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Can I compete with my own LLC?

I recently had a Q-and-A dialogue on Avvo with an LLC member-manager who had a falling out with the other (50%) member and wanted to know whether he could form a separate business that would compete with the existing LLC. An edited version of our exchange appears below.

Q. I have an LLC with a partner. We each own 50% of the business (its an e-commerce store) and we’re member-managers. I’d like to buy him out, but his price is higher than I’m willing to pay. I have been pondering starting another e-commerce store selling kind of the same thing. Question is a) Would an e-commerce business out there competing for new customers constitute a breach of fiduciary duty? b) Would it be possible to rescind title as manager in the LLC which would eliminate that non compete fiduciary duty of a manager?

A. According to CEB’s Selecting and Forming Business Entities, 2d ed., Section 11.19:

  • As a member-manager, you have a fiduciary obligation to the LLC and the other member that, among other things, precludes having an adverse interest (which is what the competing store would be).
  • Assuming that you can resign as manager while retaining your membership (one would need to look at the Articles of Organization and the Operating Agreement to determine whether and how this is possible), CA law would not impose a fiduciary duty on you, but courts have held in analogous situations (limited partners in partnerships) that a fiduciary obligation can exist under certain circumstances (such as access to confidential information).

In summary, I see no way you can compete with the LLC with complete safety. If you cannot agree upon a buyout amount, dissolution might be the best way to proceed – please see the post at the link below.

Q. Our op. agreement is a tiny legalzoom thing, so why wouldn’t I be able to resign as manager?

A. My concern is that the Articles of Organization (apparently) state that the LLC is managed by all of the members. While I know of no statutory or case authority on this point, it may be that the only way for you to resign properly would be to amend the Articles to specify that the LLC is managed by one manager (the other member).

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  1. 3/9/2010 | 2:38 pm Permalink

    I think there maybe case law as to discounting the actual value (if say, it is based on book value) because of the lack marketability, lack of control, transfer restrictions of the other membership interest.

    This should also illustrate why there needs be an effective, customized operating agreement in place, revisited at least once a year, to try to avoid situations like this.