The Business Divorce Law Report

February 25, 2021

Share Purchase for $500,000 Required in Accounting Firm Breakup

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.
A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.
A shareholder in an accounting firm organized as a professional corporation did not breach any fiduciary duties by negotiating with a competitor and disclosing general information about his and the firm’s practice, even if he was to be compensated based on the clients who followed him to his new employer.

For 22 years Robert Dick worked in a growing accounting firm before he left for a competitor, taking with him a number of clients. Before giving his resignation, however, Dick put together an estimate of his billings and a description of his client base, although apparently not providing any details on client identify. This discussion – common in a professional move – was one of the principal defenses to a lawsuit that Dick brought to compel his former employer to repurchase his Acountant share repurchase shares.

Resignation of Account from Professional Corporation

Dick was a 30 percent shareholder in Koski Professional Group, P.C. who had built a following among health care clients, having purchased shares in the professional corporation on multiple occasions since 2005. In 2015 he moved his practice to a competitor, Bland and Associates under an arrangement in which he received base compensation plus a percentage commission on his client’s billings. At the time of his departure, Dick was one of four owners. He was followed by a number of clients, leading to the litigation and ultimately an appeal to the Nebraska Supreme Court. (Opinion here) Continue reading

February 17, 2021

United Health Care Rebuffed on Injunction Request

by Jay R. McDaniel

Although a former executive was bound by a restrictive covenant, the fact that his duties after joining a competitor were directed to a different market made the scope of the restrictions unreasonable.
A restrictive covenant that is not narrowly tailored to protecting specific interests of the former employer at stake in a lawsuit is less likely to be enforced with a preliminary injunction.
A company that relies on the inevitable disclosure doctrine faces a high hurdle to show the certain use of a trade secret in a competitive manner.

An attempt by United Health Care to block an executive from joining a competitor failed when a federal judge found the medical insurance and services company had failed to establish it was likely to succeed when the case goes to trial. The dispute identifies some of the steps that a new employer take to prevent its just-hired employee from running afoul of a restrictive covenant.

The defendant Carlos Louro in this this case, United Health Care v. Louro, was an executive supervising the underwriting of national accounts at United. He had recently been promoted to vice president and served on a high-level, national accounts strategy group. He had also received stock options and restricted stock awards, which contained restrictive covenants and non-disclosure provisions..

The trial court construed Louros agreements with United that and restricted him from:“[e]ngag[ing] in or participat[ing] in any activity that competes, directly or indirectly, with any Company activity, product, or service that [Louro] engaged in, participated in, or had Confidential Information about during [Louro’s] last 36 months of employment with the Company” or assist anyone in any of those activities for one year after Louro’s termination of employment.” Continue reading

February 12, 2021

District Court Enjoins Former Executive from Competition

by Jay R. McDaniel

An executive with national responsibilities may be subjected to a broad geographic restriction in an employment restrictive covenant.
Courts can and will enjoin a former executive from working for a competitor to prevent irreparable harm to the executive’s former employer when the restriction is reasonable.
Misappropriation and use of a company’s trade secrets by a former employee may also prevent an employee who has copied information from working for a competitor

A federal district court judge in New Jersey imposed a preliminary injunction that will prohibit a former executive from working for a competitor for at least a year. The decision was based on both the existence of a restrictive covenant and the departing executive’s having copied data from his prior employer at the time of his departure. sunbelt

Resignation by Executive to Work for Competitor

The case, Sunbelt Rentals, Inc. v. Love (opinion here) is particularly notable as a lesson in how not to resign a high-level position. Because even if the trial judge had not enforced the restrictive covenant in the executive’s employment contract, the fact that he copied proprietary information by emailing customer lists and other data to his brother before his resignation doomed any defense to the preliminary injunction. Continue reading

February 11, 2021

Restrictive Covenants May Be Enforceable Against Physician

by Jay R. McDaniel

Physicians are subject to reasonable restrictions on post-employment activities that will limit their competition with a previous employer.
A restrictive covenant that prohibits competition must protect a legitimate interest, impose not undue hardship on the former employee and not injury the public interest.
Restrictive covenants must be narrowly tailored so as to only restrict activities in which the employer has a legitimate interest. Courts consider the geographic scope, duration and activities limited.
Enforcement of a restrictive covenant may also turn on such circumstances as how the covenant was agreed to and the circumstances of the separation of the physician.

Restrictive covenants limiting the activities of a physician may be disfavored, but they are not per se unenforceable. As with other restrictive covenants, the issue is whether the agreement not to compete is reasonable in scope and protects a legitimate interest of the beneficiary of the agreement not to compete. Cases-of-Note-Professionals-1024x536

The issue was last before the New Jersey Supreme Court in The Community Hospital Group v. More (full opinion here), a 2005 opinion in which the court was asked to overrule its existing precedent that permitted enforcement of restrictive covenants against physicians. The Supreme Court decided the issue just months after the appellate division had held that a restrictive covenant was unenforceable against a psychiatrist. (See Psychologists, Like Lawyers, Not Subject to Restrictive Covenants) Continue reading

February 5, 2021

Estate Plan Sows Father and Son Business Divorce

by Jay R. McDaniel

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.
A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.
In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

Some cases make you wince when you think about the underlying relationship. This case in which a son sued his father over the repayment of a mortgage is one of them. It comes from the Iowa Court of Appeals and is interesting from my perspective because the underlying statute is the same as applies here in New Jersey and because it demonstrates the scope of equity to reframe disputed issues into a more manageable solution. field-213364_1920-e1612533257149-1024x379

The dispute in Erwin v. Erwin (opinion here) addressed the dispute between Michael Irwin and his son, Richard, that grew out of the father’s attempt to pass the family farm without incurring tax liability. The father and Richard’s mother, who owned the farm individually, formed a limited liability company, Erwin Farms II, LLC, in 2012 and passed the land to the company. At the time of the transfer, the land was subject to a mortgage. Richard received a block of non-voting membership units. The remaining membership units, including all of the voting units, were owned by the parents.

The operating agreement of the company named Michael Erwin as manager. In addition to the existing mortgage, after the land was transferred to the LLC, the Erwin parents took two loans for improvements. By the time of the trial, those loans had all been paid. Continue reading

February 2, 2021

One Business Divorce, Multiple Actions

by Jay R. McDaniel

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.
A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.
Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Multiple lawsuits from a business divorce may not be entirely commonplace, but it does happen when the controlling governance documents contain an arbitration clause, but there are outsiders not bound by the agreement to arbitrate that are involved in the dispute. These may be former employees, agents, competitors or vendors. gavel-2492011_1920-1024x569

Simultaneous Arbitration and Litigation in Court

The result is that some of the parties may be obligated to arbitrate, or that some of the dispute may not be subject to the agreement to arbitrate. Consider the case in which there are disputed events that occurred while the parties still had fiduciary obligations to each other – such as between partners or employer and employee – and those that occur outside the fiduciary obligation. These might include unfair competition or claims arising from a competitor hiring someone under a restrictive covenant. Continue reading

February 1, 2021

A Non-Competition Agreement from the Great Beyond

by Jay R. McDaniel

A case in which a restrictive covenant was enforced against an accountant who happened to be beneficiary under her deceased former employer’s will is among recent business divorce cases worthy of note.

Restrictive Covenant Given in Purchase Agreement Survives Death

A covenant not to compete given in connection with the sale of an accounting practice is enforceable against a beneficiary of will who happened to be a competitor of the practice that bought the Cases-of-Note-Non-Competition-1-1024x536 deceased account. Here is what happened in McCarthy & Co, P.C. v. Steinberg, a case before a federal court in Pennsylvania. Harris Fox sold his accounting practice to the plaintiff with a multi-year restrictive covenant. The terms of the sale provided for payment of 25 percent of the revenue earned from Fox’s clients during the five-year period. The restrictive covenant remained in place for three years after the last payment under the sale agreement. The defendant, Judith Steinberg, had worked for Fox for 24 years and at the time of the sale, Fox had asked that plaintiff hire her. Steinberg stayed for four years, then resigned started practicing with a direct competitor. Continue reading

January 18, 2021

Surrender of Membership Certificates Was Dissociation from LLC

by Jay R. McDaniel

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.
A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.
A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

A sales representative who held a non-equity percentage interest in a New Jersey limited liability company effectively withdrew as a member of the company by leaving his “share certificates’ with the company’s lawyer, a trial and appellate court have agreed. building-lot-3391379_1920-e1610995346583-1024x402

This withdrawal, known under New Jersey’s version of the Revised Uniform Limited Liability Company Act (RULLCA) as a voluntary dissociation occurred even though the circumstances surrounding that act – leaving a certificate with a lawyer – was disputed. Dissociation in limited liability and partnership law is an act by which an individual owner’s association with the business is severed, voluntarily or involuntarily. It may apply in either a resignation or an expulsion.

The Appellate Division case at issue, Decandia v. Anthony T. Rinaldi, LLC (see opinion here) involved a dispute between a sales representative who received a commission styled as a membership interest in a construction company, but which was actually a non-equity profit interest in his own originations. The sole equity owner of the firm, Rinaldi, retained all of the management rights in the business. Continue reading

December 29, 2020

Psychologists, Like Lawyers, Not Subject to Restrictive Covenants

by Jay R. McDaniel

Restrictive covenants preventing competition by former employers are enforceable only to the extent that they are reasonable under New Jersey law.
Lawyers and psychologists are exceptions to the general rule, however, because both are subject to disciplinary rules that prohibit restrictions against competition.
Courts have recognized that the personal relationship and confidentiality that exist between a lawyer or psychologist and their clients are such that a restriction on competition is appropriate.
Physicians continue to be subject to restrictions on competition that protect a legitimate interest and that do not impose unreasonable restrictions on the party subject to the agreement.

In the world of business divorce, one of the key issues is the existence or absence of restrictive covenants that prohibit competition from former shareholders, partners, members or employees. It affects the value of a business – particularly professional and sales-driven businesses – because restrictive covenants generally protect the good will of the enterprise.

There are only two classes of professionals for whom restrictions on competition are always unenforceable. These are lawyers and psychologists, not because of psychologist-5154576_1920-1024x683 any specific distinction between them and other deeply personal relationships, but because the professions are subject to unique restrictions. Attorneys are prohibited from restricting competition by the Rules of Professional Conduct that govern lawyers. Psychologists are subject to an administrative regulation that have the same effect.

Restrictions on Competition Barred by Regulation

In a 2005 decision, the New Jersey Appellate Division distinguished between physicians, who are subject to “reasonable” restrictions on competition, from those imposed on psychologists.

There are also two classes of restrictive covenants to consider. The are those restrictive covenants in which there has been some purchase of good will, which courts will distinguish from a traditional employment business. Enforcing a restrictive covenant against a party that has sold a business, for example, is going to be quite different from enforcing a restrictive covenant against

When there is no contractual limation to restrict the key players from competing, or when restrictive covenants are unenforceable, the value of the good will in the business is typically diminished. Consider the rainmaker who leaves a law firm with his or her large book of business. All of the good will tied up in those relationships is portable, and any valuation of the firm has to consider the loss of those clients and so much of the reputation of the firm that was tied to the departing attorney. Continue reading

November 4, 2020

Controlling Shareholders owe Fiduciary Duties to Minority Members

by Jay R. McDaniel

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.
Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.
The fiduciary duties owed by controlling shareholders is a basis to grant injunctive relief, even it is appears that money damages might make the minority shareholders whole for any misconduct.

Corporations Attorney

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)

Statute: NJSA 14:14-1(1)(a)

Synopsis: In class action seeking injunctive relief blocking merger of defendant Power/Mate with corporation controlled by the majority shareholders, on application for a preliminary injunction, the court enjoined a going-private merger by the defendant controlling shareholders to compel the sale by the minority shareholders to a corporation they controlled. Held that despite compliance with statutory requirements, the merger would be preliminarily enjoined. See opinion Berkowitz v. Power/Mate Corporation. Continue reading

Accounting firm is compelled to repurchase the equity of departing shareholder who moved practice to competitor firm.

A shareholder agreement that is integrated and intended to be the parties’ complete agreement may preclude a claim for breach of corporate by-laws.

Resignation of Account from Professional Corporation

Although a former executive was bound by a restrictive covenant, the fact that his duties after joining a competitor were directed to a different market made the scope of the restrictions unreasonable.

A restrictive covenant that is not narrowly tailored to protecting specific interests of the former employer at stake in a lawsuit is less likely to be enforced with a preliminary injunction.

A company that relies on the inevitable disclosure doctrine faces a high hurdle to show the certain use of a trade secret in a competitive manner.

An executive with national responsibilities may be subjected to a broad geographic restriction in an employment restrictive covenant.

Courts can and will enjoin a former executive from working for a competitor to prevent irreparable harm to the executive’s former employer when the restriction is reasonable.

Misappropriation and use of a company’s trade secrets by a former employee may also prevent an employee who has copied information from working for a competitor

Resignation by Executive to Work for Competitor

Physicians are subject to reasonable restrictions on post-employment activities that will limit their competition with a previous employer.

A restrictive covenant that prohibits competition must protect a legitimate interest, impose not undue hardship on the former employee and not injury the public interest.

Restrictive covenants must be narrowly tailored so as to only restrict activities in which the employer has a legitimate interest. Courts consider the geographic scope, duration and activities limited.

Enforcement of a restrictive covenant may also turn on such circumstances as how the covenant was agreed to and the circumstances of the separation of the physician.

Managers of a limited liability company owe to the company fiduciary duties of loyalty and care, must act in good faith, and refrain from reckless or unlawful conduct.

A member who seeks information about a manager-managed limited liability company must state the purpose for the request under the Uniform Limited Liability Act.

In a dispute involving a family farm, the trial court exercises equity to look through the details of disputed loan payments and find that they were to benefit of the limited liability company and its members.

An agreement to arbitrate that is contained in the governance documents of a business, e.g, an operating agreement or shareholder agreement, may result in multiple proceedings when the dispute ripens into litigation.

A party may seek to stay a pending federal court action based on a collateral arbitration proceeding that is part of a state court action under the abstention doctrine, but it is sparingly applied.

Parties to a business dispute may be required to simultaneously litigate in different forums when not all of the parties are subject to an agreement to arbitrate the dispute.

Simultaneous Arbitration and Litigation in Court

Restrictive Covenant Given in Purchase Agreement Survives Death

A limited liability company member withdraws by voluntary dissociation, which occurs when the company has notice of his ‘express will” to withdraw. Voluntary dissociation terminates management rights, but not economic rights.

A court may refuse relief on a claim when the plaintiff has acted with unclean hands with regard to the subject matter of the action. The doctrine applies to an evil practice or wrong conduct in the particular matter for which the court has been asked to provide a remedy.

A member in a manager-managed limited liability company owes no statutory duty of loyalty to the company, but will owe a statutory duty of loyalty under the common law if he or she is also an employee.

Restrictive covenants preventing competition by former employers are enforceable only to the extent that they are reasonable under New Jersey law.

Lawyers and psychologists are exceptions to the general rule, however, because both are subject to disciplinary rules that prohibit restrictions against competition.

Courts have recognized that the personal relationship and confidentiality that exist between a lawyer or psychologist and their clients are such that a restriction on competition is appropriate.

Physicians continue to be subject to restrictions on competition that protect a legitimate interest and that do not impose unreasonable restrictions on the party subject to the agreement.

Restrictions on Competition Barred by Regulation

The controlling shareholders of a corporation owe fiduciary duties to the minority shareholders by virtue of their ability to control the affairs of the company.

Even when a merger complies with statutory requirements, where it benefits the controlling shareholders and does not have an apparent business purpose, it must also satisfy equitable principles of fairness.

Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36 (Chancery Division 1975)