In previous issues, we have discussed the fiduciary duties of officers, shareholders, and directors, and the liabilities that may arise when they attempt to break away and establish businesses that compete with their current employers. A recent Illinois Appellate Court opinion provides guidance in this highly fact-sensitive area of the law.
In 1993, Don Linse and Lori Cooper founded Hallman Capital Management, Inc., an investment advisory firm (“HCM”). In 1994, HCM hired Thomas Hallman, who purchased 20% of the voting shares of HCM, and who was named chief financial officer and vice president. In 1996, HCM hired James McQuinn. Hallman was a director and officer and McQuinn was an officer of HCM.
In April 2000, Hallman and McQuinn began steps to establish a competing firm. In June and July 2000, Hallman and McQuinn executed a lease for office space, bought office equipment, and filed articles of incorporation for a new company. Hallman copied HCM prospect lists, customer account spreadsheets and customer mailing labels, among other documents. Hallman and McQuinn resigned on September 1, 2000, taking the copied documents with them. Shortly thereafter, they completed necessary regulatory filings and then announced their departure to HCM clients.
In September 2000, HCM filed suit against Hallman and McQuinn, alleging corporate misconduct. The trial court ruled in favor of HCM on several counts, but against it on counts alleging Hallman and McQuinn had breached fiduciary duties arising from their respective status as an officer, director, and shareholder of HCM. HCM appealed.
The Appellate Court ruled that Hallman and McQuinn owed a “heightened” fiduciary duty because they were each officers of HCM. (All employees of Illinois companies owe a duty of loyalty to their employers.) Notwithstanding this “heightened duty,” the trial court correctly found that their actions did not constitute a breach of that duty.
Generally, employees may compete with a former employer and solicit former customers as long as they do not do so before the termination of their employment. They may plan, form, and outfit a competing business so long as they do not compete while still employed. Officers and directors have a heightened (or a greater) fiduciary duty of loyalty, and may not exploit their corporate positions for their own personal benefit or hinder a corporation’s business operations.
A breach of this heightened duty occurs if, during the course of their employment, officers or directors: fail to disclose that employees are forming a rival company or engaging in other fiduciary breaches; solicit the business of a customer before leaving employment; use company facilities or equipment in developing their new business; or solicit fellow employees to join a rival business. A breach also occurs when confidential information is used for the new business, or a mass exodus of employees is coordinated shortly after their resignations.
Hallman and McQuinn began planning and, in fact, incorporated a competing business while still employed. However, they did not solicit clients for their new business or begin competing with HCM until after they had resigned. Although they did not inform HCM of their intentions, and may have typed their new business plan and experimented with advertisement fonts on HCM’s computers, their conduct did not rise to the level of a breach of their fiduciary duties, because they neither exploited their positions for their personal benefit and to HCM’s detriment, nor impeded HCM’s ability to do business. They did not actively invest in a rival company, taking advantage of benefits to which they, as fiduciaries, were entitled, to insure the success of that rival company; nor did they mislead HCM about their actions, impeding its ability to do business.
Hallman and McQuinn did not use or steal HCM’s property to operate their rival business, nor did they actually begin business while still employed. According to the Appellate Court, while the record reflected Hallman and McQuinn did engage in certain prohibited conduct, they simply did not participate in the “monkey business” referenced in other Illinois cases in which liability was imposed on officers and directors. It concluded that to construe their actions as a breach of their heightened fiduciary duties would virtually prevent all officers and directors of Illinois companies from seeking new employment prior to resigning from an existing position.
Any officer or director seeking to engage in a competitive business with a former employer should carefully analyze the many Illinois cases which address fiduciary duties in order to avoid conduct that may come back to haunt them. We are available to assist such an analysis.