The Delaware Supreme Court recently clarified that forfeiture-for-competition clauses under the Employee Choice Doctrine may be enforceable against a broader range of employees, including middle managers, not just senior-level executives or more highly compensated employees. These clauses require employees to forfeit certain benefits—such as stock options or severance pay—if they leave their employer and subsequently work for a competitor. Unlike traditional non-competes, these provisions allow employees to choose to compete, albeit with financial consequences.
Background: LKQ Corporation v. Rutledge
Previously, the scope of employees against whom these clauses could be enforced in Delaware had been unclear. In early 2024, the Delaware Supreme Court reaffirmed the validity of such provisions but in a case involving partners bound by high-level partnership agreements. Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024). However, in a landmark decision issued in late December 2024, the Delaware Supreme Court provided significant clarity, holding that forfeiture-for-competition clauses could also be enforced with middle managers and other less senior employees. LKQ Corp. v. Rutledge, No. 110, 2024, — A.3d —, 2024 WL 5152746 (Del. Dec. 18, 2024).
In LKQ, Plaintiff-employer LKQ was a national supplier of recycled and salvaged automobile parts. Defendant Robert Rutledge was a plant manager there, considered a “key” employee entitled to stock awards, which were issued pursuant to agreements governed by Delaware law. The awards were optional, but Rutledge chose to accept them, agreeing in return to restrictive covenants that required forfeiture of the awards if he competed with LKQ within nine (9) months of leaving the company.
Rutledge voluntarily resigned from LKQ in April 2021 and joined a direct competitor. LKQ then sued Rutledge in Illinois federal court. The company sought, among other relief, to clawback nearly a decade of stock award proceeds Rutledge had received pursuant to the agreements. The district court, applying Delaware law, held the agreements were restraints on trade and applied a more stringent reasonableness review, as it would for standard noncompetes, thereby finding the forfeiture provision unenforceable. LKQ appealed.
The Seventh Circuit was unable to predict Delaware’s approach to the issue, largely because previous decisions, such as Cantor Fitzgerald, had only affirmed forfeiture provisions for higher-level employees than Rutledge. It therefore certified two questions to the Delaware Supreme Court to resolve the issue:
- 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 clawback, how far backward a clawback reaches, whether the employee quit or was involuntarily terminated, or whether the provision also entitled the company to injunctive relief?
The Delaware Supreme Court’s LKQ Decision
The Delaware Supreme Court answered the first question and deferred on the second in determining that forfeiture-for-competition clauses should be broadly applied and enforced. The Court emphasized Delaware’s strong preference for freedom of contract, stating that such provisions should be evaluated consistently, whether they apply to a partner, executive, or middle manager or other lower level employee. The Court upheld the clawback of Rutledge’s stock award proceeds (covering eight years), reasoning that invalidating the provision could discourage employers from offering additional benefits and compensation to employees.
The Court did caution, however, that a clawback provision could be “so extreme” that an employer seeking to enforce it against a lower-level employee would need to survive a reasonableness analysis. In Delaware, a forfeiture-for-competition provision that requires clawing back benefits is not analyzed any differently than one involving forfeiture of future benefits. Importantly, that may not be the case in other jurisdictions, as some states draw distinctions between forfeiture and clawbacks in terms of enforcing remedial measures contained in contracts.
The LKQ Court also emphasized that a forfeiture provision does not invite an identical array of employer options in the event of breach as would a standard noncompete. Because the former would only provide an employer with monetary damages, it cannot, on its own, be enforced through an application for an injunction.
Nonetheless, as we have reported, non-competes have faced significant legal scrutiny and pushback in recent years at both the state and federal level. To mitigate risk, employers should consider all available tools to safeguard confidential information and key relationships. The LKQ decision indicates forfeiture-for-competition clauses may provide a useful alternative, if appropriate in scope. Employers should carefully assess the scope and terms of such provisions to ensure enforceability and alignment with business objectives and differing (and shifting) legal standards. Stay tuned for a more fulsome treatment of this important topic in the near term.
