Delaware Court Weighs Free Market, Clawbacks in Noncompete Pacts

The Delaware Supreme Court indicated Wednesday it was struggling to balance free market interests with financial benefits offered to employees in considering broad application of its opinion finding former Cantor Fitzgerald LP partners had forfeited $9 million when they jumped ship.

Among the enforcement limits the court sought to define for noncompete agreements was whether it mattered if the benefits at risk of forfeiture for any employee moving to a competitor during a non-compete period were deferred compensation or already earned. The decision may offer clarity to state courts that have split on similar questions in the absence of federal guidelines.

“The rub here is the claw-back—where you have someone who has received financial benefits over many years, and then there’s a claw-back when they leave,” said Chief Justice Collins J. Seitz Jr. during Wednesday’s en banc argument. “That’s what makes me uncomfortable.”

The argument addressed two questions certified to Delaware’s highest court from the US Court of Appeals for the Seventh Circuit, as it seeks clarification about a Jan. 29 decision finding that forfeiture-for-competition provisions signed by six former Cantor partners were valid.

The Delaware Supreme Court had said that when the partners voluntarily left for a competitor, Cantor didn’t have to pay out $9 million in equity payments because the partners had “agreed to forfeit that benefit.”

The Seventh Circuit certified two questions about that ruling: Does it apply to employees outside limited partnership agreements? If not, what factors would make it applicable?

‘Distinction Without Difference’

Those questions arose as the appeals court reviewed an Illinois federal court’s opinion dismissing auto parts supplier LKQ Corp.’s claims that a former plant manager violated a restricted stock grant program for “key employees” by joining a competitor within a nine-month non-compete period. The Seventh Circuit affirmed the district court’s opinion.

It doesn’t matter whether an employee is bound by a partnership agreement or some other employment contract, or whether the financial benefits being forfeited have been withheld or already paid out, said LKQ’s attorney, Joel Rice of Fisher & Phillips LLP.

“That’s a distinction without a difference,” he said, arguing that the clause should be treated the same as the forfeiture-for-competition agreements in Cantor Fitzgerald and other Delaware opinions that have analyzed claw-back provisions “as a matter of contract.”

The US Court of Appeals for the Third Circuit also has applied the Delaware high court’s reasoning in Cantor “in the context of a corporate employee, not a partner, and in the context of a stock claw-back,” Rice said.

14 Factors

The former LKQ employee, Robert Rutledge, said Cantor doesn’t broadly apply. Courts should instead consider 14 factors when considering enforcement, said Rutledge’s attorney, Tiffany Carpenter of Howard & Howard Attorneys PPLC. The most important two factors are whether statutes require enforcement of specific terms of a non-compete agreement, and whether the forfeiture involves claw-backs or a contingent deferred benefit, she said.

“Why shouldn’t we let the market work this out?” Seitz asked her. “Eventually someone is going to say, ‘I don’t want to work for a company that has these draconian provisions for claw-backs.’”

In Rutledge’s case, he was a middle manager lacking the same level of bargaining power that LKQ had, Carpenter said. “If you allow the market to work itself out, the imbalance of power will most certainly be to the detriment of the employee,” she said.

The US Federal Trade Commission has proposed banning non-compete clauses in employment contracts. Over two-thirds of the Fortune 500 call Delaware home, but other states’ laws may apply to their employment agreements, and state courts haven’t reached a consensus on when a company may not enforce non-compete agreements.

Disputes over non-compete agreements and similar pacts often arise in Chancery Court. In August, it allowed an IBM Corp. affiliate to enforce equity repurchase options and non-disparagement provisions signed by a former executive who’s suing the company, citing Cantor in its ruling.

LKQ is also represented by Richards Layton & Finger. Rutledge also is represented by Clark Hill PLC.

The case is LKQ Corp. v. Rutledge, Del., No. 110,2024, oral argument 10/9/24.