The Illinois Appellate Court has reiterated what the Illinois Supreme Court said a few years ago: Employees of a corporation owe a duty of loyalty to the company by which they are employed. And that it is a breach of their fiduciary obligation to appropriate for their own gain an opportunity that rightfully belongs to the company. Advantage Marketing Group, Inc. v. Keane, 2019 IL App (1st) 181126.
In this instance it was clear that the employee was far more than an ordinary employee and that it was not clear whether the company had considered the opportunity but had decided to take a pass on it.
Keane was one of the founders of Advantage Marketing Group (AMG) and, even at the time of his purported misconduct, owned 35% of AMG’s stock. He had served AMG as an officer and director, but was simply an employee when he seized a potential corporate opportunity and made good use of it through another corporation, Keane, Inc. d/b/a The Mail House.
In addition to owning 35% of AMG, Keane performed or had performed the following for AMG:
- Hired and fired employees
- Had access to all of AMG’s books and records including client lists, employee records, tax documents, vendor information and billing data
- Had a bonus equal to AMG’s majority stockholder
- Had developed and maintained AMG’s financial records
- Had explored potential strategic acquisitions in the letter-shop business
In the summer of 2013 Keane and AMG’s majority stockholder, Patty Herman, discussed the potential acquisition of The Mail House, a competitor of AMG.
Keane resigned from AMG on September 4, 2015. Prior to his resignation he began making preparations for the acquisition of The Mail House. He organized a new corporation named Keane, Inc. d/b/a The Mail House. He told AMG’s clients and vendors AMG was in financial distress, and solicited his son, an AMG employee, to join him at the new corporation. He also obtained samples of confidential client information and delayed in returning them after being demanded to do so by AMG’s counsel. He registered an internet domain name “mailhousedm.com”. After Keane left AMG, The Mail House was in direct competition with AMG.
AMG sued Keane charging breach of fiduciary duty and improperly appropriating a potential business opportunity (the acquisition of The Mail House) for himself.
Keane defended saying that as an employee he had no fiduciary duty to AMG and, furthermore, that he had discussed the potential acquisition with AMG’s majority stockholder but AMG had not moved forward with it. The court ruled against Keane on both points.
The court said that it was settled Illinois law that an employee owes a duty of loyalty to his employer and prohibits an employee from taking advantage of a business opportunity that belongs to his employer, while still employed.
The court did say that an employee may plan, form and outfit a competing company while still working for his employer. But that was as far as he can go. He cannot commence competing with his employer.
What’s the point? This was an easy decision for the court especially in view of the fact that Keane remained a 35% stockholder in AMG. But the critical point was that an employee must be loyal to his employer while employed and not seize opportunities that would normally flow to his employer. He can make preparations to leave, but cannot actively compete before doing so.
For more information and to raise any questions, please contact any of our business attorneys.
In Part 1, we explored doing business as a sole proprietor or in a partnership. A problem with those types of business entities was that they did not shield the sole proprietor or the general partner from the claims of creditors of the business. This installment will briefly discuss the operation of a business through a corporation or a limited liability company, two forms which, if established and operated correctly, can provide the owners with limited liability.
In a corporation, the owners (“shareholders”) generally have limited liability for the corporation’s conduct of the business. This liability is “limited” to the shareholder’s investment in the corporation. This is applicable, even if there is only one shareholder. While generally the liability is limited, the corporation must observe all the corporate formalities, such as having regular meetings of its directors and shareholders, documenting all action taken (leasing property, setting up a bank account, paying compensation and dividends to the shareholders), and owning or leasing its own property, and treat the business as a separate entity. If they fail to do so, creditors may be able to “pierce the corporate veil” and assert the liability of the corporation against the shareholders.
In a limited liability company (”LLC”) as in a corporation, the owners (“members”) generally have limited liability for the LLC’s conduct of the business. Unlike a corporation, an LLC does not have to observe formalities, such as conducting meetings and documenting the actions of the LLC. However, the members must treat the LLC as a separate entity with its own assets, including bank accounts, and liabilities.
Note that other issues may arise when selecting your choice of entity. A corporation may be either a “C-corporation” or an “S-corporation.” An LLC can be ignored for income tax purposes if there is only one member; if there is more than one member, it may be treated as a partnership. If the member(s) otherwise elect, an LLC could be treated as a corporation (C-corporation, or S-corporation). No matter what the income tax election or consequences, the income tax treatment has no effect on liability issues.
This article and Part 1 have each addressed, in general terms, the types of business entities available to the business owner. No decision should be made without considering all of the issues. Please feel free to contact us with any questions you have regarding this or any other legal issues confronting your business.
If you are starting a business or have any questions regarding the legal alternatives available to your business, please contact:
312-368-0100 or firstname.lastname@example.org.