Chapter 2-11 Usurpation of Business Opportunity

• Jurisdiction: United States

2-11 Usurpation of Business Opportunity

2-11:1 Overview

Corporate officers and directors—and their counterparts in LLCs and partnerships—owe a duty of loyalty to their principals. This duty encompasses the strict prohibition against usurpation of business opportunity.

2-11:1.1 Related Causes of Action

Officer and Director Liability, Class Action Suits, Derivative Shareholder Suits, Dissolution of Partnership, Breach of Fiduciary Duty

MUST READ CASE

International Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567 (Tex. 1963)

2-11:2 Elements

(1) An officer, director, manager, or partner

• Officers or directors of corporations are proper defendants.³⁰³
• Partners in partnerships are proper defendants.³⁰⁴
• Officers, managers or member managers of LLCs are proper defendants.³⁰⁵

(2) Usurps a business opportunity

• The defendant must usurp a business opportunity/interest.³⁰⁶
• A defendant who diverts profits from the entity in violation of his fiduciary relationship is personally liable even though the profits are acquired by an agency controlled by the director.³⁰⁷

(3) Which properly belonged to the entity

• The defendant must usurp a business opportunity/interest.³⁰⁸
• A business opportunity which belongs to the plaintiff is one which:

• The plaintiff has an "interest and expectancy" in;³⁰⁹
• The financial resources to take advantage of the opportunity.³¹⁰
• Is in the plaintiff's "line of business."³¹¹

• "Where a corporation is engaged in a certain business, and an opportunity is presented to it embracing an activity as to which it has fundamental knowledge, practical experience and ability to pursue, which, logically and naturally, is adaptable to its business having regard for its financial position, and is one that is consonant with its reasonable needs and aspirations for expansion, it may be properly said that the opportunity is in the line of the corporation's business."³¹²
• The "line of business" test is broader in scope than the "interest and expectancy" test.³¹³

2-11:3 Damages and Remedies

2-11:3.1 Constructive Trust

A plaintiff may seek a constructive trust.³¹⁴

2-11:3.2 Turnover of Business Opportunity

A plaintiff may seek turnover of the business opportunity in the future.³¹⁵

2-11:3.3 Forfeiture of Compensation

Forfeiture of compensation is appropriate.³¹⁶

2-11:3.4 Disgorgement

Disgorgement is an appropriate remedy.³¹⁷

2-11:3.5 Actual Damages

An entity may hold the defendant liable for any loss it suffers as a result of mismanagement.³¹⁸

2-11:3.6 Removal of Defendant from Office

The shareholders of a corporation may call a special vote to remove a director from office.³¹⁹

A partner may be expelled by other partners or by judicial decree.³²⁰

A member of an LLC may not be expelled³²¹ unless the company agreement modifies the statutory rule.³²²

A manager of an LLC may be removed.³²³

2-11:3.7 Exemplary Damages

Exemplary damages are available if the defendant acts:

• Maliciously;

• Fraudulently; or

• With gross negligence.³²⁴

Willful usurpations suffice.³²⁵

Exemplary damages may be predicated upon an equitable remedy alone.³²⁶

2-11:4 Defenses

2-11:4.1 Statute of Limitations

The four-year limitations period applies to a breach of fiduciary duty claim.³²⁷

The period accrues when the disinterested and independent agents of the entity have actual or constructive notice of the defendant's usurpation.³²⁸

A majority of the disinterested and independent agents must have actual or constructive notice of the defendant's usurpation.³²⁹

The discovery rule applies to usurpations sounding in tort.³³⁰

2-11:4.2 Financial Incapability

A plaintiff's financial inability to pursue the business opportunity is a defense to a usurpation claim.³³¹

This is an affirmative defense.³³²

Courts are hesitant to apply this defense.

Courts strictly limit the application of this defense because it is often the defendant who is to secure financial backing for the plaintiff.³³³

2-11:4.3 Abandonment of Business Opportunity

A plaintiff's abandonment of the business opportunity is a defense to a usurpation claim.³³⁴

This is an affirmative defense.³³⁵

A valid corporate/LLC relinquishment requires:

• Approval by a disinterested group of directors after full disclosure;

• Approval by the shareholders after full disclosure; or

• Proof of...