You are the majority owner of a sales and distribution business. You’ve been working diligently to land new customers and grow sales. You’re growing increasingly frustrated that the minority owners are not putting in the same effort. A contact from your network reaches out to let you know about a producer looking to bring on a new distributor to cover your area. You know this opportunity will be lucrative for whoever lands the work but that it’s going to take real effort to make it pay off. You’re up for the extra work. But you have doubts about whether your partners share the same hunger to succeed. What do you do?
Corporate governance issues do not tend to be front of mind for most owners of closely-held businesses. Corporate formalities are viewed as irritants and, as such, tend to be limited to cursory annual consents electing board members and appointing officers. Decisions (big and small) about the business are most often discussed and then made informally by the group. When the owners, directors, and officers are focused on making the business as profitable as possible, if corporate governance issues crop up, they tend to be hashed out amicably over a cup of coffee. Interests are aligned. The system works smoothly.
Whether and how to pursue a new business opportunity may take more than a cup of coffee. Interests may no longer be aligned. That misalignment tends to cause friction. In the hypothetical above, you want to pursue this new opportunity because you believe it will be profitable. However, you can’t help but feel frustrated that your partners are not matching your effort; effectively freeloading off of your labors. As a result, you harbor concerns that if you share the opportunity with your partners, the same dynamic will take hold. You will perform the lion’s share of the work but not earn a fair return off of that effort. You would prefer to exploit this opportunity without your partners to prevent this source of frustration from getting worse.
The law governing closely-held businesses imposes ethical obligations on business owners, board members and officers requiring them to treat the business and the other business owners fairly. These obligations, commonly referred to as fiduciary duties, flow in part from statutes and in part from case law. These duties are commonly referred to as duties of loyalty, care, and good faith. The hypothetical above touches upon the duty of loyalty which obligates fiduciaries of a business to act in the best interest of the business and their fellow business owners when addressing matters that relate to the business. Depending on how closely related a new opportunity is to the scope of the existing business, decisions regarding whether to pursue an opportunity and how to pursue the opportunity may raise a question as to whether you have fulfilled your duty of loyalty to your partners.
The ‘Corporate Opportunities Doctrine’ evolved as a framework for assessing whether principals have an ethical obligation to share a new business opportunity with the other principals in the business before seeking to capitalize on it. The analysis begins with an assessment of how closely a new opportunity relates to the existing business. The more closely related, the more likely a corporate opportunity would be found to exist. The more removed from the existing business, the less likely a corporate opportunity would be found to exist. If no corporate opportunity exists, a principal has no duty to present the opportunity to the other principals. If a corporate opportunity exists, the options are more limited. A partner has an obligation either to present the opportunity to the other partners for consideration or to decline the opportunity. Failing to disclose the opportunity to your partners but pursuing the opportunity separately from the existing business would open you up to a breach of fiduciary duty claim under the Corporate Opportunities Doctrine. Frustration with a lack of effort by your partners will not justify an attempt to exploit the opportunity on your own.
Planning opportunities exist which may help entrepreneurs avoid or dampen the impact of the Corporate Opportunities Doctrine which may present themselves in the future. As the name implies, the doctrine evolved from cases exploring the nature and scope of fiduciary duties owed by officers, directors, and stockholders to the corporations they serve. Until recently, the statutes and laws governing the formation and operation of corporations did not allow principals forming corporations the flexibility to modify the scope of the fiduciary duties owed to others. With the increasing popularity of the limited liability company form, which allows greater flexibility to waive or modify these duties, forward-looking states like Delaware have begun to allow corporations to address issues like the scope of corporate opportunities in their charter documents. If the prospect of future conflicts is an issue of concern to you as an organizer, the jurisdiction in which you form your business entity is an important consideration.
As the title ‘Indiana Business Flexibility Act’ implies, the limited liability company form offers organizers greater latitude to address issues like how to handle future business opportunities should they arise. Limited liability companies are very much creatures defined by contract. A limited liability company’s operating agreement can be tailored to address when (if ever) an owner, manager or officer would be required to present a new opportunity to the company or other owners. Serial entrepreneurs are wise to consider these issues and possible solutions in advance of the next opportunity presenting itself.
Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation.