How can I stop an employee from leaving our company and starting a competitive business?

Full question:

We have a member/manger of our Arizona LLC leaving suddenly in order to provide the exact same services using one of our new contractors to do the work, because he can cut out the shared profits. We are an independent energy consultancy and marketing company for sustainable energy installers, perhaps a unique business model for our market that was hard to establish and educate the public originally. He will be in direct competition with us, and his using our business model will definately be taking from our potential client pool by using the same web marketing techniques, language, and a person that we were hiring to do work for us, but then suddenly disappeared to begin work for our withdrawing member without our knowing. We do not have a real operating agreement addressing terms for withdrawl, but of course assumed a fiduciary duty. Do we have any recourse or default restrictions under the law. We don't want to spend our life on this issue and wish him the best, but it is a competitive industry we are in with limited clientele he will be taking in order to make a few more bucks at our expense. I would prefer that he use new contractors, which there are many, and not resources or marketing language forged under the umbrella of our business. I am looking for general guidelines and specific knowledge of case law regarding the duties of a withdrawing a LLC member/minority owner without a detailed operating agreement in place.

• Category: LLC
• Date: 04/07/2025
• State: Arizona

Answer:

In a LLC, the manager owes to the members of the company the duty of care, loyalty, and disclosure, and the members may owe a similar duty to the manager. Each party is expected to always act in the best interest of the company as a whole and avoid any potential conflicts of interest with the company.

While a member may make plans to compete, he may not recruit his co-workers to join him while still employed if it leads to a mass resignation. An individual, while still employed, may not divert to a competitor business opportunities presented to him if it is within the employer’s line of work, the employer can afford to take advantage of it and, after disclosure, the employer is interested in the opportunity. Finally, the member may not use his employer’s confidential information to benefit the new employer or help it gain a competitive advantage.

Although the policies of freedom of employment and encouragement of competition generally permit members to leave at any time and enter a competing business, the law imposes certain restrictions upon former member's competitive activities. In competing with their former corporation, members may not use confidential information acquired by them while employed by the corporation, nor may they seize a business opportunity that rightfully belongs to the corporation. The doctrine of corporate opportunity precludes a corporate officer or director from diverting a corporate business opportunity for his own personal gain:

The rule is that if there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake, which is, from its nature in the line of the corporation’s business, and [is] of practical advantage to it, and which is one in which the corporation has an interest or a reasonable expectancy, and if, by embracing the opportunity, the self interest of the officer or director will be brought into conflict with that of the corporation, the law will not permit him to seize the opportunity for himself. If he does the corporation may claim the benefit of the transaction. This so-called doctrine of corporate opportunity is a species of the duty of a fiduciary to act with undivided loyalty; it is one of the manifestations of the general rule that demands of an officer or director the utmost good faith in his relation to the corporation which he represents. This doctrine precludes an officer from seizing a corporate opportunity of which he becomes aware as a corporate officer, regardless of whether the transaction is consummated during the existence of the fiduciary relationship or after its termination.

It will be a matter of subjective determination for the court to determine whether there was a breach of fiduciary duty, based on all the facts and circumstances involved. Some of the factors that may be considered include, among others, whether the fiduciary personally benefitted at the expense of the LLC, or failed to disclose information to the LLC's detriment. For example, were funds diverted to personal use? Was there knowledge of financial misdealings or risk factors that weren't disclosed by the fiduciary? In applying the statutory standards for the duty of care owed by a managing member of a LLC, the court will need to determine whether there was gross negligence, reckless conduct, intentional misconduct, or a knowing violation of law. The standards of care are measured against the subjective interpretation of how a "reasonable" person would act in similar circumstances.