One issue that frequently confronts shareholders of closely held corporations who have resigned as employees or whose employment has been terminated is whether they may now compete with their former employers. This is a situation that is frequently faced by minority shareholders who have been the victims of a corporate squeeze out and it can be especially significant when the business of the former employer is the only business the shareholder knows.
A shareholder’s ability to compete may be governed by non-competition or confidentiality provisions contained in an employment or shareholder agreement. However, even absent an employment, shareholder, or other type of agreement, a shareholder who has resigned as an employee, officer or director or has been squeezed out of management and who seeks to compete may find themselves having to defend against a claim that they have breached a fiduciary duty arising out of their status as a shareholder.
Certain Illinois courts as well as Federal courts applying Illinois law have held that it is a breach of fiduciary duty for a shareholder to compete with the corporation in which they own shares even if they are no longer participating in management of the corporation. Other Illinois courts have reached the opposite conclusion and determined that a shareholder who no longer has any ability to hinder, influence, or control the corporation no longer owes a fiduciary duty to the corporation and may compete.
Conflicting decisions have created quite a bit of confusion. However, in 2005, the Illinois legislature attempted to rectify this problem by enacting Section 7.90 of the Illinois Business Corporation Act. This Section provides that, unless otherwise provided by the corporation’s articles of incorporation, a shareholder may execute an irrevocable waiver of their right to vote their shares, to be a director of the corporation, and to directly or indirectly control corporate actions or the election or removal of any director or officer of the corporation. If a shareholder executes such a waiver, he or she will have no fiduciary duty to the corporation or any of the other shareholders arising out of his or her status as a shareholder. Section 7.90 does contain a statement providing that the statute shall not affect any other rights or obligations of the shareholder. It also contains a statement providing that the statute does not affect any claim of breach of fiduciary duty that arises prior to the effective date of the waiver.
However, Section 7.90 does provide a shareholder who executes the waiver described above with protection against claims that they have breached their fiduciary duty as a shareholder by competing with the corporation after the effective date of the waiver.
The shareholder cannot be a director or officer at the time that the waiver is executed. Therefore, if the shareholder is an officer or director, he or she must resign prior to executing the waiver.
It is important to remember that, even after executing a waiver, a shareholder’s ability to compete may be limited by agreements that the shareholder executed and that the shareholder’s ability to engage in certain competitive activities such as soliciting customers or using confidential information may also be limited by the Illinois Trade Secrets Act.
It is also important to remember that the waiver is irrevocable. Therefore, a shareholder who executes the waiver will not be able to later change their mind and seek to vote their shares, serve as a director or officer, or otherwise participate in the management of the corporation.
Horowitz Law Offices represents shareholders and partners in connection with a variety of disputes. You are welcome to contact us at (312) 787-5533 or firstname.lastname@example.org