January 2024

Delaware Supreme Court upholds forfeiture-for-competition restriction against former partners.

On January 29, in Cantor Fitzgerald v. Ainslie, the Delaware Supreme Court upheld a “forfeiture-for-competition” provision in a partnership agreement as valid and enforceable against ex-partners of a New York-based global financial services company. The decision overturned a lower court ruling from a year ago, which (a) assessed the provision for “reasonableness” rather than give it deference under the “employee choice” doctrine, (b) invalidated the provision as overly broad, and (c) declined to “blue pencil” the provision by modifying it so as to be reasonable. The upshot is that the company was contractually entitled to withhold distributions to former partners if they engage in specified activities in competition with the partnership.

There are a few key components of the Court’s holding, including:

1. The Court rejected the notion that the forfeiture provision was an unenforceable liquidated damages provision. Instead, the Court held that refraining from competition was a condition precedent to the ex-partner’s receipt of deferred compensation.
2. The Court broadly distinguished forfeiture-for-competition clauses from more traditional non-competes, holding that “forfeiture-for-competition provisions, [ ] unlike restrictive covenants, are not enforceable through injunctive relief, do not prohibit employees from competing and remaining in their chosen profession, and do not deprive the public of the employee’s services[.]”
3. The Court made clear that Delaware’s policy interest in freedom of contract in partnership agreements overrides any concern that a forfeiture-for-competition provision might preclude gainful employment.

Ultimately, the Court held, “When sophisticated parties agree in a limited partnership agreement that a partner, who voluntarily withdraws from, and then competes with, the partnership, will forfeit contingent post-withdrawal financial benefits, public-policy considerations weigh in favor of enforcing that agreement.”

The Court sent the case back to the lower court to determine whether the former partners in fact competed with the firm.

S&K Take: This is an important decision. While it relies largely on the Delaware Revised Uniform Limited Partnership Act’s directive to maximize freedom of contract in partnership agreements, it nonetheless broadly endorses forfeiture-for-competition clauses as enforceable. Also, it comes at a time when—as we covered last month—Delaware courts seem to be increasingly scrutinizing restrictive covenants, including in recent decisions that cite with approval the now-overturned lower court decision in Cantor Fitzgerald. We will monitor whether the Court’s reversal here prompts new challenges or appeals.

Fintech company cannot enforce pre-dispute arbitration agreement of discrimination and harassment suit. 

As we previously reported, the federal Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021 (“EFAA”) amended the Federal Arbitration Act to prohibit mandatory arbitration of sexual harassment or sexual assault claims. Applying this prohibition, a New York federal judge held recently that a former employee’s lawsuit—which contained a number of claims unrelated to sexual harassment or assault—could not be compelled to arbitration because it contained a plausible sexual harassment claim under the New York State and New York City Human Rights Laws (“NYSHRL” and “NYCHRL,” respectively).

The defendant employer argued that the complaint did not plausibly assert a sexual harassment claim because it alleged only “mere sporadic, insensitive comments” that would be insufficient to claim sexual harassment under federal law. The court instead applied the standards under the NYSHRL and NYCHRL, which the court held were met by allegations of gender-related comments and insults. Accordingly, the court ruled that the fintech employer could not enforce a pre-dispute arbitration agreement to arbitrate the former employee’s claims.

Additionally, the court held that that the NYSHRL and NYCHRL applied even though the plaintiff was residing temporarily in Texas when her employment was terminated. The alleged conduct and comments giving rise to the sexual harassment claim, said the court, allegedly occurred while the plaintiff worked in the company’s New York City office.

S&K Take: This case is a reminder that the inclusion of a plausible sexual harassment claim can preclude arbitrability. Employers should consider this when drafting, and when enforcing, arbitration provisions. In addition, the court acknowledged, but avoided taking a side on, a split among federal and state courts’ interpretation of the “impact” inquiry for discrimination claims under New York law. Under that inquiry, courts look to the location “where the conduct had an impact” to determine what law applies. While some courts examine a plaintiff’s physical location at the time of the alleged acts, others examine whether the discriminatory acts affected the terms or conditions of their employment within New York. Here, the court avoided addressing this “inconsistency” by holding that the impact occurred in New York City under either test because that’s where the plaintiff was working when the alleged facts giving rise to the sexual harassment claim occurred.

Be conscious of risks associated with exchanging confidential information with counterparties in anticipation of business transitions. 

In a recent New Jersey filing, Rothman Orthopaedics, a private orthopedic surgery practice, sued a contractual counterparty, HMH Hospital Corporation, a large healthcare system, for misappropriating confidential information to poach Rothman’s physicians. The complaint alleges that the parties entered into a confidentiality agreement to share—and did share—sensitive business and compensation information in furtherance of a potential joint venture. Then, after two years of discussions, HMH terminated without warning all further discussions and communications relating to the joint venture. According to the complaint, roughly seven months later, ten Rothman physicians resigned, en masse  to join HMH, forcing Rothman to shut down its operations completely. Rothman alleges that HMH wrongfully used the confidential information shared under the confidentiality agreement to induce the physicians to terminate their employment with Rothman.

In a somewhat similar matter, though much further along procedurally, the Second Circuit affirmed the dismissal of trade secret claims filed by TransPerfect Global against its competitor, Lionbridge Technologies, and its private equity owner, H.I.G. TransPerfect had alleged that H.I.G. shared TransPerfect’s confidential customer data with Lionbridge, which H.I.G. received confidentially in connection with an unsuccessful bid to purchase TransPerfect’s business. However, the Second Circuit affirmed a ruling below that there was insufficient evidence for a jury to find that Lionbridge accessed, let alone used for competitive purposes, any of TransPerfect’s confidential information.

S&K Take: Even with fulsome confidentiality agreements, businesses should take care to preserve the confidentiality of business information and trade secret information in “look-see” arrangements with counterparties, particularly where the counterparty is a potential competitor. Conversely, counterparties receiving confidential information should take measures to ensure the information is not used for unlawful purposes or otherwise in a manner that violates their nondisclosure agreements.

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