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May a Shareholder Compete After He is Fired as an Employee?

In a previous posting (9/2/08) I discussed the fact that termination of a shareholder from his or her status as an employee could constitute “oppression” under New Jersey law and entitle the shareholder to certain remedies, including a court-ordered buy-out at fair value.  Since then, I have encountered several clients wondering what their rights are while they wait for their case to play out in court.  In other words, when the company fires you and then tells you that you can’t even work in the industry, or for a competitor, is this legally binding?

The answer may depend on what documents you have signed and the circumstances of the termination. Often shareholder-employees sign a restrictive covenant containing a non-compete agreement, either as a separate document or as part of a larger shareholder agreement. While such a document is sometimes enforceable, in New Jersey there are often very fact-specific reasons why the agreement cannot be enforced (for example, the non-compete must protect a legitimate interest, like keeping proprietary information secret, and cannot be designed simply to prevent competition). In addition to such reasons relating to the nature of the particular industry, the mere fact of termination could in some cases prevent the majority shareholders or the company from enforcing the provision against you. After all, it is difficult to argue on the one hand that your work performance was so bad you needed to be terminated, while arguing on the other hand that it would damage the company if a competitor hired you.

For those shareholder-employees who do not have a non-compete, even one contained in the shareholders agreement, the situation is cleaner, but it does not necessarily mean that you are free to compete. If you seek to be bought out of your shares and make it clear that you no longer wish to be involved in corporate matters, you may have a good case for being able to compete. But if you have no claims to assert and no basis to seek a buy-out of your shares, the majority shareholders may be able to prevent you from competing based on the fiduciary duty that you owe to the company as a shareholder.

These issues are extremely fact sensitive and largely dependent upon the wording of the applicable documentation. An attorney well versed in these issues should be consulted before deciding on your next step after the majority shareholders fire you.