The Delaware Court of Chancery has been increasingly willing of late to strike down non-compete covenants as overbroad, a trend accompanied by a growing unwillingness to “blue pencil” agreements by narrowing terms to what the court finds to be reasonable. The Delaware Supreme Court may be putting on the brakes by vindicating traditional pro-contract policies.
In Cantor Fitzgerald, L.P. v. Ainslie, C.A. No. 9436 (Del. Jan. 29, 2024), the Delaware Supreme Court unanimously reversed the Chancery Court’s ruling, which had rejected as unenforceable a limited partnership agreement clause under which a limited partner’s equity is forfeited if the partner violates non-competition provisions.
Ruling on cross motions for summary judgment, the Chancery Court invalidated the provision because the “State’s interest in protecting competition outweighs [the] interest in enforcing voluntarily entered contracts.” Evaluating the “reasonableness” of the provision, the trial court weighted the policy favoring contract enforcement against “Delaware’s distaste for liquidated damages provisions that restrain trade” and concluded that the measure was unenforceable.
In reversing, the Delaware Supreme Court noted the “significant” “distinction between a “non-competition covenant that precludes a former employee from earning a living in his chosen field and an agreement allowing a former partner to compete but at the cost of relinquishing a contingent benefit….” The Delaware Supreme Court held that Delaware’s Uniform Limited Partnership Act “permits partnership agreements to contain consequences that would be ‘unavailable in a standard commercial contract, most notably penalties and forfeitures.’”
It is unclear whether Cantor reflects a broader effort to restore a more favorable environment for enforcing restrictive covenants. The Delaware Supreme Court was careful to limit its holding to limited partnership agreements. Among other things, it noted that, while employment-based non-compete and liquidated damages provisions are subject to a reasonableness standard, forfeiture-for-competition provisions in partnership agreements are enforceable “absent unconscionability, bad faith, or other extraordinary circumstances.”
The Cantor ruling comes four days after the Delaware Supreme Court agreed to accept an interlocutory appeal from a Chancery Court ruling denying a preliminary injunction enforcing a non-competition provision in a limited liability company agreement. Sunder Energy, LLC, v. Jackson C.A. No. 455, 2023 (Del. Jan. 25, 2024). Here, too, the trial court found the agreement to be unreasonably broad and declined to “blue pencil.” The order accepting the appeal gives no indication of the Delaware Supreme Court’s views on the merits.
PRACTICE TIP
The current state of Delaware jurisprudence on restrictive covenants gives employers a great deal to consider when choosing the form of any restraints, as well as governing law and forum choices.
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