Illinois First District Rejects Veil Piercing Theory for Fiduciary Duties, reaffirms that only Managers, not Employees or Shareholders, have Fiduciary Duty to “manager-managed” LLC

Novack and Macey LLP

Novack and Macey LLP

Oliver v. Isenberg, 2019 IL App (1st) 181551-U, arose from a lawsuit among members of a once-prosperous entity known as the Combined Group, LLC (“Combined” or “the company”) over the hostile breakup of the company. The circuit court held after a bench trial that Mark Oliver, a shareholder and employee of Combined, had a fiduciary duty to the company as “manager” because he was also an officer and primary shareholder of the company’s managing member, the Combined Holding Group, Inc. (CHG). The appellate court rejected this conclusion: because Oliver himself had never been designated as a manager of Combined, he had no fiduciary duty to it. However, he did have a fiduciary duty to CHG as an officer and shareholder of that closely-held entity.

In 1984, Oliver and three others merged their respective entities and founded CHG, a closely-held corporation that they treated as a partnership. After one later retired, Oliver and two others remained. They were equal shareholders of CHG and all were officers and directors of CHG.

The founders created Combined to act as CHG’s primary business. Combined was a manager-managed LLC that specialized in helping manufacturers place products with retailers for sale to consumers. About 64% of Combined was owned by CHG, and the remaining shares were divided among various junior partners. CHG was Combined’s manager and vested with sole and exclusive authority to manage and control the company’s affairs.

Combined’s operating agreement mandated retirement at the end of the fiscal year in which the founders attained the age of 70. For Oliver, this was December 31, 2012. In anticipation of his retirement, Oliver began making plans in 2011 to transition control over his major accounts to Combined. The transition process caused dissention among the three CHG shareholders. In addition, Oliver uncovered evidence of mismanagement of Combined by the other shareholders, which, along with declining sales, led him to question the viability of the company and its ability to fund his retirement payout. He presented this evidence to two key junior partners in November 2012.

All three left the company on January 1, 2013 and immediately commenced operation of a new entity, Signature Sales and Marketing. By January 19, 2013, all of the accounts belonging to the three had moved to Signature. Unable to reach an amicable agreement regarding the breakup of Combined, the parties filed suit against one another. Among other things, Combined and CHG claimed that Oliver had breached his fiduciary duties to them by “stealing” business from Combined and transferring it to Signature.

Fiduciary Duty to Combined

The circuit court determined that Oliver had a fiduciary duty to Combined in two ways: as a manager/officer and as an employee/agent of the company. The Illinois LLC Act provides that, in a “manager-managed” company such as Combined, only the managers owe a fiduciary duty to the company, while employees generally do not. Combined’s operating agreement designated CHG as the manager of Combined, with sole authority to oversee and control the day to day business of the company. Although Oliver was a manager of CHG, he was never a manager of Combined. The appellate court disagreed with both conclusions.

The circuit court’s rationale for finding Oliver had a fiduciary duty to Combined was that CHG, Combined’s manager, operated as a partnership and its shareholder/officers, including Oliver, were essentially managers along with CHG itself. But this was, as the appellate court recognized, essentially piercing the corporate veil of CHG to hold Oliver liable for CHG’s duties. The appellate court recognized that a corporation “acts through its individuals.” By giving CHG authority to manage and control the affairs of Combined, the operating agreement could be viewed as effectively conferring management power upon CHG’s shareholders. But the court rapidly dismissed this notion; Oliver himself was never appointed or elected manager, and the LLC Act does not impose such responsibility upon him merely because he is an officer in a corporation which was, in fact, designed manager.

The appellate court also held that the LLC Act imposed no fiduciary duty upon Oliver as a mere employee or agent, citing a case we treated in our case summaries here, 800 South Wells Commercial LLC v. Cadden, 2018 IL App (1st) 162882, ¶¶ 30-35. And even if such a duty did exist, Oliver did not breach it. It is generally permissible for an employee to compete with his former employer and solicit its customers as long as the employee did not undertake such solicitation before his prior employment ended. Veco Corp. v. Babcock, 243 Ill. App. 3d 153, 160 (1993). Indeed, a current employee “may go so far as to plan, form and outfit a competing corporation” while still working for his former employer as long as he doesn’t begin actual competition until after leaving that employment. Oliver, 2019 IL App (1st) 181551-U ¶ 78. Here, Oliver had refrained from soliciting his existing clients until January 2, 2013, which was two days after his mandatory retirement on December 31, 2012. Finding that this was “enough time to wait,” the court held Oliver did not breach any fiduciary duty he owed as an employee.

Fiduciary Duty to CHG

Oliver was not out of the woods, however. The circuit court held that Oliver owed a fiduciary duty to CHG based on his status as both an officer and a one-third shareholder, and the appellate court affirmed. In contrast to employees, corporate officers and directors may not actively exploit their positions in the company for their own personal benefit and may not use information acquired by virtue of their tenure to gain an advantage post-employment. Smith-Shrader Co., Inc. v. Smith, 136 Ill. App. 3d 571, 577-78 (1985). Such information need not rise to the level of a trade secret; it may include knowledge of a co-worker’s specialized skill or expertise which is then used by the officer to hire that worker away to a new business.

Oliver claimed that he waited until two days after his retirement from CHG to begin soliciting his accounts to move to Signature. But the circuit court doubted the credulity of this position given that Oliver’s clients, some of whom were large corporations, had fully or partially moved to Signature, a virtually unknown entity, within “days” after his retirement. The court also noted that Oliver had continued to work in Combined’s offices through January 1, 2013, and had used his prior email address that included the word “Combined.” Although there was no proof Oliver had engaged in outright solicitation prior to his retirement, the circuit court found he must at least have “greased the machinery,” making his clients aware of his possible exit from Combined. It was also probable that Oliver employed specific information gleaned over the years, such as his intimate knowledge of the terms of clients’ contracts. Finally, his use of an email address bearing Combined’s name, though not intentional, could have given clients the impression that the exit was ratified by the company.

This holding makes it clear that a fiduciary duty to a manager-managed LLC is only imposed upon those actually elected or appointed as managers of the LLC. No such duty applies to employees, agents or mere shareholders of the LLC’s managing entities. Executives must carefully evaluate their status before making any effort to strike out on their own.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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