The enforceability of non-compete provisions continues to be in the national spotlight.
In a recent Delaware Supreme Court decision involving a partnership dispute at an investment firm, the Court upheld the enforceability of a forfeiture-for-competition provision, instructing that courts in Delaware should not second guess the reasonableness of a contractual forfeiture-for-competition provision and the contractual provision should be legally enforceable as a matter of law.
This case is critical because many legal entities are Delaware entities. Employers should consider applying forfeiture-for-competition provisions in their executive and partnership contracts as a valid and binding way to protect against harmful competitive conduct from departing senior employees.
The Supreme Court of Delaware noted that the contract involved sophisticated actors. They could engage in competitive work. They lost the right to some financial benefit if they engaged in competitive activity. The Court held that the provision was not a penalty enforced against an employee based on the breach of a restrictive covenant; it was a condition precedent that excuses the employer from its duty to pay if the former employees fail to satisfy the condition to which they agreed to be bound to receive a deferred financial benefit.
Considering the floodgates open to enforce forfeiture-for-competition provisions would be a mistake. Delaware’s Supreme Court dealt with a limited partnership agreement. However, annual bonuses, stock awards, and other long-term incentives for executives could be structured to provide post-termination executive compensation that is forfeited if the departing executive engages in competitive conduct.
From a policy perspective, a connection between deferred compensation credited to a departing executive and profit-sharing money owed to a departing partner could be made. The Court noted that the company partners benefitted while employed when the forfeiture provision was enforced against other departing partners. The same holds in a non-partnership setting. Executives may benefit - directly or indirectly - when forfeitures of deferred compensation occur.
Remember that deferred compensation arrangements must comply with Section 409A of the Internal Revenue Code.