Delaware Supreme Court Enforces Forfeiture for Competition Provision in Partnership Agreement
In Cantor Fitzgerald, L.P. v. Ainslie, No. 162, 2023, 2024 WL 315193 (Del. Jan. 29, 2024), the Delaware Supreme Court held enforceable a “forfeiture for competition” provision in a limited partnership agreement, upholding “the freedom of contract” and enforcing “as a matter of fundamental public policy the voluntary agreements of sophisticated parties.” Given Delaware’s recent shift from its typically non-compete friendly stance, the Delaware Supreme Court’s ruling is beneficial for employers.
In Cantor Fitzgerald, six plaintiffs (the “Former Partners”) challenged the enforceability of a “forfeiture for competition” provision intheir Limited Partnership Agreement (the “Agreement”) after the six Former Partners resigned, engaged in activities which violated certain restrictive covenants in the Agreement, and, consequently, forfeited capital disbursements. The Agreement provided that a partner would forfeit capital distributions otherwise owed to the partner, if, after their withdrawal from the partnership, the partner engaged in certain competitive activities.
The Former Partners were former limited partners in Cantor Fitzgerald, L.P., a global financial services company formed under Delaware law, and employed by Cantor Fitzgerald Hong Kong Capital Markets Limited (“Cantor HK”), an affiliate of Cantor Fitzgerald, L.P. Cantor Fitzgerald maintains a capital account for each of its partners that is paid out in annual installments over four years following a partner’s withdrawal. Between 2010 and 2011, all six Limited Partners voluntarily resigned from Cantor HK, and withdrew as partners from Cantor Fitzgerald, L.P.
Upon their admission as limited partners, the Former Partners each signed the Agreement which, among other things, contained a non-competition, employee non-solicit, and customer non-solicit provisions. Under the Agreement, if a Former Partner breached any of these restrictive covenants, the Former Partner would forfeit future payments to which they were otherwise entitled to under the Agreement, which included the four annual capital disbursements.
Within one year of their resignation from Cantor Fitzgerald, all six of the Former Partners engaged in activities which breached the restrictive covenants in the Agreement. Accordingly, Cantor Fitzgerald withheld the Former Partners’ capital disbursements, which ranged from just under $100,0000 to over $5 million.
The Former Partners filed a lawsuit in the Delaware Court of Chancery against Cantor Fitzgerald for breach of the Agreement and requested a declaration that the restrictive covenants contained therein were unenforceable. The Court of Chancery found that the forfeiture for competition provision was unenforceable under the “reasonableness” standard applied to restrictive employment covenants. Specifically, the provision was “an unreasonable restraint built on unreasonable restrictive covenants,” and could not excuse Cantor Fitzgerald from its obligation to pay the Former Partners. Accordingly, the Former Partners’ failure to abide by the restrictive covenants could not constitute a breach of the Agreement.
The Delaware Supreme Court reversed the Court of Chancery’s decision, finding that the forfeiture-for-competition provision was not akin to restraints of trade which are subject to review for “reasonableness.” The Court noted that the public policy distinctions between an employee non-compete—which “precludes an employee from earning a living in their chosen field”—and a forfeiture for competition provision—which allows a Former Partner to compete, but at the cost of relinquishing a contingent benefit—are “significant.”
Rather, the Court analyzed the provision using standard contract interpretation principles. In doing so, the Court concluded that, when “sophisticated” parties voluntarily enter into an “unambiguous” agreement, courts should, absent unconscionability, bad faith, or other extraordinary circumstances, hold the parties to their agreements. Accordingly, the forfeiture for competition provision was enforceable.
While the Delaware Supreme Court’s ruling is limited to the context of partnership agreements, its ruling is helpful for employers in light of Delaware’s recent shift from its non-compete friendly history.
