When a Side Venture Becomes a Corporate Opportunity

By Cliff Ennico

March 31, 2020 6 min read

"I have a very successful service business with two partners who have become very close friends. The business is organized as a limited liability company (LLC).

"Our business is doing quite well, but we see an opportunity to start a wholly unrelated business (in the online retail space) that might serve as a marketing and distribution channel for our service business. Basically, we would be offering a wholly unrelated line of products online in the hopes of 'cross selling' our LLC's services down the road.

"Here's the hitch: one of my partners is very excited about the idea, but the other isn't. She feels that this is a dramatic change from our original business plan, and fears that this new venture will be a 'time vampire' that will take our time and energy away from the core business.

"We are equal partners in the business, so with two votes out of three my partner and I could force the issue if we wanted to. Our LLC Operating Agreement does not restrict members from pursuing outside ventures as long as they don't 'directly compete' with the LLC, which this won't.

"We really respect our third partner, however, and don't want to do anything to 'rock the boat' and jeopardize our core business.

"So ... my partner and I are thinking about launching the retail business as a 'side venture.' We would set up a separate company with just the two of us, using our own money and none of the resources of our existing LLC. Is there any way the third partner could sue us if we did that?"

Congratulations. You and your partner are about to enter the Twilight Zone we lawyers call usurping a corporate opportunity.

In virtually all states, the majority owners of an LLC have a fiduciary duty to the LLC and the other owners. This means they should place the LLC's interests ahead of their own. If minority owners believe in good faith that the majority has breached that fiduciary duty, they can sue.

Having said that, the majority owners of an LLC have every right to run the business as they see fit without undue interference from minority owners. Owning one-third of an LLC does not give you the right to run the show — as long as your rights are respected (you are kept informed, given the opportunity to participate in discussions, etc.), you have to go along for the ride and trust that the majority knows what they're doing.

In this situation, you and your partner are not doing any of the icky things that might get you sued for breach of fiduciary duty, such as diverting LLC funds to the new project or using LLC equipment and other resources in the venture without fair compensation. You intend to fund the side venture yourselves without any connection to the LLC.

In many states, however, there is something called the corporate opportunity doctrine. Simply stated, it means the majority shareholders of a corporation cannot divert for their own benefit and without board approval any opportunity that should be deemed an asset of the corporation. While the doctrine applies to corporations, many states have expanded it to cover LLCs as well. You will need to talk to a local lawyer to find out where your state stands.

Courts look at a number of factors in corporate opportunity cases including the following:

— Whether the opportunity was presented to the fiduciary in his individual or corporate capacity.

— Whether the company understood that the fiduciary would pursue other interests.

— Whether a third party in the opportunity refused to do business with the company.

— Whether the opportunity was developed with company assets.

— Whether the company is financially able to take the opportunity.

— Whether additional investment is required for the company to capitalize on the opportunity.

— The extent to which the opportunity is consistent with the company's past and current business model.

— Whether the opportunity directly or indirectly competes with the company.

— Whether the opportunity was unique or of special value to the company.

Without knowing more about the specific opportunity you wish to pursue, it is difficult to determine how a court in your state would weigh these factors.

But note that requirement of board approval. Courts in most states have held that majority owners of an LLC can engage in a side venture without liability under the corporate opportunity doctrine if the members consent and acquiesce to the venture. Since your third member is already aware of the side venture, the best approach is to schedule a meeting with all three of you, discuss the side venture openly and then pass a resolution by which the LLC acknowledges and acquiesces to the side venture. As long as the third member is given an opportunity to attend the meeting and present her objections in a fair and open discussion, there isn't much she can do about it.

Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.

Photo credit: StartupStockPhotos at Pixabay

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