Restrictive Covenants in Shareholder Disputes

Covenants not to compete and non-solicitation agreements are frequent fixtures of employment agreements. They are also frequently found in operating, shareholder or partnership agreements. Though courts and legislatures across the country have become increasingly hostile to the notion of enforcing non-compete agreements against employees, courts have not displayed a similar reluctance to enforce restrictive covenants in shareholder disputes.

When shareholders have a dispute or desire to sell their interest in a company, restrictive covenants seek to protect the existing company and shareholders by placing limitations on what departing shareholders can and cannot do in terms of competing with the business. Non-compete agreements place limits on where and when and how a departing shareholder may compete against the company. Non-solicitation agreements place limits on who the departing shareholder may solicit for business or employment. Typically, non-solicitation agreements prohibit a departing shareholder from contacting the company’s customers or employees to convince them to leave for the departing shareholder’s new business. In disputes involving a departing shareholder, courts will often side with the existing business against a shareholder who has left the company and now seeks to compete against it.

As in every case involving restrictive covenants, whether a non-compete or non-solicitation agreement is enforceable depends largely on the language of the covenants in the applicable agreement. When deciding whether to enforce a non-compete or non-solicitation provision in a shareholder agreement, court will consider the reasonableness of the restraints.

Specifically, courts look to the nature of the geographic and temporal limitations in the restrictive covenant. This means a court will consider whether the geographic area in which the departing shareholder is prohibited from competing is reasonable. Similarly, the court will consider whether the duration of the restrictive covenant is reasonable. In addition to these considerations, courts will also consider whether the company has a protectable interest at stake. A protectable interest can be a trade secret or customer relationships that the business has cultivated and maintained at great expense over a period of time.

Individual circumstances will influence the strategy for enforcing restrictive covenants between shareholders. As a general rule, the party seeking to enforce a restrictive covenant against a departing partner, member or shareholder, cannot be in breach of the underlying agreement itself. A general rule of contract enforcement provides that a party cannot enforce a contract that it is breaching itself. In the context of shareholder disputes, the argument can be made that once the shareholder, LLC or partnership breaches the underlying agreement, the departing shareholder is no longer bound by the restrictive covenants contained within that agreement. Several factors play into this determination and consultation with an experienced non-compete and non-solicitation law attorney is always advisable.

Even if an operating, shareholder or partnership agreement does not contain such restrictive covenants, a departing shareholder should not just assume he is free to compete with his former company with impunity. A departing shareholder, member, or partner without such restraints in a written contract must be mindful of other common law or statutory duties that may be owed to the company or other shareholders. These include such duties as the fiduciary duties of loyalty and honesty which prohibit a shareholder from keeping secrets from the company or other shareholders, such as a competing business, or diverting opportunities from the company. Shareholders considering departing from a company must consider all these factors carefully when planning a departure from an existing company.

Super Lawyers named fiduciary duty and shareholder dispute attorneys Peter Lubin and Patrick Austermuehle a Super Lawyer and Rising Star respectively in the Categories of Business Litigation, Class Action, and Consumer Rights Litigation. Lubin Austermuehle’s Chicago and DuPage County minority shareholder oppression lawyers have more than three decades of experience litigating freeze-out, squeeze-out, and fiduciary duty breach disputes. We also handle emergency business litigation seeking to enforce or invalidate restrictive covenants involving injunctions and TROS and many different kinds of business disputes involving shareholders, partnerships, closely held businesses and employee breaches of fiduciary duty.

 

Lubin Austermuehle’s experienced non-compete and non-solicitation attorneys have more than thirty-five years of experience helping our business clients unravel the complexities of Illinois and out-of-state business laws. Our Chicago business divorce litigation lawyers represent individuals, family businesses and enterprises of all sizes in a variety of legal disputes. In every case, our goal is to resolve disputes as quickly and successfully as possible, helping business clients protect their investments and get back to business as usual. If you’re facing a business or class-action lawsuit, or the possibility of one, and you’d like to discuss how the experienced Illinois breach of fiduciary duty attorneys at Lubin Austermuehle can help, we would like to hear from you. To set up a consultation with one of our Chicago class action attorneys and Chicago business trial lawyers, please call us toll-free at 833-306-4933 or contact us online.

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