The Federal Trade Commission (FTC) is slated to vote on a widespread proposal to ban noncompete agreements in April, forcing employers to take note. The proposed ban would eschew any restrictions effectually hindering a worker’s pursuit or acceptance of competitive employment. This marks a departure from the treatment of such clauses in yesteryears, where many US jurisdictions were more lenient and did not subject these provisions to the reasonableness review that is typically applied to noncompetes.
It remains uncertain how clauses that do not explicitely forbode competitive employment but dissuade competition by conditioning benefits such as deferred compensation on an employee’s adherence to restrictive clauses will fit under the FTC’s final rule. It is worth noting that the FTC’s proposed rule fails to mention such forfeiture-for-competition provisions as an example being subjected to the ban.
Forfeiture clauses, hence, seem to find themselves in a regulatory grey zone. The current modus operandi allows an employee to choose between respecting the noncompete and securing the perks, or competing and relinquishing said benefits. The question at hand is whether such forfeiture clauses will persist with their current lenient treatment under the impending FTC’s rule.
Insights on this came from a unanimous decision ruled by the Delaware Supreme Court in Cantor Fitzgerald L.P. v. Ainslie in January, where the higher court of Delaware reversed a Chancery Court decision declining to enforce a forfeiture-for-competition clause in a limited partnership contract.
The Delaware Supreme Court highlighted a vital distinction between noncompetes, which cease an employee’s opportunity to make a livelihood, and a forfeiture-for-competition clause that permits competition in exchange for a conditional benefit. The former serves as a direct obstruction to competition, whereas the latter merely works as a deterrent. The court, therefore, suggested forfeiture-for-competition clauses should be reviewed under conventional contract law principles, not under a reasonableness standard present in noncompetes.
The decision of the court has given a lifeline to the “employee choice” principle and extended a hand to employers during a time when many jurisdictions are increasingly curbing, if not outrightly banning, noncompete clauses. Moreover, considering that forfeiture clauses are frequently found amid compensation packages for sophisticated players at the higher end of the wage ladder, there’s a possibility of continued leniency even after the final FTC ruling.
An important note to consider is how the W.R. Berkley Corp. v. Dunai case applied Ainslie’s decree outside the partnership agreement milieu, indicating a broader possible application of the ruling. However, employers must also acknowledge that several jurisdictions, including the likes of California, Florida, Illinois, and New Jersey, continue to subject forfeiture provisions to reasonableness review and scrutiny in certain scenarios that can potentially resist a total FTC ban.
At the crossroads where traditional noncompetes may cease to exist due to regulatory intervention and the potential survival of forfeiture clauses hanging in the balance, employers are left with the decision to use them as alternatives, or in conjunction with the noncompete clauses, as and where applicable.
This article has been drafted with information adapted from an original publication on Bloomberg Law, authored by John H. Chun, a partner at Herrick, Feinstein’s litigation department and a member of the firm’s employment practice.