The Corporate Opportunity Doctrine: An Illinois Primer

I typically encounter a corporate opportunity issue (a claim that a defendant usurped a corporate opportunity) in situations where a former employee goes to work for a competitor and the ex-employer claims the employee is exploiting a business opportunity he learned of solely through his association with the employer.

The employer will usually sue for injunctive relief and money damages under a breach of fiduciary duty theory premised on the assertion that the employee violated the corporate opportunity doctrine. The employee typically defends by arguing that he didn’t compete with his former employer and that any business he now does is purely the product of his own initiative and was developed outside the confines of his prior position.

Illinois state and Federal cases through the decades have sharpened the doctrine’s contours to these fine points:

– A corporate officer has the duty to act with “utmost good faith and loyalty” in managing the company;

– A corporate officer breaches his fiduciary duties where (i) he tries to enhance his personal interests at the expense of the corporate interests, or (ii) he hinders his corporate employer’s ability to carry on its business;

– Where a corporate officer solicits business for his own benefit or uses his employer’s facilities or resources to further his personal interests without informing the company, he breaches his fiduciary duties to that company; the core principle of the doctrine is that a fiduciary will not be permitted to usurp an opportunity developed through the use of corporate assets;

 – A plaintiff alleging a defendant usurped a corporate opportunity must show that the company benefitting from the officer’s actions are in the same line of business as the plaintiff/employer; but the companies don’t have to be direct competitors;

 – A corporate opportunity exists when a proposed activity is reasonably incident to the corporation’s present or prospective business and is one in which the corporation has the capacity to engage;

– Where a corporate officer uses corporate assets to develop a business opportunity, he can’t then argue that his former employer lacked the ability to pursue that opportunity;

– Two key factors are: (1) whether the corporation had an actual or expected interest in the opportunity and (2) whether the acquisition of the questioned opportunity would impede the (ex-employer, e.g.) corporation’s ability to carry on its day-to-day business;

– Additional corporate opportunity factors include: (1) the manner in which the offer was communicated to the officer, (2) the good faith of the officer, (3) the use of corporate assets to acquire the opportunity, (4) the financial ability of the corporation to acquire the opportunity, (5) the degree of disclosure made to the corporation, (6) the action taken by the corporation in response to any disclosure, and (7) the need or interest of the corporation in the opportunity;

Case Examples Of Corporate Opportunity Breach

Corporate officers have been found in breach of their fiduciary duties when, while still employed by the company, they:

(i) failed to inform the company that employees are forming a rival company or engaging in other fiduciary breaches;

(ii) solicited the business of a customer before leaving the company;

(iii) used the company’s facilities or equipment to assist in developing their new business;

(iv) solicited fellow employees to join a rival business;

(v) used the company’s confidential business information for the new business; and

(vi) orchestrated a mass exodus of employees shortly after resigning from a company.

Afterwords: The above provides a good framework for handling a corporate opportunity breach. When representing a plaintiff in this type of case, I argue that the above factors weigh in favor of a finding of breach and will focus on any secret conduct of the defendant. The more clandestine, the better. 

Conversely, when defending a corporate opportunity suit, I stress that the opportunity was developed independently of my client’s former association with the plaintiff and that it (the opportunity) came to fruition by my client’s own efforts and not from the plaintiff’s resources.

Sources:

Drench, Inc. v. South Chapel Hill Gardens, Inc., 274 Ill.App.3d 534 (1st Dist. 1995);

Star Forge, Inc. v. Ward, 2014 IL App (2d) 130527-U;

Foodcomm Int’l v. Barry, 328 F.3d 300, 303 (7th Cir. 2003);

Lindenhurst Drugs, Inc. v. Becker, 154 Ill.App.3d 61, 68 (2d Dist. 1987)

Illinois Agency, Ratification and Alter-Ego Basics: Case Snapshot

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Photo credit: passionateproject.blogspot.com

Several recurring commercial litigation issues are examined in Saletech, LLC v. East Balt, Inc., 2014 IL App (1st) 132639, a case that chronicles a dispute over a written distribution agreement for the sale of bakery products.

The plaintiff entered into the agreement with a Ukranian subsidiary  of various U.S. companies.  The plaintiff sued these U.S. defendants, claiming they were bound by the foreign subsidiary’s breach, that they were alter egos of the subsidiary, or at least ratified the subsidiaries’ conduct.  The trial court granted the U.S. companies’ motion to dismiss for failure to state a cause of action on all counts and the plaintiff appealed.

Held: Affirmed.

Rules/Reasons: Finding for the defendants, the court applied black-letter agency law, ratification and corporate liability rules.

Agency Law and Ratification

– agency is a fiduciary relationship where a principal has the right to control the agent’s conduct and the agent has the power to act on the principal’s behalf;

– an agent’s authority can be actual or apparent.   Actual authority can be (a) express or (b) implied and means that the principal has explicitly granted the agent authority to perform a certain act;

– apparent authority arises where (a) the principal holds the agent out as having authority to act on the principal’s behalf and (b) a reasonably prudent person would assume the agent has authority to act in light of the principal’s conduct;

– to show apparent agency, the plaintiff must prove (1) a principal’s consent or knowing acquiescence in the agent’s exercise of authority; (2) the third party’s good-faith belief that the agent possessed such authority; and (3) the third party’s detrimental reliance on the agent’s authority;

– apparent agency must be based on conduct of the principal; not the agent;

– ratification applies where a principal manifests an intent to be bound by an agent’s unauthorized act, after the fact;

– ratification can be shown mainly by a principal retaining the benefits of the unauthorized act.

¶¶ 14-15, 21

Here, the Court found the plaintiff failed to establish that the foreign subsidiary (who signed the contract) was the agent for the solvent U.S. defendants.  The plaintiff made only naked allegations of a principal-agent relationship between the domestic and foreign entities.

Without allegations that the defendants knew of the subsidiaries’ distributor agreement or that they held out the foreign firm as having actual or apparent authority to bind the defendants, the plaintiff’s agency allegations were too conclusory to survive a motion to dismiss under Illinois fact-pleading rules.

The plaintiff also failed to plead facts to show the defendants ratified any unauthorized conduct of the foreign company.  For example, plaintiff didn’t allege that the defendants accepted benefits from the distributorship contract after plaintiff alerted defendants to the foreign firm’s misconduct.

Alter-Ego

The plaintiff’s alter-ego allegations were also lacking. The plaintiff claimed that the signing foreign company was an alter-ego of the U.S. companies.

The alter ego doctrine affixes liability to a dominant person (or company) that uses a sham entity as a front or “conduit” in order to avoid contractual liability.  An alter ego plaintiff must make a “substantial showing” that one corporation is a dummy or “front” for another.

In breach of contract cases, the required showing for alter ego (piercing) liability is even more stringent than in tort cases.  This is because a party to a contract presumably entered into the contract with another company voluntarily and is presumed to suffer the consequences if the counterpart breaches and has no collectable assets. ¶ 25

The court found that here, the plaintiff failed to plead sufficient facts to demonstrate a unity of interest between the foreign company and the U.S.-based defendants that would permit the court to impute liability to the U.S. defendants.

Additionally, the plaintiff’s bare allegation that the defendants were “commingling funds” in order to defraud creditors lacked factual support and wasn’t enough to state a breach of contract claim predicated on an alter ego theory. ¶¶ 17-18, 22, 29.

Afterwords:

(1) Illinois fact-pleading rules require more than bare parroting elements of a cause of action to survive a motion to dismiss;

(2) Ratification only applies where plaintiff can plead facts showing a principal retained benefits of an improper agent transaction;

(3) Piercing the corporate veil based on alter ego allegations is difficult to prove; especially in breach of contract setting.

 

Serving the Elusive Tenant: The Illinois Forcible Statute’s ‘Posting’ Rules

In Equity Residential v. Nasolo, 364 Ill.App.3d 26 (1st Dist. 2006), the Court held that four unsuccessful Sheriff service attempts over a six-day period didn’t qualify as “due and diligent inquiry” under the service by posting section of the Illinois forcible statute.

Vacating the possession order, the Court stated the key service of process rules:

– service of process has  two purposes: (1) to give a defendant notice that his rights are about to be affected by the plaintiff’s action; and (2) to allow a court to exercise jurisdiction over the person whose rights are to be affected by the litigation;

– constructive notice (like posting or publication) is only allowed where personal service of summons can’t be had and there are no other options”;

– the posting notice statute’s due and diligent inquiry standards require more than superficial efforts at locating a defendant;

– a plaintiff must make as comprehensive an effort as possible to locate a defendant including checking with neighbors, making inquiry into court records and investigating employment information before claiming that he can’t locate a defendant after due or diligent inquiry;

– where a defendant hasn’t been served with process, the court has no jurisdiction over him and any judgment entered is void and can be attacked at any time;

– a defendant’s actual knowledge that a suit is pending is not equivalent to service of summons and doesn’t relieve a plaintiff of his burden of vesting a court with jurisdiction over a defendant;

– where a defendant files a sworn affidavit that challenges plaintiff’s location and service efforts, the court should hold an evidentiary hearing on whether plaintiff has met its burden for establishing grounds for constructive service;

Nasolo, 364 Ill.App. 3d at 33-35

Applying these rules, the Court doubted whether four service attempts was enough to show the landlord made a  due or diligent inquiry into the tenant’s location or current residence address. 735 ILCS 5/9-107.

The Court held that the tenant was entitled to an evidentiary hearing since she filed an affidavit that challenged the landlord’s diligence in trying to locate the tenant. This affidavit led the Court to vacate the possession order and remanded the case for an evidentiary hearing on the thoroughness of the plaintiff’s service attempts.

Bank of New York v. Smith (2013 IL App (1st) 120398-U) is a more recent case on the constructive service issue. There, the First District held that the tenant was entitled to an evidentiary hearing on whether she could have been located by the landlord.  

The tenant filed an affidavit that contained her sworn testimony that she wasn’t dodging service, that she always answered the door when someone knocked and that she was regularly on the premises.

This was enough to get the tenant an evidentiary hearing on whether the landlord exhausted all normal service channels before it posted. 

Take-aways:

Synthesizing Nasolo and Bank of New York, four unsuccessful attempts are not enough to justify posting while six tries are borderline.

These cases also show that if a tenant files an affidavit, the Court must hold an evidentiary hearing on whether the landlord met the statutory diligence standards.

To avoid a possible motion to quash or vacate a possession order, I at a minimum try to personally serve the tenant through both the Sheriff and a process server before filing my posting affidavit.

In difficult cases (where a tenant is blatantly dodging service), I have my process server available to give testimony and let the judge decide whether we carried our burden of establishing proof of service on the tenant.