In certain instances, a member of a Delaware LLC may not find it desirable to continue doing business with the other members of the company. This can be the result of divergent views of how the business should be run, feuds between members, or simply because the member may believe that they can start up a competing business and make more money.
If a member of a Delaware LLC withdraws and forms a competing business, the issue becomes what liability would that member owe to the LLC or other members of the LLC. Would the withdrawing member owe fiduciary duties to the other members which would prevent he, she or it from withdrawing and competing?
A very significant decision on this issue was recently handed down by the Delaware Court of Chancery. In the case of Touch of Italy v. Salumeria and Pasticceria, LLC v. Bascio, C.A.No.8602-VCG (Del. Ch. Jan. 13, 2014), the Court addressed whether a member of a Delaware LLC who withdraws and forms a competing business would face liability to other members of the LLC. Based upon that company’s LLC agreement, the Court found that the withdrawing member could compete without penalty.
Of note, the operating agreement of the LLC did not contain a non-competition clause or otherwise prohibit a withdrawing member from competing with the company. Recognizing that LLCs are “creatures of contract”, the Court interpreted the LLC agreement as written. The Court found that “there are undoubtedly sound business reasons to include … covenants not to compete in or in connection with LLC agreements.” The parties could not replicate these provisions post hoc through alleging breaches of contract, or violations of the covenant of good faith and fair dealing.
Touch of Italy makes it clear that members of an LLC should take care to contain explicit non-compete clauses in the operating agreement as to withdrawing members; otherwise, nothing will preclude such a member from withdrawing and forming a competing business. Moreover, in the event that a member of a Delaware LLC wishes to withdraw and compete, this case shows the necessity to carefully examine the LLC’s operating agreement to determine whether forming a competing business would be in violation of such agreement, and hence subject the withdrawing member to potential liability.