The Seventh Circuit Seeks Guidance from Delaware Supreme Court on Forfeiture-for-Competition Clauses

The United States Court of Appeals for the Seventh Circuit, based in Illinois, certified two questions for the Delaware Supreme Court on the applicability and scope of forfeiture-for-competition provisions stemming from Delaware’s recent decision in LKQ Corporation v. Robert Rutledge. The questions the Seventh Circuit certified concern the enforceability of competition clauses beyond the limited partnership context, specifically regarding their implications within employer-employee relationships. The outcome of the Delaware Supreme Court’s decision is likely to influence employer incentive programs commonly utilized for key employees.

What is a Forfeiture-for-Competition Clause?

Forfeiture-for-competition clauses are contractual stipulations often included in employment agreements. These clauses require an employee to forfeit specific benefits, such as stock options, bonuses, or other financial incentives, if they leave the company and engage in competitive activities. These provisions are designed to deter employees from violating covenants that protect employers from competition.

LKQ Corporation v. Robert Rutledge

Robert Rutledge worked for LKQ Corporation and received several restricted stock unit awards.  Rutledge was required to sign a restricted stock unit agreement and certain restrictive covenant agreements (the “Agreements”). As part of the Agreements, Rutledge agreed to a forfeiture-for-competition provision allowing LKQ to claw back the payments Rutledge received under the Agreements if he violated the covenants in the Agreement. When Rutledge left LKQ, he joined a competitor, and LKQ filed suit seeking to enforce the forfeiture-for-competition provisions in the Agreements to recover more than $600,000 Rutledge received under the Agreements.

Cantor Fitzgerald L.P. v. Ainslie

The Delaware Supreme Court’s decision in Cantor Fitzgerald L.P. v. Ainslie upheld the enforceability of forfeiture-for-competition provisions without subjecting them to a reasonableness standard. This ruling suggested a broad applicability of such provisions, irrespective of the severity of the penalties involved.

Nevertheless, in the LKO case, the Seventh Circuit highlighted a crucial distinction: the Cantor Fitzgerald case involved a limited partnership agreement, as opposed to an employer-employee contract typically involving less sophisticated parties and subject to stricter scrutiny. This distinction prompted the Seventh Circuit to seek the Delaware Supreme Court’s input on the broader applicability of the Cantor Fitzgerald decision, leading to two pivotal questions:

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

Why is this Important for Employers?

The Seventh Circuit’s inquiry underscores the dynamic nature of non-compete agreements and the ongoing tension between contractual freedom and equitable employment practices. Given that many employment agreements apply Delaware law, the Delaware Supreme Court’s potential response to the certified questions could have wide-reaching implications. Employers should be prepared to adapt their agreements to align with evolving legal standards. 

For detailed insights and strategic advice on drafting restrictive covenant agreements, employers should consult Levin Ginsburg’s employment law practice group including Walker Lawrence, chair, Mitchell Chaban, and Camila Kaplunov.