Cantor Fitzgerald, L.P. v. Ainslie: Delaware Supreme Court Upholds Validity of Forfeiture-for-Competition Provisions in Limited Partnership Agreement Based on Freedom of Contract Principles
January 30, 2024
Publication| Limited Liability Company & Partnership Advisory
In Cantor Fitzgerald, L.P. v. Ainslie, C.A. No. 9436 (Del. Jan. 29, 2024), the Delaware Supreme Court reversed a prior ruling by the Delaware Court of Chancery and found that provisions of a limited partnership agreement authorizing a partnership to withhold distributions otherwise owed to former partners who compete with the partnership (forfeiture-for-competition provisions) are enforceable. The Court distinguished forfeiture-for-competition provisions in a partnership agreement from restrictive non-competition covenants and liquidated damages provisions used to enforce such covenants. While restrictive non-competition covenants and related liquidated damages provisions are generally subject to scrutiny for reasonableness under Delaware law, the Court held that absent unconscionability, bad faith, or other extraordinary circumstances, forfeiture-for-competition provisions in a partnership agreement are not subject to reasonableness review. Instead, the Court found that the express and stated public policy of the Delaware Revised Uniform Limited Partnership Act of giving effect to the principle of freedom of contract and the enforceability of partnership agreements supported enforcing a forfeiture-for-competition provision without regard to reasonableness.
The dispute at issue in the opinion arose out of the limited partnership agreement (the “Agreement”) of Cantor Fitzgerald, L.P. (the “Partnership”). The Agreement included provisions that denied certain deferred distributions of capital account balances and grant amounts (the “Conditioned Payments”) to former limited partners if such former partners engaged in competitive activities within four years after ceasing to be limited partners. The plaintiffs, a group of former limited partners of the Partnership, withdrew from the Partnership, resigned from their employment with an affiliated entity, and began working for various competitors. After their withdrawal, the Partnership determined that the former partners breached their non-competition obligations by engaging in competitive activities, and the Partnership withheld the Conditioned Payments in amounts ranging from roughly $100,000 to over $5 million. The plaintiffs subsequently filed suit in the Delaware Court of Chancery, alleging breach of contract claims and, among other things, that the forfeiture-for-competition provisions were unenforceable. In January 2023, the Delaware Court of Chancery ruled in the plaintiffs’ favor, noting that Delaware’s public policy has a “distaste for liquidated damages provisions that restrain trade by requiring employees to pay former employers if they compete,” and held that forfeiture-for-competition provisions are subject to review for reasonableness.
In a decision rendered on appeal on January 29, 2024, the Delaware Supreme Court reversed the Court of Chancery’s holding. The Court reviewed the public policy considerations associated with non-competition provisions and related liquidated damages provisions and compared them to the public policy considerations associated with forfeiture-for-competition provisions. In analyzing whether to enforce the forfeiture-for-competition provisions, the Court distinguished between a restrictive non-competition covenant that prevents an individual from working in a specific field (which may be subject to injunctive relief) and a forfeiture-for competition provision that allows an individual to work but imposes a cost for doing so (which is not subject to injunctive relief). The Court also noted that 6 Del. C. § 17-306 permits partnership agreements to contain consequences that are not available in other commercial contracts, such as penalties and forfeitures, and that the Delaware Revised Uniform Limited Partnership Act has a stated policy “to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements.” While recognizing that freedom of contract is not unbounded, the Court found that the public policy interest that is present when a court reviews the reasonableness of a restriction on working in a specific field is much stronger than the public policy interest in preventing employees from forfeiting benefits for choosing to compete. As a result, the Court found that the forfeiture-for-competition provisions in this case are not subject to review for reasonableness.
The Court’s opinion in Cantor Fitzgerald highlights that, in the context of Delaware limited partnerships, Delaware courts (i) recognize a strong public policy of freedom of contract, and (ii) absent some form of bad faith or unconscionability, will generally preserve contractual flexibility and hold parties to their bargained-for agreements.