Can a Non-Compete Agreement Apply to a Related Entity?

Full question:

I partnered with a guy in 11/2008. He made me sign an employee handbook for his other company (which I was not an employee nor had any affiliation, other than that I was working out of the same offices and figured he wanted to feel the info on his other business was safe). A non-compete was in it, which will matter later. We formed LLC 1 we'll call it, about the same time. Online marketing, no operating agreement. Then, we formed DE LLC 2, (internet lending company) 1 month later. 4 months after that, we signed an operating agreement for LLC 2, no non-compete in it. We began operations, I am the managing member and the underwriting and processes are out of my industry experience, but are refined and developed as we go (later he'll call 'trade secrets' not owned by me). Partner and I began raising more funds. Funds would go into a different LLC so by nature would compete with LLC 2. (which I felt means it was evident LLC 2 was going to have competing entities and I had no bind to him that I must include him in them)... Then, my partner's business ethics began to show. He would lie in investor meetings, I felt borderline securities fraud. One of the investors we'd solicited together (again, would have been a different LLC that would've competed with LLC 2), they came to me and said they want to start a company, but only with me, they didn't like my partner. My lawyer told me that so long as I have no non-compete (partner later claims the employment agreement is non-compete), since they solicited me not vice versa, I can do it and it not be in breach of my duty. Also, we were soliciting to create new LLCs to compete with LLC 2, so it was implied it was ok to compete against LLC 2 I'd hoped. We began moving forward behind the scenes, I began dissociating from my partner. I also began talks with other interested investor groups I'd met via LLC 2, to entire partnership with me directly, nothing came of my colluding and conspiracies. Next, dissociation from my partner was completed, and I get email confirmation that we can compete without any obligation or breach to the other, on 11/09. Next I begin operations on the new entity without him. I later resign as manager on LLC2, but remain member. He finds out about the new entity, he finds out I was colluding and conspiring prior to his 11/1 email. All sorts of accusations arise: misappropriation of trade secrets (underwriting & processes), usurping a LLC2 opportunity (they would only partner with me), conspiring to form other competing partnerships (all partnerships would inherently compete against LLC2, why is this not OK only when he's not involved in the other entity). He claims the 11/1 is not valid since I was in breach prior to 11/1 and he did not know. He claims the employment agreement 11/2008 for a company I had nothing to do with is binding and non-compete is valid. On another note, he claims the operating agreement is not valid b/c I only sent him the last page and he signed it and I attached (I have email acknowledging this is not true). He claims I am/was in breach of several fiduciary duties and is therefore now going to issue a TRO against me and my new entity, unless I hand over my membership in LLC2. He is not willing to give legal release in exchange, or anything whatsoever, just wants me to surrender my membership. He can afford to drag this out a long time, I certainly can not. However, I don't want to be bullied out of my membership(today has no value, but will have a lot in 2-3 yrs). How does this play out?

• Category: Employment
• Subcategory: NonCompete Agreement
• Date: 04/07/2025
• State: Illinois

Answer:

In a corporation, the president owes to the members of the company the duty of care, loyalty, and disclosure. Each officer 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.

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. We are prohibited from giving a legal opinion, as this service provides information of a general legal nature. I suggest you have your attorney review all the facts and documents involved. Some of the factors that may be considered include, among others, whether the fiduciary personally benefitted at the expense of the company, or failed to disclose information to the company'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 corporate officer, 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.

The elements of a cause of action for breach of fiduciary duty are:

(1) Plaintiff and Defendant share a relationship whereby:

(a) Plaintiff reposes trust and confidence in Defendant, and

(b) Defendant undertakes such trust and assumes a duty to advise, counsel and/or
protect Plaintiff;

(2) Defendant breaches its duties to Plaintiff; and

(3) Plaintiff suffers damages.

The elements of a claim for breach of fiduciary duty are not fixed as the claim may arise from virtually any case where one party accepts the trust and assumes the duty to protect a weaker party.

Affirmative defenses to a claim for breach of fiduciary duty can include, but are not limited to:

(1) The passing of the statute of limitations for filing the claim.

(2) Lack of fiduciary relationship (for example, when the parties did not enter a fiduciary relationship, but rather conducted business in an arm’s length transaction there is no duty to protect the other party or disclose facts which the other party could have discovered by its own diligence.)

(3) Lack of standing

(4) Approval (for example, if the alleged actions followed full disclosure to and the consent of the Plaintiff)

(5) Business judgment rule (ex. that the corporate fiduciary's actions were motivated by a bona fide interest in the well being of the corporation where shareholders are the ones owed the fiduciary duty)

Injunctive relief consists of a court order called an injunction, requiring an individual to do or not do a specific action. It must be proven that without the injunction, harm will occur which cannot be remedied by money damages. To issue a preliminary injunction, the courts typically require proof that

(1) the movant has a ‘strong’ likelihood of success on the merits;
(2) the movant would otherwise suffer irreparable injury;
(3) the issuance of a preliminary injunction wouldn't cause substantial harm to others; and
(4) the public interest would be served by issuance of a preliminary injunction.

A trade secret is a process, method, plan, formula or other information unique to a manufacturer, which has value due to the market advantage over competitors it produces. Use or disclosure of a trade secret by an employee, former employee, or anyone else may be prohibited by a court-ordered injunction. The owner of a trade secret may seek damages against such a person for revealing the secret. Also, when trade secrets are involved in a lawsuit, a "protective order" may be requested from the judge to prohibit revelation of a trade secret or a sealing of the record in the case where references to the trade secret are made. A trade secret is separate from and covered under different law from a patentable invention. Trade secrets include, among others, business assets such as financial data, customer lists, marketing strategies, and information and processes not known to the general public.

Under the Uniform Trade Secrets Act, trade secrets are defined as follows:

""Trade secret" means information, including a formula, pattern, compilation, program, device, method, technique or process that: (1) derives independent economic value, actual or potential, from not being generally known to, and not being easily ascertainable by proper means, by other persons who can obtain economic value from its disclosure or use, and (2) is the subject of efforts that are reasonable under circumstances to maintain its secrecy."

A request for a declaratory judgment may be filed with the court, seeking to have a judicial declaration of the rights of parties involved. A petition for a declaratory judgment asks the court to define the legal relationship between the parties and their rights with respect to the matter before the court. It is used to determine the legal status of a situation, rather than the enforcement of the rights involved. Please see the link to the form below requesting a declaratory judgment on the validity of non-compete agreements.