In a bombshell ruling last year that upended longstanding Delaware law, the Delaware Chancery Court ruled in Ainslie v. Cantor Fitzgerald, L.P., 2023 WL 106924 (Del. Ch. Jan. 4, 2023), that forfeiture-for-competition clauses, under which departing employees must forfeit certain long-term incentive compensation if they join a competitor, are akin to post-employment noncompetes and other restraints of trade.  As a result, the Chancery Court determined these forfeiture provisions should be analyzed under a reasonableness standard rather than the employee choice doctrine, which provides that such agreements should be enforced absent unconscionability, bad faith, or other extraordinary circumstances. In so doing, the Chancery Court concluded that the subject provision was unreasonable and, thus, unenforceable.

To the relief of Delaware companies nationwide, on January 29, 2024, the Delaware Supreme Court overruled the Chancery Court, citing the express policy of the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) of giving “maximum effect to the principle of freedom of contract,” and clarified that the employee choice doctrine applies to forfeiture-for-competition clauses, observing that “[p]arties have a right to enter into good and bad contracts[;] the law enforces both.” See Cantor Fitzgerald, L.P. v. Ainslie, 2024 WL 315193 (Del. Jan. 29, 2024); see Del. Code tit. 6 § 17-1101.

The plaintiffs, six former partners of Cantor Fitzgerald Limited Partnership (“Cantor Fitzgerald”), initiated the action when Cantor Fitzgerald withheld unpaid installments owed to the former partners from their capital accounts after determining that they engaged in competition with the partnership within one year of voluntarily withdrawing from the partnership.  The amounts owed to these six former partners range from just under $100,000 to over $5 million.

Cantor Fitzgerald’s partnership agreement, executed pursuant to the DRULPA, provides that departing partners receive one fourth of the funds remaining in their capital account each year for four years.  The agreement further provides that partners agree to a series of obligations following withdrawal from the partnership, including refraining from engaging in competitive activity.  If a partner breaches any obligations within four years of their departure, they forfeit amounts remaining in their capital accounts.  As an illustration: a departing partner who refrains from competing for two years after withdrawing from the partnership would receive two installments from their capital account, but forfeits the two remaining distributions if they begin engaging in competitive activity in the third year after withdrawing.

In January 2023, despite recognizing that the employee choice doctrine is the “majority” approach in Delaware and nationwide, the Chancery Court ruled that the provisions at issue constitute restraints of trade that should be evaluated for reasonableness—the same analysis Delaware courts apply to traditional noncompete agreements or other restraints of free competition and employee mobility.  Applying this rationale, the Chancery Court concluded Cantor Fitzgerald’s forfeiture-for-competition provisions were facially overbroad and void against public policy, citing the four-year term, unspecified geographic scope, significant amounts potentially forfeited, and the potential deterrent effect on employee mobility.  Further, the Chancery Court likened the forfeiture-for-competition provisions to disfavored liquidated damages provisions that restrain trade by requiring employees to pay former employers an amount untethered to the employer’s loss, i.e., a penalty.

The Delaware Supreme Court reached the opposite conclusion and held that the Chancery Court erred by imposing its notion of reasonableness, concluding instead that a forfeiture-for-competition provision adopted by sophisticated actors who agree that a departing partner will forfeit a specified benefit if they engage in competition should be enforced just like any other contractual provision; in other words, public policy favors holding these parties to their agreements. While the Chancery Court invoked a comparison to liquidated damages, the Delaware high court viewed the provisions as conditions precedent to Cantor Fitzgerald’s duty to pay any remaining installments remaining in a departed partner’s capital account; the amounts are not payable unless the condition not to compete has been met.  The plaintiffs’ purported competition, an open issue to be determined on remand, would excuse Cantor Fitzgerald from its duty to distribute the funds remaining in the departed partners’ capital accounts. The Court further pointed out that liquidated damages cannot be triggered by conditions precedent, but rather only by contractual breaches.

The Delaware Supreme Court’s conclusion is consistent with the majority “employee choice” doctrine which dictates that courts should not review forfeiture-for-competition provisions for reasonableness so long as the agreements were voluntarily entered into and are enforced against a partner who voluntarily withdraws from, and then competes with, the partnership, because it is assumed that “an employee who elects to leave a company makes an informed choice between forfeiting a certain benefit or retaining the benefit by avoiding competitive employment.” Cantor Fitzgerald, 2024 WL 315193 at *11 (quoting Lucente v. Int'l Bus. Machines Corp., 310 F.3d 243, 254 (2d Cir. 2002)).  The decision is also consistent with prior decisions from state and federal cases in Delaware, including W.R. Berkley Corporation v. Dunai, 2021 WL 1751347 (D. Del. May 4, 2021) and W.R. Berkley Corporation v. Hall, 2005 WL 406348 (Del. Super. Ct. Feb. 16, 2005), both of which enforced similar forfeiture and clawback provisions.

The court contrasted the forfeiture-for-competition provision with traditional noncompete agreements or other restrictive covenants subject to judicial review for reasonableness and highlighted that forfeiture-for-competition provisions do not subject a former employee to a potential injunction, do not prohibit employees from competing and remaining in their chosen profession, and do not deprive the public of the employee’s services. Rather, they provide employees with a choice that is set forth clearly in the relevant agreements: compete and forfeit certain compensation or don’t compete and keep it. As a result, forfeiture-for-competition provisions do not compel the same balance of policy interests and equities typically applied to noncompetes or other restrictions on trade, and rather, are on “equal footing with any other bargained-for-term in a limited partnership agreement.” Although this decision arose in the context of a limited partnership agreement, as opposed to a long-term incentive plan or the like, there is no reason to believe that the outcome would have been different in another like context.

As resistance to traditional noncompete agreements grows, employers can consider alternative measures that may deter or delay a former high-level professional from engaging in competitive activity. In addition to forfeiture-for-competition clauses, employers may consider garden leave provisions, customer and coworker non-solicitation covenants, and, of course, nondisclosure agreements.

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