Delaware Supreme Court Upholds "Forfeiture for Competition" in Partnership Agreement

In Cantor Fitzgerald, L.P. v. Ainslie (Del. Jan. 29, 2024), the Delaware Supreme Court reinforced the principle of “freedom of contract” by upholding a “forfeiture for competition” clause in a limited partnership agreement. This ruling, significant given Delaware's traditionally non-compete friendly stance, signals a shift in favor of enforcing sophisticated contractual agreements between parties.

 Case Background

Cantor Fitzgerald, L.P. and its affiliate Cantor Fitzgerald Hong Kong Capital Markets Limited (“Cantor HK”) are involved in global financial services. Six former limited partners of Cantor Fitzgerald, referred to as the "Former Partners," resigned from their positions between 2010 and 2011. Upon their departure, they were bound by a Limited Partnership Agreement (the “Agreement”) that included restrictive covenants such as non-compete, non-solicit of employees, and non-solicit of customers.

Under the Agreement, these Former Partners would forfeit their capital distributions if they engaged in competitive activities following their departure. After their resignations, the Former Partners breached these covenants by engaging in competitive activities, leading Cantor Fitzgerald to withhold their capital disbursements, which ranged from approximately $100,000 to over $5 million.

The Former Partners sued Cantor Fitzgerald in the Delaware Court of Chancery, challenging the enforceability of the restrictive covenants and seeking a declaration that the forfeiture provisions were invalid.

 Court of Chancery Decision

The Delaware Court of Chancery ruled that the forfeiture for competition provision was unenforceable. The Court applied the “reasonableness” standard typically used for restrictive employment covenants and found that the forfeiture clause was an “unreasonable restraint.” It deemed the restrictive covenants unreasonable and held that Cantor Fitzgerald could not rely on the provision to avoid paying the Former Partners their capital disbursements.

 Delaware Supreme Court Ruling

The Delaware Supreme Court reversed the Court of Chancery’s decision. The Supreme Court distinguished the “forfeiture for competition” provision from traditional non-compete clauses, which generally restrict an individual's ability to earn a living in their field. The Court emphasized that the forfeiture provision did not prevent the Former Partners from competing; instead, it conditioned the receipt of a contingent benefit (capital distributions) on adherence to the restrictive covenants.

The Court applied standard contract interpretation principles, affirming that courts should enforce unambiguous agreements made by sophisticated parties, barring claims of unconscionability, bad faith, or extraordinary circumstances. The ruling affirmed that such contractual provisions, when clearly articulated and voluntarily agreed upon, are enforceable.

 Implications for Employers

The Delaware Supreme Court's decision in Cantor Fitzgerald marks a notable endorsement of enforcing sophisticated contractual provisions in partnership agreements. This ruling aligns with Delaware’s broader commitment to honoring contractual freedom and upholding the agreements of sophisticated parties.

For employers, this decision is beneficial as it reinforces the enforceability of contractual provisions designed to protect business interests, even when they involve forfeiture clauses. Companies can now be more confident that carefully drafted provisions in partnership and employment agreements will be upheld, provided they are clear and entered into voluntarily.

Key Takeaways for Employers:

1. Enforceability of Forfeiture Clauses: Employers can include forfeiture for competition provisions in agreements with partners or employees, knowing that such provisions are enforceable if they are well-defined and voluntarily agreed upon.

2. Focus on Contractual Clarity: Ensuring that agreements are unambiguous and clearly stipulate the consequences of breaching restrictive covenants can help in enforcing these provisions.

3. Sophisticated Parties: The decision underscores that sophisticated parties are held to their agreements, reinforcing the principle of freedom of contract.

Employers should remain vigilant in drafting and enforcing such provisions and consult with legal professionals to ensure compliance with evolving legal standards.

If you are in need of legal advice in drafting and enforcing contractual provisions in limited partnership agreements, contact Lars Soreide, Esq., at Soreide Law Group:  888-760-6552.