A partner who starts another business may create more than a competitive problem if they divert customers, opportunities, employees, or company resources.
Discovering that your business partner has started a competing company can raise serious concerns about your business’s future. The situation becomes particularly troubling when the partner remains involved in your company while developing a competing operation. This may result in longtime customers moving elsewhere or employees leaving to join the new company. Your partner may even pursue business opportunities that should have been presented to your company or use company resources, confidential information, or customer relationships to support the competing venture.
Starting another business is not automatically unlawful but competing with a company while owing duties to that business can create significant legal issues. The critical questions are what obligations the partner owes, what conduct occurred, and whether the competing venture has improperly benefited at your company’s expense.
Starting a Competing Business Is Not Always Prohibited
Business owners sometimes assume that a partner cannot operate another company in the same industry. Whether that assumption is correct depends on the circumstances. The company’s operating agreement, partnership agreement, shareholder agreement, or other governing documents may restrict competition, outside business activities, conflicts of interest, or the use of company opportunities. The partner’s position also matters. A managing member, general partner, director, or corporate officer may have obligations that differ from those of a passive investor or minority owner.
For example, a person who owns a minority interest in a company may not necessarily be prohibited from investing in another business. But a partner who actively manages the company while secretly directing its customers and opportunities to a competing venture may face a very different legal analysis. The first step is determining what restrictions and duties apply before concluding that the competing business itself is improper.
Competing While Still Involved in the Company Can Create Conflicts
A particularly serious dispute can arise when a partner launches a competing business while continuing to participate in the original company’s operations. That partner may still have access to customers, pricing information, vendor relationships, financial records, and business plans. And they may also influence decisions about which opportunities the company pursues.
Consider two owners of a consulting company. One partner secretly starts another consulting business and directs prospective customers to the new company while continuing to receive compensation from the original business. The concern is not simply that another company exists but rather that the partner is using their position to benefit a competing venture at the expense of the business they are obligated to serve. The timing of the competing company’s formation, the partner’s continuing responsibilities, and the nature of the activities undertaken may all become important evidence.
Taking Customers May Give Rise to Legal Claims
Customer relationships can be among a company’s most valuable assets. When a partner starts a competing business, disputes frequently arise over whether customers are free to follow that partner or whether the partner improperly diverted them.
A customer generally cannot be treated as property that a business owns indefinitely. Customers may choose whom they want to do business with. However, the methods used to obtain their business can matter significantly. For example, a partner who tells customers the original company is closing when that is untrue, redirects incoming inquiries to a personal business, or uses confidential customer information in violation of legal obligations may expose itself to potential claims.
The analysis should examine how the customer relationship developed, who maintained it, what communications occurred, and whether the partner used company information or resources to obtain the business. This issue is closely related to the questions addressed in our article, “Who Owns the Client? Partnership Disputes Over Customers and Business Opportunities.”
Diverting Business Opportunities Can Be More Serious Than Ordinary Competition
A partner may also face scrutiny for pursuing opportunities that should have been presented to the company. Suppose a business regularly provides services to a particular customer. The customer approaches one partner about a substantial new project. Instead of presenting the opportunity to the company, the partner directs the customer to a newly formed competing business that they own.
Depending on the circumstances, that conduct may raise questions under fiduciary-duty principles, including the corporate opportunity doctrine where applicable. Not every opportunity an owner encounters necessarily belongs to the company. The analysis may consider the company’s existing business, its ability and interest in pursuing the opportunity, how the opportunity arose, and whether the partner used their position or company resources to obtain it. The distinction can be critical. A legitimate independent opportunity may be permissible, while secretly diverting a company opportunity may support legal claims.
Using Confidential Information or Company Resources Can Increase Liability
A competing business may gain a significant advantage if its founder uses information or resources obtained through the original company. That information might include customer lists, pricing strategies, proposals, financial data, supplier terms, marketing plans, or other confidential business information.
Similarly, a partner may use company employees, equipment, software subscriptions, funds, or office resources to develop the competing venture. The legal consequences depend on the nature of the information, the applicable agreements, whether the information qualifies for legal protection, and how it was obtained and used.
A partner’s general knowledge, experience, and skills are not necessarily confidential property belonging to the company. But using protected information or company assets to advance a competing business may create claims for breach of contract, breach of fiduciary duty, trade secret misappropriation, or other misconduct.
Soliciting Employees Can Become Part of the Dispute
A partner who starts a competing business may attempt to recruit employees from the original company. Employees generally can pursue other employment opportunities, subject to applicable legal obligations. Recruiting employees is therefore not automatically unlawful.
However, the circumstances surrounding the recruitment may matter. A partner may be accused of using confidential employee information, violating an enforceable contractual restriction, or organizing employee departures as part of a broader effort to divert customers and business opportunities.
For example, if a partner secretly recruits several key employees while arranging for major customers to transfer their accounts to the new business, the combined conduct may warrant examination. The legal issue is not merely that employees left. It is whether the partner engaged in conduct that violated duties owed to the original company.
Fiduciary Duties May Affect What a Partner Can Do
Many disputes involving competing businesses ultimately turn on fiduciary duties. Depending on the company’s structure, governing agreements, the partner’s role, and applicable law, certain owners and managers may owe duties of loyalty and other obligations concerning the company’s interests.
Those duties can become significant when a partner allegedly engages in self-dealing, diverts company opportunities, misuses company assets, or conceals competing activities that conflict with their obligations. For example, a managing partner who secretly negotiates contracts for a competing company while representing the original business may face allegations that they placed personal interests ahead of the company’s interests.
Courts must carefully evaluate the existence and scope of fiduciary duties. New York law does not impose identical obligations on every shareholder, LLC member, partner, or manager. Governing agreements may also affect the duties that apply. Determining whether the conduct was improper requires examining both the partner’s legal obligations and the actions taken to establish and operate the competing business.
A Competing Business May Change the Future of the Partnership
When one partner starts a competing company, the dispute may extend beyond whether that conduct was lawful. The remaining owners may question whether they can continue working together, whether the original company has lost valuable customers or opportunities, and whether a negotiated separation is still possible.
A proposed buyout may become particularly contentious if the competing venture has affected the company’s revenue or value. One owner may argue that the company’s declining performance justifies a lower valuation, while the other contends that the decline resulted from the partner’s improper diversion of business. Those questions may require examining the company’s financial performance, the timing of customer losses, the competing company’s activities, and any potential claims arising from the partner’s conduct.
A partner starting another company does not automatically establish wrongdoing. But when competition involves diverted customers, business opportunities, confidential information, or company resources, the legal consequences can be substantial.
Alisme Law represents business owners, partners, shareholders, and closely held companies in partnership disputes, fiduciary-duty claims, ownership disputes, and related commercial litigation throughout New York. We review governing agreements, business records, potential misconduct, and available remedies to develop strategies to protect our clients’ interests.
Contact us to schedule a confidential case evaluation at 917-540-8432.
This article is for informational purposes only and does not constitute legal advice.