We began 2024 with the Delaware Supreme Court’s decision in Cantor Fitzgerald, L.P. v. Ainslie. We end the year with further clarity around the scope and contours of that decision. On December 17, responding to two questions certified by the Seventh Circuit in LKQ v. Rutledge, 96 F.4th 977 (7th Cir. 2024), the Delaware Supreme clarified that: 

• Cantor Fitzgerald’s holding that forfeiture-for-competition provisions — through which a contracting party agrees to give up or forfeit financial benefits if they later compete for a specified period of time — are not subject to the more exacting “rule of reason” analysis attendant to standard post-employment restrictions, and this rule applies irrespective of whether those provisions are found in an agreement between a partner and a partnership or in agreements between an employer and an employee.

• The “Employee Choice Doctrine” instead governs, meaning that forfeiture-for-competition provisions receive treatment similar to any other standard contractual term, subject only to regular contract-based defenses.  

• Delaware’s default application of the “Employee Choice” analysis to forfeiture-for-competition provisions is not necessarily dependent upon the relative sophistication of the contracting employee or businessperson, nor is it necessarily dependent upon whether the restrictive covenant agreement in question includes other terms that may also seek to enjoin the contracting party from affirmatively engaging in competitive business activities.  

The Winding Road to LKQ’s Certified Questions

In Cantor Fitzgerald, six former partners left the firm and joined competing businesses. Cantor Fitzgerald’s limited partnership agreement included a forfeiture-for-competition provision, which allowed the firm to withhold certain payments from partners who competed with the firm within four years of their departures.

The Delaware Court of Chancery ruled that the forfeiture-for-competition provision was an unreasonable restraint on trade and thus unenforceable. The court applied a reasonableness review akin to that used for standard post-employment non-compete and non-solicit provisions that seek to limit or enjoin a person’s business activities following their association with the contracting firm. Premised on the concept that restraints on trade are disfavored as a matter of public policy, this analysis requires courts to analyze the background facts relative to the scope of the restrictions, and in turn determine whether they extend beyond a valid and protectable business interest.

But on January 29, 2024, the Delaware Supreme Court reversed, emphasizing that the freedom to contract takes a front seat when the post-employment restraint gives the contracting individual a choice and does not actually restrain their business endeavors: Take the financial benefit and adhere to the restrictive terms, or violate them and forfeit the money.

The Cantor Fitzgerald court reasoned that such provisions do not truly impede a businessperson’s freedom of movement or limit that person’s business opportunities and they are thus not actual trade restraints justifying a more exacting analysis. Thus, the court held such provisions should be honored and enforced, save the applicability of standard contract defenses (like duress, unconscionability, lack of consideration, and fraud).

Cases Collide: Enter LKQ v. Rutledge

In 2021, LKQ Corporation filed a lawsuit against former employee Robert Rutledge in the Northern District of Illinois, alleging breaches of contract and unjust enrichment. LKQ sought both to enforce the restrictive covenants preventing Rutledge from engaging in certain post-employment business activities and to recover proceeds from stock sold by Rutledge under certain restricted stock unit agreements governed by Delaware law (“RSU Agreements”). The RSU Agreements included “forfeiture for competition” provisions, which LKQ argued should be enforced as written, irrespective of their broader scope, because they did not by themselves prevent Rutledge from any business activities. The district court analyzed both the restrictive covenant provisions and the RSU Agreement provisions under the same reasonableness analysis. Finding the provisions in both agreements overly broad and unreasonable under that analysis, the district court deemed them unenforceable and ultimately dismissed LKQ’s claims. LKQ appealed.   

The Seventh Circuit had no problem affirming the district court’s dismissal of LKQ’s unjust enrichment claim and the district court’s holding that the standard post-employment restrictive covenant agreements were unreasonable, overbroad, and therefore unenforceable.

By the time the Seventh Circuit began considering how to address the RSU Agreements, Cantor Fitzgerald had only recently crossed the docket. Based on that decision, the Seventh Circuit certified two key questions:

• The Seventh Circuit noted that Cantor Fitzgerald arose in a non-employment context; specifically, under partnership agreements. The Seventh Circuit therefore asked whether Cantor Fitzgerald “precludes reviewing forfeiture-for-competition provisions for reasonableness in circumstances outside the limited partnership context.” In other words, does Cantor Fitzgerald’s holding that such provisions are only reviewed subject to standard contract defenses apply when an RSU Agreement between an employer and employee — as in LKQ — is the subject of the review?                                                                        
• The Seventh Circuit then asked whether, if Cantor Fitzgerald applied to forfeiture-for-competition provisions only in certain instances (such as in the limited partnership agreement/relationship context), were there specific factors that should be applied to determine its application? The Seventh Circuit expounded with directed inquiries tailored to LKQ’s facts: “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?” 

Ask and You Shall Receive: Delaware Responds to the Seventh Circuit

As already summarized, the Delaware Supreme Court effectively answered the first question “yes” — it does apply (and bars the use of the more rigorous “reasonableness” analysis) in other circumstances, including forfeiture-for-competition provisions between an employer and an employee. The court further emphasized that direct trade restraints are largely non-existent when the agreement calls only for forfeiture of certain financial benefits and hearkened back to Cantor Fitzgerald’s emphasis on the freedom to contract between private parties.  

As to the second question, the Delaware Supreme Court stated that because it answered the first question “yes” it need not respond directly to the second question. But the court did add some color, indicating that the freedom to contract will generally take the front seat.

For example, the court rejected the idea that Rutledge’s position as an arguably less-sophisticated middle-management employee (as opposed to a more senior executive role) altered the analysis. Likewise, the court stated that the use of provisions requiring the return of benefits already received (like in LKQ), as opposed to the forfeiture of benefits that hadn’t vested (like in Cantor Fitzgerald), does not change the analysis. Respecting private agreements between contracting citizens, the court reasoned, has “wealth-creating and peace-inducing effects” which are “undercut if citizens cannot rely on the law to enforce their voluntarily-undertaken mutual obligations.” Thus, coupled with the fact that trade restraint concerns are diminished if not “vanish[ed]” in the case of such provisions, the court maintained that the freedom to contract is the more pressing priority when interpreting “forfeiture for competition” covenants.

The court left the door open to potential exceptions, but stopped short of articulating anything concrete, noting that it can only analyze issues of law using stipulated facts under Delaware law and therefore cannot entertain hypothetical rules based on non-existent facts. Still, the court said that it “might be the case . . . that a forfeiture-for-competition provision which requires a claw back is so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party and should be reviewed for reasonableness.”¹

As we noted at the start of 2024 when it was handed down, the Cantor Fitzgerald decision “swings the pendulum back a bit in the other direction,” favoring the enforcement of post-employment restrictions that require the repayment or forfeiture of benefits, and taking a nuanced approach to the application of the more rigorous “reasonableness” analysis in the restrictive covenant context. The Delaware Supreme Court’s answers in LKQ push the pendulum further in that direction.

Littler’s Unfair Competition and Trade Secret Practice Group is closely monitoring these decisions and companies are strongly encouraged to consult with counsel to discuss the parameters of any existing or contemplated agreements containing forfeiture for competition provisions or other restrictive covenants.