Labor & Employment Law Daily Wrap Up, CONTRACT CLAIMS—7th Cir.: Per Delaware Supreme Court, noncompete forfeiture provision in manager’s RSU agreements were enforceable, (Jan 23, 2025)

By Marjorie Johnson, J.D.

The state’s high court clarified that forfeiture-for-competition provisions outside of limited partnership agreements were generally enforceable under the employee choice doctrine and not subject to review for reasonableness.

Following the Delaware Supreme Court’s clarification that its recent decision in Cantor Fitzgerald, L.P. v. Ainslie precludes judicial review of forfeiture-for-competition provisions for reasonableness in circumstances outside the limited partnership context, the Seventh ruled that LKQ Corporation could enforce a forfeiture-for-competition provision set forth in the restricted stock unit (RSU) agreements of a former manager who went to work for a competitor five days after resigning. Though Delaware’s high court left open the possibility of recognizing an exception where a forfeiture provision is “so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party,” the Seventh Circuit found that those circumstances did not exist here and reversed the district court’s dismissal of the contractual claim on summary judgment (LKQ Corp. v. Rutledge, No. 23-2330 (7th Cir. Jan. 22, 2025)).

RSU agreements. The plaintiff worked as a plant manager at LKQ Corporation, a national supplier of salvage and recycled automobile parts, for over a decade. During that time, the employer designated him as a “key person” eligible to receive RSU awards on a vesting schedule. These awards were conditioned on his execution of RSU agreements, and during his many years at LKQ he received several stock awards and executed several RSU agreements.

Forfeiture-for-competition provision. Importantly, the RSU agreements contained forfeiture-for-competition provisions that prohibited the manager from working for a competitor within nine months of leaving LKQ. In the event of a breach, the agreements permitted the employer to claw back all proceeds from his stock unit awards.

Hired by competitor, employer sues. In 2021, the manager resigned and began working for a competitor five days later. LKQ initiated this lawsuit in federal court, alleging claims of unjust enrichment and breach of both the RSU agreements and separate restrictive covenant agreements. The district court entered summary judgment in favor of the manager on all claims, and the company appealed.

Competing views. In its first opinion, the Seventh Circuit affirmed as to the unjust enrichment and restrictive covenant claims but grappled with whether, under Delaware law, it should review the forfeiture-for-competition provisions for reasonableness before enforcing them. The appeals court noted that two views have emerged on how to treat these types of provisions. Some jurisdictions have concluded that, regardless of form, forfeiture provisions function as restraints on trade and should be reviewed for reasonableness like restrictive covenants. Other jurisdictions have been more inclined to embrace an “employee choice” doctrine, which “enforces some forfeiture-for-competition provisions under more traditional principles of contract law without inquiry into their reasonableness.”

Certified questions in light of Cantor Fitzgerald. While the appeal was pending, the Delaware Supreme Court held in Cantor Fitzgerald, L.P. v. Ainslie that forfeiture-for-competition provisions in limited partnership agreements are generally enforceable under the employee choice doctrine and therefore not subject to judicial review for reasonableness. Therefore, the Seventh certified two questions to Delaware’s high court: (1) Whether Cantor Fitzgerald precludes reviewing forfeiture-for-competition provisions for reasonableness in circumstances outside the limited partnership context; and (2) If Cantor Fitzgerald does not apply in all other circumstances, what factors inform its application?

High court’s clarification. The Delaware Supreme Court accepted the certification and answered the first question, holding that “Cantor Fitzgerald is not restricted to the limited partnership context,” and finding that it therefore did not need to address the second certified questions. The court explained that “in Cantor Fitzgerald,” it had “weighed the competing policy concerns and chose the employee choice doctrine,” under which “courts do not review forfeiture-for-competition provisions for reasonableness so long as the employee voluntarily terminated her employment.”

Exception not applicable. “The Delaware Supreme Court’s answer to our first certified question establishes that the forfeiture-for-competition provisions in the RSU agreements are not subject to judicial review for reasonableness,” the Seventh Circuit stated. And while the Delaware Supreme Court left open the possibility of recognizing an exception where a forfeiture provision is “so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party,” the state court also made clear that the exception would apply only in the most extraordinary of circumstances.

Concluding that this case did not fall within that limited exception, the Seventh Circuit compared the case to the Delaware Supreme Court’s decision in W.R. Berk-ley Corp. v. Hall. There, the court enforced a provision of an employer’s incentive stock option plan with a six-month noncompete provision against a management-level employee earning an annual salary of under $200,000. Though he was not as sophisticated as the Cantor Fitzgerald defendants, who were partners at a global financial services firm, the Hall court allowed the employer to claw back around $180,000 in gains the employee realized from exercising stock options.

“Hardly unsophisticated.” Here, the RSU agreements similarly barred competition within nine months of departure and, if enforced, would allow LKQ to reclaim hundreds of thousands of dollars’ worth of stock awards from the manager. While he did not earn as high a salary as the Hall and Cantor Fitzgerald defendants, “he is hardly unsophisticated,” as he held a management position with a salary of around $109,000. He also voluntarily agreed to a RSU benefit available only to “key persons”—a designation reserved for less than two percent of LKQ’s workforce.

And while allowing LKQ to claw back a substantial sum would subject him to a hardship, the Delaware Supreme Court explained that the employee choice doctrine is “broad,” and the state “enforce[s] as a matter of fundamental public policy the voluntary agreements of sophisticated parties.” Here, the manager “did not face the type of extraordinary hardship that might allow us to override that fundamental public policy, as determined by Delaware’s highest court.”

Remanded. Because the district court did not address whether the manager breached the RSU agreements, the Seventh Circuit remanded for the court to determine whether to reopen summary judgment proceedings, proceed to trial, or some combination of those options.

The case is No. 23-2330.

Judge: Scudder, M.

Attorneys: Craig R. Annunziata (Fisher & Phillips) for LKQ Corp. Joseph W. Barber (Howard & Howard Attorneys) for Robert Rutledge.

Companies: LKQ Corp.

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