Delaware Supreme Court “Forfeiture-for-Competition” Provisions May be Enforceable
On Monday, the Delaware Supreme Court reversed a Chancery Court decision that found forfeiture-for-competition terms in Cantor Fitzgerald LP’s limited partnership agreements to be unenforceable.
The restrictive covenants prohibited partners from engaging in competitive agreements for up to two years and provided Cantor Fitzgerald the right to seek injunctive relief and damages for violations. The agreement also authorized the firm to withhold distributions otherwise owed to a partner who withdraws from the partnership if he engages in completive activity for four years following his withdrawal.
In its January 4, 2023 decision, the Chancery Court held that the restrictive covenants were “facially overbroad and void against public policy,” and applied “the same reasonableness analysis our courts apply to traditional noncompetes." Vice Chancellor Morgan T. Zurn stressed that this case pitted against each other “competing policy interests of enforcing private agreements on one hand, and disfavoring restraints of trade and allowing individuals to freely pursue their profession of choice, on the other hand.”
In weighing the balance of the equities, the Vice Chancellor noted that the plaintiffs knowingly entered into the partnership agreement fully aware of the terms and had benefitted from their enforcement against other departing partners. However, the Vice Chancellor found that various factors supported a finding that enforcement would not be equitable, including the fact that Cantor Fitzgerald relied on the determinations of its managing general partners rather than a neutral factfinder. Additionally, the restrictions were “so broad” and “so vague” that it would put former partners at risk of breach when seeking employment in or adjacent to the financial services field. Consequently, the restrictive covenants were found unreasonable and therefore unenforceable.
On appeal, the Delaware Supreme Court unanimously held that “absent unconscionability, bad faith or other extraordinary circumstances," the restrictive covenants in Cantor Fitzgerald’s partnership agreement are enforceable. The Court reasoned that there is a “distinction between a restrictive non-competition covenant that precludes a former employee from earning a living in his chosen field and an agreement that allows a former partner to compete but at the cost of relinquishing a contingent benefit.” The Court reversed the Chancery Court’s decision, finding that the lower court erred by applying the reasonableness analysis for forfeiture-for-competition provisions.
The Court referenced the Delaware Revised Uniform Limited Partnership Act (DRULPA)’s policy of giving “maximum effect to the principle of freedom of contract and enforceability of partnership agreements,” which corresponds with Delaware courts’ tradition of ensuring freedom of contract. The Court concluded that, in light of DRULPA’s policies, "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." The Court ruled that, “[w]hen 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.”
The Court remanded the case to the Chancery Court for further consideration.