Sunday, November 28, 2010

Non-Compete/Confidentiality Agreement Between Independent Contractor And Mistakenly Unincorporated Corporation Held To Be Valid And Enforceable By Ohio's Tenth Appellate District

Starting a business or making fundamental changes to the structure of a growing business can be an exciting, fast paced, and a potentially confusing experience for small business owners and entrepreneurs. Finding the time to deal with customers, manage employees, market products and services, and complete other daily tasks necessary to maintain and grow a business can be challenging enough. The added requirement of keeping a business legal can be time consuming and overwhelming.  When fundamental changes are undertaken without proper legal advice and support, mistakes can happen that lead to unnecessary risk and liability. 

A mistake that sometimes occurs, is a new or growing company forgets to file paperwork necessary to convert or register its business with the Ohio Secretary of State. This is what happened in Americare Healthcare Servs. v. Akabuaku, 2010 Ohio 5631, No. 10AP-777 (10th Dist., Franklin Co., November 18, 2010), when America Healthcare Services, LLC ("Americare"), a home health care agency, attempted to convert its business from a Limited Liability Company to a Corporation, but forgot to file the necessary paperwork to complete the conversion. When Americare subsequently filed a lawsuit against former employees who had violated non-competition agreements in their employment contracts, the former employees argued that since the non-compete agreements were with "Americare Healthcare Services, Inc.," (not Americare LLC) a corporation that did not exist when the agreements were signed,  the agreements were invalid and unenforceable.     

Under Ohio Law, a business that fails to properly incorporate may still be treated as registered corporation, if it meets the requirements of a de facto corporation or corporation by estoppel doctrine. 

To achieve the status of a de facto corporation, a business entity must make a good-faith attempt to comply with statutory provision governing incorporation.  Jade Sterling Sttel Co. v. Stacey, 8th Dist. No. 88283, 2007 Ohio 532.  In Americare Healthcare Servs., the court found that Americare did not qualify as a de facto corporation because, although Americare believed it had taken appropriate steps to incorporate by notifying all the entities that it worked with of the change and revising all of its forms to reflect a new corporate structure, it failed to file articles of incorporation with the Ohio Secretary of State, as required by O.R.C. 1701.04. See Jade Sterling (rejecting de facto corporation argument where business entity sent articles of incorporation to the Secretary of State, but failed to show any good-faith effort to verify or complete the incorporation); Quality Interiors, Inc. v. Am. Mgt. & Dev. Corp. (Dec. 7, 1990), 11th Dist. No. 89-T-4303 (no de facto corporation formed where articles of incorporation were not filed with the state).

However, the court did find that Americare qualified as a corporation by estoppel.  Under the corporation by estoppel doctrine, a person who enters into a transaction and treats an organization as a corporation will be estopped (disallowed) from later denying the existence of the corporation.  Society Perun v. Cleveland (1885), 43 Ohio St. 481, 490; Lowe v. Tire Clearing House Co. (Nov. 3, 1924), 8th Dist. No. 5253 (affirming judgment where the trial court found that the defendant was estopped from denying the plaintiff's corporate existence, having contracted with the plaintiff; "[w]hen a contract has been made from which a party has derived benefits, estoppel applies").  The court found that Americare qualified as a corporation by estoppel because  the former employees contracted with Americare, Inc., without objection, treated Americare as a corporation, and because it would not have been unfair to hold the defendants to there non-compete agreements. The court subsequently found the non-competition agreements to be otherwise valid and enforceable and affirmed the an injunction that was granted for Americare by the trial court.     

Although the court treated Americare as a corporation by estoppel and upheld the non-compete agreements made with the former employees, the case serves as an example of the unnecessary risks that a business can face when mistakes are made and basic legal requirements are not met.  Under different facts, the non-competition agreements may have not been found enforceable and Americare could have exposed itself unnecessary liability.  If you are in the process of launching or making fundamental changes to a business, you should contact an attorney in your area to make sure that you receive proper legal counsel for the process.