California Business Divorce: Corporate Opportunity Usurpation and Best Practices to Avoid it in Your California LLC

Going into business with someone requires a high level of trust. For a business to thrive, business partners must be loyal to the business and each other. As in a marriage, when a partner in a business is disloyal, things tend to fall apart.

California law mandates a duty of loyalty on business partners, such as members of a California limited liability company. According to Section 17704.09(b)(1) of the California Corporations  Code 17704.09(b)(1):

A member’s duty of loyalty to the limited liability company and the other members is limited to the following:

(1) To account to the limited liability company and hold as trustee for it any property, profit, or benefit derived by the member in the conduct and winding up of the activities of a limited liability company or derived from a use by the member of a limited liability company property, including the appropriation of a limited liability company opportunity.” (emphasis added)

There are many different ways business partners can breach their duty of loyalty, but for purposes of this article, we’ll address a common variety that tends to lead to business divorce, which is the usurpation of business opportunities by a member.

What is Corporate Opportunity Usurpation?

Corporate opportunity usurpation, also known as the corporate opportunity doctrine, refers to a breach of a fiduciary duty when an LLC member takes advantage of a business opportunity that rightfully belongs to the LLC. In California, LLC members owe a duty of loyalty to the LLC and other members, which includes not appropriating corporate opportunities without proper disclosure and consent from the company.

Hypothetical Examples of Usurpation

Corporate opportunities come in all shapes and sizes, so let’s review a few hypothetical scenarios that involve the types of actions by a member that typically give rise to corporate opportunity usurpation disputes. 

Scenario 1: John, an LLC member, had insider knowledge that his company was interested in purchasing a prime piece of real estate for a new development project. Instead of sharing this information with the other members, John secretly acquired the property through a separate entity under his control. When the LLC discovered John's actions, they filed a lawsuit against him for usurping a corporate opportunity.

Scenario 2: Mary, an LLC member, learned that a competitor was experiencing financial difficulties and was looking to sell some of its valuable assets at a discounted price. Instead of bringing the opportunity to the attention of the LLC, Mary decided to pursue the deal personally, hoping to profit from the acquisition. Eventually, the other LLC members found out about Mary's actions and sued her for usurping a corporate opportunity.

Scenario 3: A family-owned LLC consisted of three siblings: Alice, Bob, and Carol. Alice discovered a new, profitable market niche and decided to start a separate competing business without disclosing her plans to Bob and Carol. Alice's new business began to directly impact the LLC's revenue, leading Bob and Carol to file a lawsuit against her for usurping a corporate opportunity and breaching her fiduciary duty.

So, did John, Mary and Alice usurp corporate opportunities in a way that breached a fiduciary duty in the foregoing scenarios? As with most legal issues, these types of cases involve intense inquiries of the underlying facts, including the important question of whether a corporate opportunity existed in the first place. 

In general, to determine whether something is a corporate opportunity, courts look to factors such as:

• Whether the business would be financially able to take the opportunity.
• If the opportunity is in the same line of business as the corporation.
• Whether the corporation has an interest or expectancy in the opportunity.
• Whether taking the opportunity would create a conflict of interest or be a breach of a fiduciary duty.

To the extent a corporate opportunity exists, an LLC member cannot pursue such opportunity for their own personal benefit. Instead, to fulfill his or her fiduciary duty, an LLC member must first offer the business opportunity to the LLC. Failure to do so can give rise to a cause of action by the LLC against the breaching member—not to mention lead to a business divorce due to loss of trust among members. 

Practical Tips: Proactive Measures to Avoid Corporate Opportunity Usurpation Issues in Your California LLC 

The best way to avoid difficult and costly fights involving allegations of breaches of fiduciary duties is to be proactive and ensure that all members of an LLC understand and are fulfilling their fiduciary duties. The following tips are practical best practices for avoiding corporate opportunity usurpation issues that your LLC may want to consider: 

1. Establish clear policies and procedures for disclosing and evaluating potential corporate opportunities: This should include a defined procedure for evaluating the opportunity, determining whether it falls within the scope of the LLC's interests, and obtaining consent before any member pursues the opportunity personally.
2. Implement regular training on fiduciary duties, particularly the duty of loyalty and the corporate opportunity doctrine: This training should cover legal requirements, case studies, and real-life examples to reinforce the importance of adhering to these duties.
3. Encourage open communication among LLC members to foster trust and transparency: Encourage members to openly discuss potential opportunities and conflicts of interest. This open dialogue can help mitigate the risk of corporate opportunity usurpation and strengthen trust among members.
4. Adopt a conflict of interest policy: Draft a comprehensive conflict of interest policy that outlines the steps members must take to disclose any potential or actual conflicts, as well as the process for resolving such conflicts.
5. Establish a clear decision-making process: Define a transparent decision-making process for evaluating and approving business opportunities, including a voting system, quorum requirements, and any necessary approvals from outside advisors or legal counsel. This process will help ensure that all members have an equal say in the pursuit of opportunities and reduce the risk of corporate opportunity usurpation.
6. Consult with legal counsel: Retain experienced legal counsel to advise on the development and implementation of policies and procedures related to fiduciary duties and corporate opportunities. Regularly seek guidance on matters involving potential conflicts of interest or business opportunities to ensure compliance with the law and minimize legal risks. An attorney can help you navigate complex situations and provide valuable insights to protect your LLC's interests.

By incorporating these best practices into your LLC's operations, you can foster a culture of transparency, accountability, and adherence to fiduciary duties. This proactive approach can help prevent corporate opportunity usurpation, avoid disputes between members, protect your LLC's interests, and contribute to its long-term success.