Shelby Stack
Staff Editor, Delaware Journal of Corporate Law, Volume 50
Introduction
Justice Traynor, writing for the Delaware Supreme Court in Cantor Fitzgerald, L.P. v. Ainslie, reinforced that Delaware “hold[s] freedom of contract in high—some might say, reverential—regard[,]” by concluding that a forfeiture-for-competition provision in a limited partnership agreement warranted review under the employee choice doctrine despite public policy concerns of restraints of trade.[2] In LKQ Corp. v. Rutledge, the Court again reinforced this principle by broadening the scope of Cantor Fitzgerald to extend beyond the limited partnership context in a certified question of law from the Seventh Circuit Court of Appeals.[3] This blog will review these decisions and their impact on forfeiture-for-competition provisions in employment contracts.
Cantor Fitzgerald
In Cantor Fitzgerald, L.P. v. Ainslie, the Delaware Supreme Court reviewed an appeal concerning “the enforceability of ‘forfeiture for competition’ provisions of a limited partnership agreement,” that authoriz[ed] the partnership to withhold distributions otherwise owed to a partner who withdraws from the partnership if he engaged in specified activities in competition with the partnership” within four years of withdrawing as partners.[4] The six plaintiffs—former partners—forfeited these distributions in amounts ranging from about $100,000 to $5 million, for engaging in competitive activities under the partnership agreement within four years of leaving the partnership.[5] The Delaware Supreme Court held that “a Delaware limited partnership provision allowing the partnership to withhold unpaid distributions from a withdrawing partner who competes with the partnership—a so-called forfeiture-for-competition provision—is not a restraint of trade subject to reasonableness review.”[6]
The Court relied on the “contractual flexibility” intended by the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) to enforce the forfeiture-for-competition provision in the limited partnership agreement as written.[7] The Court noted that “freedom of contract is not absolute” under circumstances where contracts are contrary to public policy or harmful to the public.[8] But the Court found that a “significant” difference exists “between a restrictive non-competition covenant that precludes a former employee earning a living in his chosen field and agreement that allows a former partner to compete but at the cost of relinquishing a contingent benefit[.]”[9] That difference, according to the Court, is that competition is permitted under the provisions litigated in this case, but the former partners pay the cost of choosing to work with a competitor.[10] On the other hand, restrictive non-competition covenants present increased public policy concerns on restraints of trade because competition can be without vindication. This results in “effectively depriv[ing the employee] of his livelihood, and correspondingly, exposed to the risk of serious financial hardship.”[11]
The Court also noted that because of “DRULPA’s statutory mandate to honor the freedom of contract in partnership agreements, . . . forfeitures in limited partnership agreements should enjoy this court’s deference on equal footing with any other bargained-for-term in a limited partnership agreement.”[12] Accordingly, this warranted a “divergence from” the “common law’s disfavor of forfeitures[.]”[13]
The Court held that “[w]hen sophisticated parties agree in a limited partnership agreement that a partner, who voluntarily withdraw from, and then competes with, the partnership, will forfeit contingent post-withdrawal financial benefits, public-policy considerations weigh in favor of enforcing that agreement.”[14] As a result, the Court endorsed Cantor Fitzgerald’s argument that the employee choice doctrine was applicable under these circumstances given the competing public policy interests. Because the employee choice doctrine applied to the forfeiture for competition provision in this case, the Court remanded to the Court of Chancery to determine whether the former partners engaged in competitive activities as provided for by the limited partnership agreement provision—i.e., breached their contractual obligations.[15]
LKQ Corporation Broadens Cantor-Fitzgerald Scope
In LKQ Corp. v. Rutledge, the United States Court of Appeals for the Seventh Circuit asked the Delaware Supreme Court a certified question of law as to “whether the employee choice doctrine applies outside the limited partnership context.”[16] The forfeiture-for-competition provision at issue on appeal for the Seventh Circuit was similar to the forfeiture-for-competition provision addressed in Cantor Fitzgerald, but originated from the corporation’s restricted stock unit agreements.[17]
LKQ Corporation (“LKQ”) is a corporation formed under Delaware law “in the auto salvage and recycled parts business.”[18] Two percent of its employees (“Key Persons”) were eligible to receive Restricted Stock Units (“RSUs”) by RSU Agreements, which were awarded based on a vesting schedule.[19] The RSU Agreements were governed by non-competition requirements that prevented Key Persons from competing if a Key Person decided to leave the LKQ Corporation.[20] Robert Rutledge, a plant manager in a LKQ facility in Florida and Key Person, signed the RSU Agreements and agreed: (1) “not to compete with LKQ if he left the company”; (2) to “forfeit his RSUs and any stock issued through the RSUs if he left and competed within nine months post-departure”; and (3) that “forfeiture would trigger a repayment obligation for any stock sold under the RSU grants[.]”[21] “In April 2021, Rutledge voluntarily resigned from LKQ and joined a competitor shortly after his departure.”[22]
LKQ brought this action against Rutledge in Illinois federal court, suing for breaches of contract and unjust enrichment. LKQ requested injunctive relief to prevent Rutledge from working for a competitor, and “demanded that Rutledge pay LKQ the proceeds from all LKQ shares received and sold under the RSU Agreements.”[23] The district court in Illinois held that the provisions of the RSU Agreements, which were governed by Delaware law, were an unreasonable restraint of trade. The Court relied on the Court of Chancery’s decision in Ainslie v. Cantor Fitzgerald, L.P.,[24] which the Delaware Supreme Court rejected and reversed on appeal in Cantor Fitzgerald, L.P. v. Ainslie.[25] The Seventh Circuit certified two questions of law to the Delaware Supreme Court as a result of the Cantor Fitzgerald reversal: (1) whether the Cantor-Fitzgerald decision extends beyond the limited partnership context for reviewing forfeiture-for-competition provisions, and (2) “[i]f Cantor Fitzgerald does not apply in all other circumstances, what factors inform its application?”[26]
The Delaware Supreme Court agreed with the Seventh Circuit’s “broad” interpretation of Cantor Fitzgerald that, although the decision “in part” relied on the “contractual flexibility” intended by DRULPA, the “reasoning was not . . . limited to the partnership act.”[27] The other reasons for allowing such contractual flexibility under forfeiture-for competition provisions include: (1) that it “does not restrict competition or a former [employee’s] ability to work[,]” but rather forfeits a benefit for competing during the relevant time; (2) “unlike restrictive covenants, forfeiture-for-competition provisions ‘are not enforceable through injunctive relief’ and ‘do not deprive the public of the employee’s services[,]’” so “restraint of trade policy implications are ‘diminished—if . . . not vanish[ed]—’ for forfeiture-for-competition provisions”; and (3) “[b]usiness entities would be discouraged from offering employees additional benefits if [the court] did not respect their contracts.”[28][RK1]
Although the RSU Agreements contained a claw back provision, requiring Rutledge to return any stock sold under the RSU grants, the LKQ Corp. Court found its reliance on W.R. Berkley Corp. v. Dunai and W.R. Berkley Corp. v. Hall in Cantor Fitzgerald instructive.[29] In W.R. Berkely Corp. v. Dunai, the District Court of Delaware held, and the Third Circuit affirmed, that a $200,000 repayment obligation for stock benefits from an employee’s former employer under stock grant agreements, “conditioned on non-competition for a year post-departure[,]” were enforceable under Delaware law. The district court reasoned that it was “not a $200,000 penalty for working for a competitor; it [was] returning a supplemental benefit for breaching the terms of a bargain.”[30] Similarly, in W.R. Berkley Corp. v. Hall, the Delaware Superior Court held that a company’s stock option plan prohibiting an employee from working for competition for six months post-departure was enforceable under Delaware law because “the court was simply enforcing a contractual obligation to repay the employment benefit that did not restrain the employee’s freedom of employment.”[31]
Consequently, the Delaware Supreme Court certified the Seventh Circuit’s first question in the affirmative: Cantor Fitzgerald applies outside the limited partnership context, including RSU Agreements.[32] The decision broadens the scope of Cantor Fitzgerald to forfeiture-for-competition provisions contexts outside the limited partnership agreement, including contractual obligations that implicate claw back provisions.[33]
Implications
Although the outcome of Cantor Fitzgerald and LKQ Corp. may seem harsh to some, both decisions fortify Delaware’s deference to upholding unambiguous contracts as written. The facts of such cases reveal that many litigants can face dealers’ remorse. But what Cantor Fitzgerald and LKQ Corp. can teach sophisticated parties is to keep hindsight in foresight. Sophisticated parties should keep these principles at the forefront of negotiations when entering into employment contracts to understand what their rights are when voluntarily leaving employment. These parties must also understand how these principles affect future employment and conferred benefits from past employment. Further, litigators can now expect a shift in focus to defenses for breaches of contract under the employee choice doctrine when litigating forfeiture-for-competition clauses in employment contracts, rather than going the enforceability route. LKQ Corp. also highlights the prevalence of Delaware’s contractarian principles in jurisdictions throughout the country given the number of companies formed under Delaware law, but operating elsewhere.
Moreover, in LKQ Corp., the Court noted that “a forfeiture-for-competition provision which requires a claw back that is so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party and should be reviewed reasonableness.”[34] Rutledge argued that the circumstances of the RSU Agreements differed because Rutledge was “a plant manager earning a modest salary,” therefore “[i]t would be unfair for LKQ to recover eight years of LKQ stock sale proceeds.”[35] Although certification requests limit the Delaware Supreme Court’s analysis to “issues of law based on stipulated facts[,]” the Court seems to address Rutledge’s argument, and potential future arguments, in relation to how the principles from LKQ Corp. and Cantor Fitzgerald apply in the context of unsophisticated parties.[36] Thus, unsophisticated parties entering into forfeiture-for-competition provisions may still have recourse under reasonableness review under Delaware law.
About the Author
Shelby is a third-year law student at Widener University Delaware School of Law and is a Staff Editor for Volume 50 of the Delaware Journal of Corporate Law. She graduated from Towson University in 2020, earning a bachelor’s degree with a major in Sport Management. She went on to receive her master’s degree in Communications Management in 2022 from Towson University. Throughout her last year of law school, Shelby has served as a Josiah Oliver Wolcott Fellow to Justice Gary F. Traynor in the Delaware Supreme Court. After graduating law school, Shelby will complete a judicial clerkship with the Honorable Judge Calvin Scott in the Superior Court of Delaware. Upon completion of her clerkship, Shelby plans to practice law as a corporate litigator.
[1] Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024); LKQ Corp. v. Rutledge, No. 110, 2024, 2024 WL 5152746, at *1 (Del. Dec. 18, 2024).
[2] 312 A.3d at 676–77.
[3] LKQ Corp., 2024 WL 5152746, at *6.
[4] 312 A.3d at 677.
[5] Id.
[6] LKQ Corp., 2024 WL 5152746, at *1 (citing Cantor Fitzgerald v. Ainslie, 312 A.3d 674 (Del. 2024)).
[7] Cantor Fitzgerald, 312 A.3d at 677; see also Del. Code Ann. tit. 6,§ 17-1101.
[8] Cantor Fitzgerald, 312 A.3d at 689.
[9] Id. at 691.
[10] Id. at 691.
[11] Id. at 691.
[12] Cantor Fitzgerald, 312 A.3d at 692.
[13] Id.
[14] Cantor Fitzgerald, 312 A.3d at 692.
[15] Id. at 690, 962–93.
[16] LKQ Corp., 2024 WL 5152746, at *1.
[17] Id.; see also Cantor Fitzgerald, 312 A.3d at 677.
[18] LKQ Corp., 2024 WL 5152746, at *1.
[19] Id.
[20] Id. at *1–2.
[21] LKQ Corp., 2024 WL 5152746, at *2.
[22] Id.
[23] Id.
[24] Id. at *3; see also Ainslie v. Cantor Fitzgerald L.P., No. 9436, 2023 WL 106924, at *1 (Del. Ch. Jan. 4, 2023). Cantor Fitzgerald, 312 A.3d 674 (Del. 2024).
[25] LKQ Corp., 2024 WL 5152746, at *3.
[26] Id. at *1, *3.
[27] LKQ Corp., 2024 WL 5152746, at *4; see also Cantor Fitzgerald, 312 A.3d at 677.
[28] LKQ Corp., 2024 WL 5152746, at *4–5.
[29] Id. at *5 (citing No. 19-cv-01223, 2021 WL 17551347, at *1 (D. Del. May 4, 2021); No. 03C-12-146WCC, 2005 WL 406348, at *1 (Del. Super. Ct. Feb. 16, 2005)).
[30] LKQ Corp., 2024 WL 5152746, at *5 (quoting Dunai, 2021 WL 17551347, at *1, aff’d,No. 22-2963, 2024 WL 511040 (3d Cir. Feb. 9, 2024)) (internal quotation marks omitted).
[31] LKQ Corp., 2024 WL 5152746, at *6 (citing Hall, 2005 WL 406348, at *5).
[32] LKQ Corp., 2024 WL 5152746, at *6.
[33] Id. at *6.
[34] LKQ Corp., 2024 WL 5152746, at *6.
[35] Id. at *4.
[36] Id. at *6.
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