I.    Background—Cantor Fitzgerald v. Ainslie

The Delaware Supreme Court case, Cantor Fitzgerald v. Ainslie,^[1] decided in January 2024, was groundbreaking as to the enforceability of forfeiture-for-competition and clawback provisions in equity and deferred compensation arrangements. Cantor Fitzgerald dealt with a partnership dispute at the investment firm Cantor Fitzgerald, and overruled the Delaware Chancery Court’s decision, leading to the enforcement of a multi-million-dollar forfeiture for competition against several executives who left Cantor and competed with the firm.

This decision underscores Delaware’s “contractarian approach,” enforcing contracts entered into by sophisticated parties according to the terms rather than assessing the reasonableness of the forfeiture and the non-competition clause under a more traditional analysis. Cantor Fitzgerald has significant implications for employees nationwide, as many entities are incorporated in Delaware and include Delaware choice of law provisions in their agreements.

Forfeiture-for-competition and claw back clauses are commonplace in private equity and venture capital firms, hedge funds, and various other partnerships, in the financial services industry and otherwise. Employees with agreements containing these clauses and have significant sums at stake should seek legal advice before leaving and transitioning to a competitor or potential competitor.

When evaluating the enforceability of forfeiture-for-competition provisions, courts apply at least two quite different approaches: 

II.    Tests Used to Evaluate Proposed Forfeitures

• Reasonableness Test: Used in more employee-friendly jurisdictions, this test examines the proportionality and fairness of the proposed forfeiture in relation to the damages incurred or which could be reasonably expected to be incurred due to the employee’s competitive behavior upon leaving the company. For example, in the Massachusetts case, Kroeger v. Stop & Shop,^[2] the supermarket chain asserted its right to cause the forfeiture of its former employee’s retirement benefits, since he violated his noncompetition agreement. The court looked at the reasonableness of the duration, geographic scope, and legitimate business interests of Stop & Shop, as well as the reasonableness of the damages before finding that the clause was enforceable and upholding the forfeiture. 
• Employee Choice Doctrine/Contractarian Test: This test is based on the notion that, especially with sophisticated employees, who choose to willingly depart a job and deliberately choose to either maintain their contractual rights to post-employment benefits or to surrender those entitlements by working for a competitor, the employee should be held to their choice. Because the employee has a choice and is not actually barred altogether from competing, courts in some states, including Delaware, refrain from applying the “reasonableness” test that pertains to traditional noncompetition agreements.

The Cantor Fitzgerald case emphasizes the importance and public policy of enforcing  contractual terms as mutually agreed upon by sophisticated parties, provided they are not unconscionable. This approach underscores Delaware’s commitment to favoring the enforcement of the terms of private agreements and promoting the enforceability of clauses that protect business interests if they do not impose excessive constraints.

III.   The Seventh Circuit’s Certified Questions on Cantor Fitzgerald’s Scope

Soon after the Cantor Fitzgerald decision, the United States Court of Appeals for the Seventh Circuit certified questions to the Delaware Supreme Court asking it to elaborate upon the scope and breadth of its ruling in Cantor Fitzgerald. In LKQ Corporation v. Rutledge,^[3] which involved a forfeiture-for-competition clause in a restricted stock award governed by Delaware law, the Seventh Circuit confronted the issue of whether the former employee, Rutledge, was bound by a  noncompetition clause it found to be unreasonable. The Seventh Circuit certified the following questions to seek clarification from the Delaware Supreme Court:

• Whether Cantor Fitzgerald precludes reviewing forfeiture-for-competition provisions for reasonableness in circumstances outside the limited partnership context, and
• If 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 should reach, whether the employee quit or was involuntarily terminated, or whether the provision also entitled the company to injunctive relief?

An oral argument in this case was held on October 9, 2024, and the decision is due soon. During oral argument, the court grappled with, among other things, the distinction between a forfeiture of compensation that was yet to be received and a claw back of compensation already earned.  The case has attracted considerable attention, drawing many amicus briefs from the securities industry, the U.S. Chamber of Commerce, and others. ^[4]  The court’s decision is likely to shed light upon the parameters of Delaware law on the issue.

IV.   Practical Considerations

Because Delaware law is more “business-friendly” than other jurisdictions, many companies choose Delaware law as the place of incorporation and their governing law, which has implications for employees across the country. Delaware law is typically chosen by private equity firms and venture capital terms that grant a “carried interest” in their funds, which turns out to be the most lucrative form of compensation to its executive employees. Ironically, despite the Delaware court’s emphasis on the sophistication of these employees, forfeiture and claw back terms are rarely negotiated, except by the most senior executives, such as fund founders. In fact, many executives don’t thoroughly read the Limited Liability Partnership (LLP) or Limited Liability Company (LLC) agreements containing these forfeitures and claw backs, which can span a hundred pages, and are executed by Adobe sign or other e-signature platform. Yet, these employees are still held to these draconian terms, as if thoroughly negotiated by parties with relatively equal bargaining power.

Executives should not automatically assume that Cantor Fitzgerald is unfavorable to them. Even though a company may have contractually adopted Delaware law, this is not the definitive consideration. An executive with significant money on the line may choose to initiate a declaratory judgment action in another state (such as in their home state) to challenge the application of Delaware law to their dispute.  These challenges can be based on arguments that Delaware law is in conflict with the law of the executive’s home state and violates a strong public policy or legislation that protects citizens of the home state.  

For instance, the Massachusetts Noncompetition Agreement Act (“MNAA”) applies to most noncompetition agreements entered after October 1, 2018 (and, according to a recent trial court decision, to reaffirmations of pre-10/1/18 agreements made after that date). The MMNA applies, by its terms, to forfeiture-for-competition agreements as well, and sets Massachusetts law as the governing law, and designates Massachusetts courts as the exclusive and mandatory venue for disputes addressing the MMNA’s requirements. The MMNA also adopts the reasonableness tests for enforceability (preserving the common law doctrine that evaluates both the reasonableness of the noncompetition restriction and of the damages to be incurred by the proposed forfeiture).   

When determining the governing law to be applied to a forfeiture-for-competition agreement, different courts follow a variety of tests and standards to determine which state’s law should apply. Although there is substantial precedent that the corporate law of the state of incorporation governs the rights and duties of equity owners and the corporation, there are persuasive arguments that the individual’s rights to compensation should be governed by the jurisdiction that has the most substantial relationship to the parties or the subject transaction. Under this approach, if the choice-of-law provision fails to comply with the executive’s state of residence, the choice of law clause may be unenforceable. Likewise, courts consider which state has a greater material interest in connection with the enforceability of the agreement and may disregard the contractual choice of law made in the subject agreement.

There are significant ramifications of Cantor Fitzgerald for departing executives. Even if an executive employee works in Massachusetts, companies that adopt the law of Delaware may decline to pay the executive amounts due to him or her, thereby forcing the executive into very costly and protracted litigation. Employees with proprietary or confidential information, or trade secrets, must be cautious not to disclose such information outside the company, as violating a confidentiality or non-disclosure agreement could trigger a forfeiture. In summary, employees with equity rights or deferred compensation should exercise due diligence and seek legal counsel when leaving a job to minimize potential losses. Consulting a lawyer when negotiating severance and new employment agreements can help reduce the risk of financial harm.

The ruling of Cantor Fitzgerald leaves executives with many questions: In the wake of companies increasing reliance on Delaware law, how should employees fully prepare to defend their rights effectively? Will the rise in forfeiture-for-competition agreements replace traditional non-compete clauses, and if so, how will employees’ rights be impacted? How do executives navigate the developing landscape of restrictive covenants and, specifically, forfeiture-for-competition agreements? These, and other pressing questions, are among the many reasons executives should retain experienced employment counsel as early as possible in their transition to and from such firms.

For more information, you may email Michael Chinitz at mike@chinitzlawllc.com or call him at (781) 418-5124.

This information is a general description of the law and is intended for general information purposes only.  It is not intended to provide specific legal advice nor is it intended to create an attorney-client relationship with Chinitz Law LLC.  Before taking any action on this information you should seek professional counsel.  Attorney advertising.  Prior results do not guarantee a similar outcome. 

^[1]  Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024).

^[2] Kroeger v. Stop & Shop Companies, Inc., 13 Mass. App. Ct. 310, 432 N.E.2d 566 (1982)

^[3] LKQ Corp. v. Rutledge, 96 F.4th 977 (7th Cir. 2024)

^[4] In W.R. Berkley Corp. v. Dunai, decided in February 2024, Dunai, a corporate officer, received over $200,000 in stock benefits from her former employer on the condition that she would not engage in competitive activities following her termination. If she competed, her employer could impose a forfeiture of these post-employment benefits. The Trial Court upheld this claw back provision as enforceable under Delaware law. Dunai argued that the Court failed to apply the reasonableness test to the noncompete terms. However, based on Cantor Fitzgerald that the noncompetition clause was enforceable, leaving Dunai without legal grounds to contest the forfeiture. W. R. Berkley Corp. v. Dunai, No. 22-2963, 2024 WL 511040 (3d Cir. Feb. 9, 2024).