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Issues Arising After a Shareholder-Employee Departure

Change is a constant in business. At no other time does change offer greater legal challenges than when a company goes out of business or when an employee group voluntarily leaves or is forced out. Even though business relationships have been abandoned, the ties that bound company and shareholder will affect the financial futures of both. In their simplest forms, these ties are contractual in nature.

The essence of a contract is the requirement that both parties fulfill certain obligations. If the business is dissolving, then it must review all of its current contracts and make plans accordingly. Simply closing up shop and leaving others hanging is likely to lead to breach of contract claims. Contractual and/or fiduciary issues may also apply to the loss of certain individuals.

Fiduciary Duty

Fiduciary duty arises when a party is in a special position of trust and is thereby required to act in another's best interests, even if it means subordinating its own interests. A corporation must ensure that its officers and executives do not take advantage of their positions or use information against the best interests of the company.

When a shareholder-employee of a company, especially a small company, leaves, the shareholder agreement is vital to how the departure affects all parties. A departing employee who has fiduciary obligations must not use inside information to gain an unfair business advantage. Legal challenges are possible when the employee violates this duty.

In general, employees who own shares in the company face some unique challenges. If they have been officers of the company, there could be limitations as to when they may liquidate their shares. From the company's perspective, these officers may be due other considerations such as severance packages. If the shareholder agreement contains a buyout clause, exiting officers may be entitled to sell off their shares to the other shareholders.

Every shareholder agreement should contain a plan in case of a shareholder's departure. This will help to prevent misunderstandings and avoid litigation. If litigation is necessary, however, the parties should consult with experienced business attorneys.

Employment Contracts

An employment contract can be written, verbal or implied, but in any case they require the employer and employee to perform (or abstain from performing) certain actions. Just how well an employment contract spells things out affects both parties, especially in the long run. Unfair competition and intellectual property rights are two key employment contract items that have long-range implications.

Unfair Competition and Trade Secrets

In the context of business law, unfair competition arises when a party in a current or former business relationship uses deceit or inside information to gain advantage over its competitor. For example, an employee who leaves a company and uses the company's trade secrets or "steals" customers may be liable for unfair competition. While this may seem like extreme conduct, it is actually quite common for an employee to use information learned in one job in a subsequent job. This could be information as simple as pricing or client identification that is learned over time and exists in the employee's memory. Whether the use of that information will rise to the level of unfair competition or a trade secret violation will depend on the facts of each case.

Intentional Interference with Contract

Another form of unfair competition occurs when a former employee interferes with a former employer's contract so that the contract is broken or damaged. An example of this is when one party takes a client away from its competitor. There are no hard and fast rules that can tell businesses what exactly constitutes improper interference with the contract, so it is very easy to be sued for this type of claim. An explicit clause in an employment contract may help prevent this situation by notifying the employee of activities that are prohibited upon separation from the company.

Noncompete Clause

A noncompete clause in an employment contract can prevent an employee from starting a business in the same field or working for a competitor. A noncompete clause must not be too broad, however, or a court may be reluctant to uphold it for fear of preventing the former employee from making a living. However, these clauses are sometimes necessary to protect a business from the risk that an employee will absorb the company's knowledge and then directly compete, thereby harming the former employer. On the other hand, if you are an employee being asked to sign a non-compete agreement, you need to be aware of the potential long-term consequences on your future employment.

Intellectual Property

The employment contract may state that the employee must assign rights to any intellectual property the employee creates while working for the employer. From the employee's perspective, not being able to reap the rewards of the intellectual property he or she created might seriously limit earnings in the future. On the other hand, the employer will not want the employee to unduly benefit from the resources the employer provided, especially if the employee is later in competition with the employer.


An employee-shareholder departure can bring up a host of legal questions. To protect your interests -- whether you are an employer or an employee -- it is wise to seek the assistance of an attorney and use a solid employment contract.

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