Delaware Supreme Court Ruling Opens the Door to “Forfeiture-for-Competition” Provisions of Longer Durations Than Traditional Non-Competes

By Ami Zweig (February 8, 2024)

Employers looking for ways to enhance their restrictive covenant protections should take note of an important recent decision from the Delaware Supreme Court regarding a “forfeiture-for-competition” clause in a limited partnership agreement.

A traditional “non-compete” clause restricts an employee from working for a competitor for a reasonable period following termination of employment and is typically enforceable via injunctive relief. Thus, if the employer can show that the terms of the covenant are reasonable (and/or satisfy any other applicable state law requirements), the employer can obtain a court order enjoining the employee from engaging in competitive activity in violation of the covenant. A “forfeiture-for-competition” clause is similar to a non-compete, but rather than being enforceable via injunctive relief, the result of the employee engaging in competitive activity is that the employee forfeits certain deferred compensation. In other words, a forfeiture-for-covenant clause does not prohibit the employee from working for a competitor but creates an economic incentive for the employee to avoid doing so.

The question before the Delaware Supreme Court in Cantor Fitzgerald, L.P. v. Ainslie was whether a forfeiture-for-covenant clause in a limited partnership agreement was subject to the same reasonableness test as a traditional non-compete. The clause at issue provided for forfeiture of certain deferred compensation if a partner engaged in competitive activities within four years of leaving the partnership. The Court of Chancery had applied a reasonableness test to the forfeiture-for-competition clause and, accordingly, found the clause unenforceable due mainly to its unreasonable duration of four years.

Overturning the Court of Chancery decision, the Delaware Supreme Court held that the forfeiture-for-competition clause at issue – unlike traditional non-competes – should not be subject to a reasonableness test but rather, “should enjoy this court's deference on equal footing with any other bargained-for-term in a limited partnership agreement.” 2024 WL 315193, at *13 (Del. Jan. 29, 2024). In other words, such clause should be enforceable “absent unconscionability, bad faith, or other extraordinary circumstances.” Id. at *1 (Del. Jan. 29, 2024). As the Court concluded, “When sophisticated parties agree in a limited partnership agreement that a partner, who voluntarily withdraws from, and then competes with the partnership, will forfeit contingent post-withdrawal financial benefits, public-policy considerations weigh in favor of enforcing that agreement.” Id. at *13.

Cantor Fitzgerald is significant because it solidifies the law in this area in Delaware (which, is the governing law for many corporate operating agreements) and allows for the possibility of protections against competitive activities spanning materially longer durations than traditional non-competes. While the Delaware Supreme Court’s decision came about in the context of a limited partnership agreement under Delaware law, practitioners may point to it as support for the enforceability of forfeiture-for-competition provisions (without regard to any test for reasonableness) in other contexts.

Based on this development from Delaware’s highest court, many businesses that use deferred compensation arrangements with partners or employees can now, much more confidently than before, utilize forfeiture-for-covenant provisions as an additional tool – coupled with non-competes and other traditional restrictive covenants – for disincentivizing post-employment competitive activities. Particularly given the heightened focus in recent years on traditional non-competes (including a wave of state-level laws, as well as a proposed rule from the Federal Trade Commission that would ban non-competes in the employment context, which currently remains pending – check out our previous discussion of the FTC’s proposed rule for more detailed coverage), the availability of forfeiture-for-covenant provisions may prove to be increasingly important for employers in the years to come.