities, you want to include language in the Certificate of Incorporation, or a separate shareholder agreement, that specifies what competing businesses the shareholder may appropriate.
One of the most common forms of shareholder oppression (a statutory defined term that has become a euphemism for wrongful conduct) is taking, and using for personal purposes, corporate property. Misappropriation of corporate assets can involve, among other things, the misuse of trade secrets, proprietary formulas, business models and customer or vendor information to compete with the company.
In situations where one owner feels that the other is taking advantage of them, they may plan to leave the company and engage in a similar, competing business. They may be sorely tempted to begin setting up that business, contacting customers and seeking to obtain commitments to use the new business even before leaving the existing business. Such actions, of course, are not proper or equitable and will be one reason for a court to grant an injunction preventing the new business from using the resources or information of the original business.
One common way to try and prevent such action is to have employees and owners sign non-competition agreements ostensibly preventing them from competing with the company for a specific period of time after cessation of employment. New Jersey, however, has a strong public policy interest in the right to earn a living and promoting competition. As a result, any non-compete agreement will be construed by any New Jersey court to be only as broad as reasonably necessary to protect the legitimate interests (proprietary information) of the company. A non-competition agreement may be narrowed in scope by the court with respect to either time or geographic area because the court considers such agreements that are too broad to simply be agreements trying to prevent competition, not protect legitimate company interests.
Non-competition agreements obtained from an owner in connection with the sale of their business are more strictly enforced. This is because the agreement was bargained for as part of the sale and the selling owner is in a position to deprive the purchaser of the business of their bargain by engaging in competition. The same is true in the case of a shareholder oppression claim and one shareholder or the company is purchasing the interest of another, but typically only if the case is resolved through settlement. If the case is settled, the parties can include any provisions desired. While the court has general equitable powers, and might impose a non-competition requirement, the statutory remedy only provides for a purchase of stock, not for the granting of a non-competition agreement. This is just one more reason why it is beneficial to create a shareholder buy/sell agreement when forming the company; you can include non-competition provisions from the outset that are triggered upon a sale.