Fiduciary Duties Change With Time

Posted by Jay McDaniel on January 03, 2012

Partnership Failed to Keep Inactive Partner Informed

The fiduciary duties owed among partners can change with time and circumstances, and the disclosures that were appropriate when all of the partners worked together in the business may become inadequate when one of the partners has ceased to take an active role.

This is the lesson of Munoz v. Perla, Docket No. A-5922-08T3 (App. Div. Dec. 20, 2011) in which the Appellate Division affirmed a trial court decision holding that the members of a partnership had failed to make adequate disclosure of the terms of the leases held by the engineering firm, of which the parties had all once been partners.

Although the case involved the now-repealed Uniform Partnership Act, and thus not all of the holdings may be applicable to partnerships formed under later law, the decision is instructive as to how the fiduciary relationships between partners my evolve as time passes and circumstances change. (For another reason decision involving fiduciary duties among partners, see our blog post here.)

Continue Reading

Limited Liability Co Founders May Have Disclosure Duties

Posted by Jay McDaniel on December 27, 2011

Promoters of LLC Subject to Breach of Fiduciary Duty Claims

Limited liability companies are clearly the vehicle of choice for new, closely held businesses.  That means that more often than not the principals have some existing relationship before they take up their new business together.  Can that prior relationship create fiduciary duties even before the company has begun operations?

A decision out of the New York Court of Appeals indicates that there may be fiduciary duties in such a relationship, in particular duties of full disclosure and fair dealing.  Moreover it appears that these duties may exist before the limited liability company is formed or membership interests are acquired.  In Roni LLC v. Arfa, 2011 N.Y. Slip Op. 09163 (Dec. 20, 2011),  The court held that the existence, or not, of a fiduciary relationship depends up the relationship of the parties and whether it meets the traditional criteria necessary to create fiduciary obligations.

 Real Estate Investments by LLC

This case involved the conduct of promoters, the individuals who organize a new business and seek out other participants or investors.  The defendant promoters organized seven limited liability companies under New York law for the purpose of buying and renovating buildings in the Bronx and Harlem for resale.  The plaintiffs were a number of Israeli investors who acquired interests in the LLCs.

Continue Reading

Failure to Disclose Transfer of Partnership Not Wrongful

Posted by Jay McDaniel on October 19, 2011

Secret for partnership transfer.bmpPartnership Interest Secretly Transferred to Family Member

Does a partner have an obligation — separate and apart from the terms of a partnership agreement — to disclose the fact that one of the partners has transferred their interest to another member of the partnership?

The question seems to answer itself.  Of course it is.  After all, is there anything more material to the business of a partnership than the identities of the partners?  But in a case earlier this year involving a secret transfer from a mother to one of her sons, the New Jersey Appellate Division’s came to the contrary conclusion.  The narrow reading given by the court to the Uniform Partnership Act and its failure to find that there was a duty to disclose the transfer is troubling.

 

Fiduciary Duties under the Uniform Partnership Act

The question that is lurking in this decision, Taylor v. Taylor, Docket No. A-4363-09T1 (N.J. App. Div. July 8, 2011), is whether the adoption of the UPA fundamentally altered the relationship between the partners of a partnership, and whether precedent going back to the early 20th Century is still good law.  The Taylor decision suggests it is not.

I do need to confess my personal bias.  I think the current trend of allowing parties in a business relationship to contract away basic principles of honesty and loyalty, demonstrated by statutory and occasional court approval of agreements that eliminate fiduciary duties, is a bad idea.  In my opinion, it’s like the Japanese gangster who willingly cuts off his own fingertip to atone for a mistake.  The fact that the Yakuza participated in the wrong done to himself doesn’t make it right.  On the other hand, I appear to be in the minority and the drafters of the Uniform Partnership Act, adopted in New Jersey in 2000, and a growing number of courts seem to think otherwise.

Continue Reading

Fidudiary Duties in Unfair Competition Case

Posted by Jay McDaniel on March 14, 2011

You just learned that an employee secretly formed and operated a competing business while employed by you.  Is there a claim against the competing business or just the employee? Most likely there are viable claims against both.  The fiduciary duties of the employee are likely to be imputed to the company he or she formed.

Breach of Fiduciary Duties

Similar facts were before the court recently in an unfair competition and breach of fiduciary duty case, Vibra-Tech Engineers, Inc. v. Kavalek, Civil Action No.: 08-cv-2646, in the United District Court for the District of New Jersey. (opinion here) A vice president and director of Vibra-Tech, along with his wife, formed two businesses.  One of the businesses sold equipment to Vibra-Tech; the other competed directly for the same customers.  Vibra-Tech, of course, had no idea that one of their executives was involved in the two businesses.

The two companies formed by the employee moved for summary judgment, arguing that neither owed Vibra-Tech any fiduciary duties.  Normally that would be the case.  Fiduciary duties are created by the specific nature of a relationship.  The hallmark of a fiduciary duty is that one party places "trust and confidence" in the other, who has the ability to exercise discretion and expertise on their behalf.  Officers, directors and management employees generally owe their employers fiduciary duties.

Directors and Officers Duty

The fiduciary duty of a director, officer or management employee is to exercise their discretion on behalf of the best interests of the corporation, limited liability company or partnership.  This is true even when his or her personal interests may be at odds with the best interests of the business.  The fiduciary duty usually falls into one of two types: the duty of care or the duty of loyalty.

Competitors and others who contract at arms length owe no fiduciary duties.  It is presumed that they will act in their own self-interest.  That was the argument made by the New Jersey attorney representing the two businesses formed by the defendants in the Vibra-Tech case.  They argued that since they had no direct relationship with the plaintiff, they could have not fiduciary duties.

The court agreed that there were no fiduciary duties between the corporations, but held that the duties of the former employees and officer could be imputed to the businesses formed by the defendant.  New Jersey courts recognize that when an employee secretly forms a corporation to compete with his or her employee, the employee's breach of duty of loyalty can be imputed to the newly formed corporation.

Preparation to Compete

It is probably worth noting that employees who prepare to compete, but who do not actually compete, are usually not breaching any fiduciary duty.  Unless there is a restrictive covenant or non-competition agreement in place, employees can lawfully form new businesses and then resign to compete with their former employers.

There are a few caveats to the former employee's right to compete, however.  He or she may not use their employer's time to set up the business, may not take proprietary information -- including in most cases customer lists -- and may not solicit customers while still employed.

 

VIBRA-TECH ENGINEERS, INC., Plaintiff, v. SCOTT KAVALEK, et al., Defendants, Civil Action No. 08-2646-NLH, United States District Court, D. New Jersey, January 14, 2011.

EDWARD F. BORDEN, JR. DELIA ANNE DOUGHERTY EARP COHN CHERRY HILL, NJ Attorneys for Plaintiff Vibra-Tech Engineers, Inc.;JOHN JOSEPH MASTER, JR. LAW OFFICES OF JOHN J. MASTER, JR. HADDONFIELD, NJ, Attorney for Plaintiff Vibra-Tech Engineers, Inc.; STEPHEN J. LABROLI LEONARD, SCIOLLA, HUTCHISON, LEONARD & TINARI, LLP MOORESTOWN, NJ Attorney for Defendants Scott Kavalek, Roberta Kavalek, Intergrated Geotechnical Solutions, Inc. and Geotech Instruments, Inc.; ANDREW JOHN PODOLSKI Stark and Stark, PC Princeton, NJ Attorney for Defendant Charles Bauman; EDWARD G. ENGELHART SOMMER, ENGELHART & PESCATORE, ESQS. FAIRFIELD, NJ Attorney for Interested Parties Newmark Engineering, P.C. and Glenn Newmark.

 

<script type="text/javascript">
  var _gaq = _gaq || [];
  _gaq.push(['_setAccount', 'UA-13246692-4']);
  _gaq.push(['_setDomainName', '.newjerseybusinessdissolutionjournal.com']);
  _gaq.push(['_trackPageview']);
  (function() {
    var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true;
    ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js';
    var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s);
  })();
</script>