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February 26, 2025
The Delaware Supreme Court, in early 2024, issued a decision in Cantor Fitzgerald, L.P. v. Ainslie in which it held that a Delaware limited partnership provision that allows the partnership to withhold unpaid distributions from a withdrawing partner who competes with the partnership (a forfeiture-for-competition provision) is not a restraint of trade that is subject to reasonableness review (i.e., a review of the provision’s duration, geographic scope, and restricted activities to ensure that it does not unduly burden the employee while it protects the employer’s legitimate business interest). Instead, the Delaware Supreme Court endorsed the employee choice doctrine, holding that the reviewing court should deem the limited partnership provision enforceable, subject to ordinary breach of contract defenses (e.g., fraud, lack of consent, unconscionability).
The United States Court of Appeals for the Seventh Circuit was considering an appeal raising a similar forfeiture-for-competition dispute under Delaware law that arises from a company’s restricted stock unit agreement.
Specifically, LKQ Corporation, a Delaware corporation, required certain key employees to sign RSU Agreements that awarded stock units subject to vesting and forfeiture if the employee competed with LKQ within nine months of departure. Robert Rutledge, a plant manager at LKQ, signed RSU Agreements containing forfeiture-for-competition provisions and received stock through the agreements over several years. After voluntarily resigning from LKQ, Rutledge joined a competitor, and LKQ sued to enforce the forfeiture provisions and recover the proceeds from the sale of LKQ stock received under the RSU Agreements.
To aid in its consideration of an appeal in the LKQ case, the Seventh Circuit certified two questions to the Delaware Supreme Court, the first of which was whether Cantor Fitzgerald precludes reviewing forfeiture-for-competition provisions for reasonableness in circumstances outside the limited partnership context.[1]
In December 2024, the Delaware Supreme Court responded to the Seventh Circuit’s questions, holding that Cantor Fitzgerald applies outside the limited partnership context, meaning that forfeiture-for-competition provisions in employee agreements, such as restricted stock unit (RSU) agreements, are enforceable under Delaware law based on freedom of contract principles, and are not subject to reasonableness review as restraints of trade. See LKQ Corp. v. Rutledge, No. 110, 2024, 2024 Del. LEXIS 419 (Dec. 18, 2024). The requirement to return previously received benefits (i.e., claw back) upon competition does not alter the enforceability of forfeiture-for-competition provisions under the employee choice doctrine.
The Delaware Supreme Court reasoned that its decision in Cantor Fitzgerald was not limited to the limited partnership context but relied on broader principles of freedom of contract and respecting voluntary agreements between sophisticated parties. The Court found that forfeiture-for-competition provisions, like those in RSU agreements, do not restrict competition or an employee’s ability to work, and employers need not confer deferred benefits if the employee chooses to compete. The Court rejected arguments that requiring the return of previously received benefits alters the enforceability analysis, citing cases upholding such “claw back” provisions as enforceable contractual obligations.
Employers: Because Delaware precedent now supports forfeiture-for-competition provisions, choose Delaware as the law to govern your equity and deferred incentive arrangements if a legitimate nexus to Delaware exists.
Note, however, that reasonable drafting of your agreements and plan documents, as well as the facts and circumstances applicable to your employment arrangements, still matter. Specifically, the Delaware Supreme Court left open the possibility that a forfeiture-for-competition provision would be subject to a reasonableness review if it requires a claw back “so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party.”
Note also that, in its response to the certified questions, the Delaware Supreme Court did not address an involuntary termination situation. It expressly stated that, under the employee choice doctrine, “courts do not review forfeiture-for-competition provisions for reasonableness so long as the employee voluntarily terminated her employment.”
The author of this article, Patricia Tsipras, is a member of the Bar of Pennsylvania. This article is designed to provide one perspective regarding recent legal developments, and is not intended to serve as legal advice in Pennsylvania, Delaware, or any other jurisdiction, nor does it establish an attorney-client relationship with any reader of the article where one does not exist. Always consult an attorney with specific legal issues.
[1] The Seventh Circuit also asked, “[i]f Cantor Fitzgerald does not apply in all other circumstances, what factors inform its application? For example, does it matter what type of agreement the forfeiture provision appears in, how sophisticated the parties are, whether the parties retained counsel to review the provision, whether the forfeiture involves a contingent payment or claw back, how far backward a claw back reaches, whether the employee quit or was involuntarily terminated, or whether the provision also entitled the company to injunctive relief?” The Delaware Supreme Court did not need to respond to this question, given its holding on the first certified question.
