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 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)
Ultimately the defendant accounting firm was ordered to honor a provision in the shareholder’s agreement requiring the repurchase of Dick’s shares. The case is worthy of note because it raised a number of issues common to disputes among the owners of professional practices over the withdrawal of a principal or key executive. Here there was not covenant not to compete at issue and no solicitation of clients or employees before the resignation. The issues before the court involved the application of legal principals shared in most jurisdictions, including New Jersey and New York, where I practice.
Instead, much of the dispute centered around Dick’s conduct as he negotiated with a new CPA firm, conduct that the Goski firm alleged was in breach of his fiduciary duties, involved the disclosure of trade secrets and was an attempt to deprive his old firm of the benefit of an existing shareholders agreement. The case was tried to a jury verdict in the defendants favor and affirmed on appeal.
Principal of Accounting Firm Negotiates to Relocate Practice
The relationship between Dick and the Goski firm cam to an end over Dick’s belief that the firm needed to devote additional resources to the growth of its practice. Revenue at the firm had grown significantly in recent years and Dick contended that he had generated all of the firm’s new health care clients. Dick had initially discussed a merger of the two accounting firms with the new firm, but when those talks failed, the discussion switched to Dick’s relocation of his practice to the Bland firm.
During the course of this discussions, Dick sent Bland information about his book of business in the form of a spreadsheet. In it, he described the type of work that he performed, the nature of the fees and billings generated by his work, the state in which the accounting work was performed and summaries of revenue. He did not, however, provide the identify of clients. The evidence at trial was that the Bland firm asked for this information – a reasonable and common request – in order to formulate a compensation package.
After he joined the new firm, a significant percentage, but not all, of the clients serviced by Dick joined his new firm. Dick then sought the repurchase of shares that he had made over the years. He paid $257,000 for the shares and sought to compel their repurchase under a provision in the shareholder agreement requiring the mandatory purchase of departing shareholders at a price based on the value of the firm, reduced by the billings of clients who followed the departing shareholder. Goski rejected the demand and filed a number of unsuccessful counterclaims.
Breach of Fiduciary Duty Alleged in Accoutant’s Disclosure of His Book of Business
The most interesting of the defenses were the breach of fiduciary duty and disclosure of trade secrets claims that Goski alleged had arisen from the negotiations between Dick and his new firm and due diligence information given to Bland’s representatives. Goski claimed that various duties had been breached in that Goski allegedly
- disclosed confidential business techniques and commercial data;
- shopped his firm’s long-term clients to other accounting firms to find the one that would offer him the largest fees for taking those clients to them;
- negotiated with the Bland firm while still employed by Goski anagreement in which he would receive a commission on Goski clients brought to Bland;
- concealed his efforts to transition to a rival accounting firm;
- violated the corporation’s bylaws by sending confidential business techniques and commercial data to a competitor.
The court rejected the claim based on the bylaws, reasoning that although such documents would often and appropriately be read together, here the shareholders had executed an agreement among themselves that was fully integrated:
This Agreement contains the entire understanding among the parties and supersedes any prior understanding among the parties and agreements between them respecting the within subject matter. There are no representations, agreements, arrangements or understandings, oral or written, between or among the parties hereto relating to the subject matter of this Agreement which are not fully expressed herein.
The court reasoned that the provision of in the by-laws did not apply because the shareholder agreement made no mention of the bylaws. The similarly rejected claims that Dick had breached his fiduciary duties to the corporation by preparing his resignation and failing to inform the Goski firm of his plans. Nor, the court held, would Dick have had any continuing fiduciary obligations after his resignation.
[N] egotiating to leave one’s fiduciary position with a closely held corporation and to enter into competing employment elsewhere is not a transaction that shifts the burden to the fiduciary to prove the negotiation’s fairness. It is not, standing alone, a violation of fiduciary duty. This is true regardless of whether the fiduciary in question was a shareholder and officer.
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It is well settled that “[a]n employer’s right to demand and receive loyalty must be tempered by society’s legitimate interest in encouraging competition.” An at-will employee with a fiduciary relationship with his or her employer may properly plan to go into competition with the employer and may take active steps to do so while still employed, and such an employee has no general duty to disclose such plans to the employer.
Claims of Breach of Covenant of Good Faith and Fair Dealing are Rejected
The court also went on to reject extra-contractual claims, including the breach of covenant of good faith and fair dealing, a theory common to business divorce litigation.
The law does not allow the implied covenant of good faith and fair dealing to be an everflowing cornucopia of wished-for legal duties; indeed, the covenant cannot give rise to new obligations not otherwise contained in a contract’s express terms.” Instead, a violation of the covenant of good faith and fair dealing occurs only when a party violates, nullifies, or significantly impairs any benefit of the contract. Similarly to the alleged breach of fiduciary duty, KPG failed to identify any express terms of the Shareholder Agreement tied to the alleged breach of an implied covenant of good faith and fair dealing. An instruction on the affirmative defense of breach of the implied covenant of good faith and fair dealing was not warranted by the evidence.
Ultimately, the appellate court affirmed the verdict in favor of Goski for $470,312, which the jury determined to be the purchase price under the mandatory repurchase provision of the shareholder agreement.