CURRENT MONTH (April 2024)
Delaware Supreme Court Reverses Court of Chancery Decision, Upholding Forfeiture-for-Competition Provision in Limited Partnership Agreement
Cantor Fitzgerald, L.P. v. Ainslie, No. 162, 2023 (Del. Jan. 29, 2024).
By Michael Maxwell and Timothy Spangler
On January 29, 2024, the Delaware Supreme Court reversed a decision by the Delaware Court of Chancery, finding that a limited partnership can enforce a “forfeiture-for-competition” provision in its partnership agreement. The provision operates to deprive a partner of certain undistributed payments if the partner engages in competitive activities as outlined in the partnership agreement.
The case involved Cantor Fitzgerald, L.P. and former limited partners who voluntarily withdrew from the partnership. Under the operative partnership agreement, after ceasing to be a partner, certain amounts (the “Conditioned Amounts”) were to be paid to the former partner in equal annual installments over a period of four years. Under the partnership agreement, the Conditioned Amounts are forfeited if the former partner undertakes competitive activity within that four-year period as specified in the partnership agreement.
Cantor Fitzgerald’s Managing General Partner determined each former partner was ineligible to receive the Conditioned Amounts because each engaged in a competitive activity within one year of withdrawing. The former partners sued to recover the Conditioned Amounts. The Delaware Court of Chancery determined, among other things, that the forfeiture-for-competition provision was unenforceable.
The Delaware Supreme Court reversed and found that the forfeiture-for-competition provision at issue was valid under Delaware’s strong public policy favoring freedom of contract in the alternative entity setting. The Delaware Supreme Court distinguished previous noncompete cases that sought injunctive relief and held that, unlike in the previous cases, “the provision at issue here is not a penalty enforced against an employee based on the breach of a restrictive covenant; it is a condition precedent that excuses Cantor Fitzgerald from its duty to pay if the [former partners] fail to satisfy the condition to which they agreed to be bound in order to receive a deferred financial benefit” (emphasis added).
The Delaware Supreme Court then addressed the competing policy rationales at play: promoting freedom of contract and restricting restraints on trade. The Delaware Supreme Court held that the forfeiture-for-competition provision at issue did not implicate the public policy disfavoring restraints on trade because the provision did not prevent the former partners from competing. Rather, the forfeiture-for-competition provision allows the former partners to choose whether to compete, which would result in forfeiting the Conditioned Amounts. Under the employee-choice doctrine, which the Delaware Supreme Court favorably addressed, a provision that allows an employee to choose between a restraint on employment or losing a financial benefit is not a restraint on trade, so the provision does not offend Delaware public policy.
Finally, the Delaware Supreme Court found that the common law doctrine disfavoring forfeitures does not extend to limited partnership agreements. The Delaware Supreme Court reasoned that the Delaware Revised Uniform Limited Partnership Act’s mandate to honor freedom of contract puts a forfeiture provision in a limited partnership agreement on equal footing with any other provision in that agreement. The Delaware Supreme Court also noted that in certain circumstances, public policy or equitable concerns might be enough to outweigh the statutory freedom of contract principles applicable to a limited partnership agreement, but this case did not involve such public policy or equitable concerns.
Takeaways: This decision provides reassurance that governing agreements of alternative entities, including forfeiture-for-competition provisions in such agreements, ordinarily will be enforced as drafted. The Delaware Supreme Court’s decision did not rule, however, on the enforceability of the partnership agreement’s noncompete terms per se, leaving questions around the standards for evaluating these provisions, and related issues such as choice of law, to be addressed in future cases.
FTC Final Rule Outlaws Nearly All Noncompete Agreements
Visit Business Law Today’s April 2024 in Brief: Business Regulation & Regulated Industries to read the full entry on this final rule.
