How California Law Provides Recourse
The Hollywood movie The Social Network portrays a young Mark Zuckerberg, founder of Facebook, on his first endeavor to create a social networking website. Zuckerberg joins forces with twins, Cameron and Tyler Winklevoss, to create a website, Harvard Connection. As the movie goes, and according to the Winklevoss twins, Zuckerberg became a part of the Harvard Connection development team, and presumably a partner in the business venture.
Then, according to the Winklevoss twins, they were robbed! Their business partner, Zuckerberg, took their business idea and created a competing social networking website – Facebook. The Winklevoss twins were outraged and sued Zuckerberg. The complaint entailed numerous claims against Zuckerberg including a claim for breach of fiduciary duty under Massachusetts common law. It has beenwell-publicized that Zuckerberg eventually settled with the Winklevoss twins for a whopping $65 million.
While the Winklevoss-Zuckerberg dispute was governed by Massachusetts law, let’s discuss how California law treats those same set of circumstances – when a partner leaves the partnership to pursue a competing business venture.
California Partnership Law
After the business partnership is formed, the partners have certain duties and obligations to each other and to the partnership itself. These obligations can include contractual obligations if the partners enter into agreements with each other. The partners also owe fiduciary duties to the partnership and each other. See Leff v. Gunter (1983) 33 Cal.3d 508, 514.
California’s Uniform Partnership Act provides that a partner owes not only a duty of care to the partnership and the partners, but also owes a duty of loyalty to the partnership and the partners. According to California Corporations Code Section 16404, a partner’s duty of loyalty includes the following duties.
To account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property or information, including the appropriation of a partnership opportunity. To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.
This statute creates clear duties that the partners owe each other and the partnership during the operation of the partnership business and during the winding up process. The common law takes these fiduciary duties one big step further. California case law imputes to a partner that withdraws from the partnership, a fiduciary duty that persists even after the partner withdraws.
Partners, as fiduciaries, cannot pursue the object of the venture to the exclusion of the other partners. Leff, 33 Cal. 3d at 514. In Leff, the partners sought to submit a bid on a government construction project. Defendant-partner secretly began working with a third party to submit a bid that would compete with the partnership’s bid that the partnership was preparing. Months later, defendant-partner withdrew from the partnership. Plaintiff-partner went forward with submitting the bid alone, but defendant-partner and its new third party partner submitted a separate bid and were awarded the project. Plaintiff-partner sued defendant-partner for breach of fiduciary duty and received a jury award of 1/6 of the profits that would have been earned through the original partnership’s procurement and execution of the project. In Leff, the California Supreme Court stated that “where one partner secretly enters into a contract sought to be contracted by the partnership which another partner is negotiating on behalf of the partnership such partner is in violation of his fiduciary duty to the excluded partner.” Leff, 33 Cal. 3d at 513.
In Page, the California Supreme Court held that “a partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity.” Page v. Page (1961) 55 Cal. 2d 192
More recently, the United States District Court of the Northern District of California recognized a similar rule for fiduciaries in a co-venture (a business entity, which from a legal standpoint, is treated virtually the same as a partnership). In Interserve, Inc. v. Fusion Garage PTE. LTD. (N.D. Cal. Aug. 24, 2010) No. C09-5812 RS PVT, 2010 WL 3339520, plaintiff and defendant started a collaborative effort to develop a computer tablet. Before the parties finished the product development, defendant left the venture. Afterward, defendant brought its own computer tablet product to market. Plaintiff sued defendant for breach of fiduciary duty among other claims.
The court denied the plaintiff’s preliminary injunction on the grounds that the requested relief was not warranted. However, the court found that plaintiff was likely to succeed on the merits of showing the existence of a co-venture and accordingly, there were grounds for finding that defendant may have breached a fiduciary duty to the co-venture and to the other co-venturers. As such, the court in Interserve recognized a rule of law similar to the one articulated in Leff and Page: that a partner may not withdraw from the partnership to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity.
Cutting Ties with a Partnership
If a partner seeks to withdraw from a partnership to pursue a new venture that may use the partnership’s assets or opportunities, then the partner runs the risk of breaching a fiduciary duty to the former partners. To protect against potential liability, the withdrawing partner could solicit a written waiver from the partnership and other partners whereby they waive their interest to any of the profits of the withdrawing partner’s new business venture. Unfortunately, the feasibility of this protective measure presumes that a withdrawing partner is amicably splitting ways from the other partners to start a competing business. In most cases, the other partners are not going to be thrilled and will consider doing their best impression of a Winklevoss triplet.