My Partner Started a Competing Business. Is That Legal?

Start with the entity and the date

The answer changes depending on whether your partner is still an owner and what kind of company you share. The chart is short:

General partnerships: competing is a statutory breach

Section 152.205 of the Business Organizations Code lists what a partner's duty of loyalty includes. The third item is refraining from competing or dealing with the partnership in a manner adverse to the partnership. The first item requires the partner to account to and hold for the partnership any property, profit or benefit derived in the conduct of the partnership business or from use of partnership property. Put together, a partner who starts a competing company while still a partner breaches the duty, and the profits he earns by diverting partnership business belong to the partnership.

Two qualifications. Section 152.002(b)(2) lets the partners agree that specific types or categories of activities do not violate the duty of loyalty, as long as the categories are not manifestly unreasonable, so a partnership agreement can authorize outside businesses, including some competition. And section 152.204(c) says a partner does not breach a duty merely because his conduct furthers his own interest; the breach is competing or dealing adversely, not profiting. Under section 152.210, a partner who violates these duties and causes harm is liable to the partnership and the other partners, and section 152.211 lets the partnership or a partner sue, including for an accounting of the profits.

LLCs: the company agreement decides

The LLC chapter contains no duty list. Section 101.401 lets the company agreement expand, restrict or eliminate duties, including fiduciary duties. Many agreements include a clause stating that members may engage in other business ventures, sometimes expressly including competing ones, and that neither the company nor the other members have any right to those ventures. If your agreement says that, a member's competing business is not a breach, however much it hurts.

If the agreement forbids competition or requires members to present opportunities to the company first, the competing business is a breach of contract and the remedies are contractual plus any injunctive relief the agreement provides. If the agreement is silent, courts look to the member's role. A manager or managing member who controls the company's customers, pricing and contracts and quietly builds a parallel business with them is treated much as a disloyal agent would be; a passive investor-member with no management role has a far weaker duty, if any. The full picture is in what fiduciary duties partners and LLC managers owe in Texas.

Example

Suppose two members own a Dallas commercial roofing LLC equally and both manage it. One forms a new roofing company in his own name, has estimates for the LLC's pending bids re-issued on the new company's letterhead at a slightly lower price, and hires the LLC's two best crews. The company agreement says nothing about competition or outside activities. As a managing member who controlled the bids, he diverted the company's pending business to himself. The remedies would include the profits on the diverted jobs (the LLC's claim, which the other member can bring and, under section 101.463, have treated as his own), damages for the crews' departure if he induced breaches of their obligations, and an injunction against further use of the LLC's bid information. Had the agreement expressly permitted competing ventures, the diverted bids would still be actionable because they were the company's existing opportunities, but the new company itself would not.

Corporations: officers and directors

An officer or director who starts a competing company while in office faces the corporate-opportunity doctrine. In Ritchie v. Rupe (Tex. 2014) the Supreme Court of Texas restated that officers and directors owe the corporation a fiduciary duty prohibiting them from usurping corporate opportunities for personal gain and requiring them to exercise uncorrupted business judgment for the corporation's sole benefit. A shareholder who is neither an officer nor a director and holds no contractual restriction is in a different position; the corporation's claim against him, if any, depends on a shareholders' agreement or on an informal fiduciary relationship.

After the partner leaves

Duties of loyalty end when the relationship that creates them ends. A withdrawn general partner, a member whose interest has been bought out or a resigned officer may compete the next day unless something he signed says otherwise. Three things can:

• A non-compete. Enforceable in Texas under Business and Commerce Code section 15.50 if it is ancillary to an otherwise enforceable agreement and its limits on time, geographic area and scope of activity are reasonable and no greater than necessary to protect the goodwill or other business interest at stake. Covenants in a buyout or partnership agreement, given by a seller of an interest, are generally reviewed more favorably than covenants imposed on employees. An overbroad covenant is reformed by the court rather than struck, but damages are unavailable for the period before reformation (section 15.51(c)). See whether a non-compete is enforceable in Texas.
• Non-solicitation and confidentiality clauses. Treated as restraints of trade when they restrict competition, so they are tested under the same statute, but narrower clauses are easier to enforce.
• Trade secret law. Taking customer lists, pricing models or bid data that qualify as trade secrets is misappropriation regardless of any contract, and supports an injunction and damages. See whether a departing person can take the customer list.

What you can ask a court for

• An accounting and disgorgement. Section 152.205(1) requires a partner to account for and hold the profits derived from partnership business; courts order a disloyal fiduciary to give up what he gained, not only to pay what you lost.
• Damages. Lost profits on diverted business, the cost of replacing employees he induced away, and the diminished value of your interest.
• An injunction. To stop continued use of the company's bid information, customer data or confidential pricing, and to enforce a valid non-compete. Texas Rules of Civil Procedure 680 to 684 govern temporary restraining orders and temporary injunctions, which require proof that damages later would not adequately repair the harm.
• Contract remedies. If the company or partnership agreement restricts competition or outside activities, breach of contract and its fee-shifting provisions apply.

Evidence to preserve now

The case is won on dates and documents. Preserve the company's bid files, customer communications and pricing for the period in question; the partner's company-issued devices and email, under the company's own policies; formation records for the new entity, which are public; marketing and job postings by the new company; and the departure dates and new employers of staff who left. Do not access the partner's personal accounts or devices. If the new company is already operating, a litigation hold letter to him and to it is appropriate before the first conversation about settlement.

What it costs the business

A competing partner is a live wound: every week he operates, customers choose sides and employees decide whether to follow. The decision is less whether to act than how fast and in what order. A records demand and a demand letter can be sent within days; a TRO application can follow if the response is more diverted work. A litigator's job is to match each act to the right theory, partnership duty, agreement, non-compete or trade secret, and to seek relief that a court can actually grant on the evidence you hold. Tina Wysk represents owners on both sides of these disputes in Dallas state and federal courts and in arbitration. See breach of fiduciary duty for the scope of that work.