Litigating Non-Compete Agreements in Delaware Courts

A non-compete agreement is a contract in which an employee agrees not to compete with an employer after leaving the company. These agreements are often controversial because they impose restrictions on trade and employment. While the Federal Trade Commission attempted to ban non-competes nationwide, the measure was struck down, leaving individual states to determine their enforceability. Delaware is a critical jurisdiction due to the high number of companies incorporated there, and its legal approach to non-competes influences courts across the United States.

While Delaware courts do enforce non-compete agreements, they require them to be reasonable. The reasonableness of a non-compete is determined through a three-part test:

Regarding geographic scope and duration, courts assess whether the restrictions are appropriately tailored. Generally, non-competes lasting one year or less are seen as reasonable, while those exceeding a year face greater scrutiny. The broader the geographic restriction, the shorter the acceptable duration, and vice versa. A national or multi-state non-compete is more likely to be challenged unless justified by a compelling business interest.

For the legitimate economic interest factor, courts consider whether the non-compete protects the employer’s competitive advantage. High-level employees with access to confidential and/or strategic plans or proprietary information are more likely to be subject to enforceable non-compete agreements. Non-competes tied to the sale of a business are also more enforceable, as buyers seek to prevent competition from the seller who has received substantial compensation. However, merely stating in a contract that an agreement is reasonable does not guarantee enforceability; courts independently assess the actual need.

The third factor, balancing the equities, is subjective. Courts consider whether the agreement is fair, the employee’s ability to negotiate, the skills involved, and how the restrictions affect the employee’s ability to work. Delaware courts hesitate to modify non-competes through “blue pencilling”, which involves revising overbroad agreements to make them legally compliant. Instead, they encourage employers to draft precise and reasonable agreements from the outset.

To mitigate the risk of non-enforcement, employers can use forfeiture-for-competition provisions as an alternative to traditional non-competes. These provisions do not prohibit competition outright but instead condition certain financial benefits, such as severance, stock options, or deferred compensation, on the employee’s agreement not to compete. Delaware, as a contractarian state, generally upholds such provisions because they provide employees with a voluntary choice rather than imposing outright restrictions.

A landmark Delaware Supreme Court case, Cantor Fitzgerald v Ainsley (2024), upheld forfeiture-for-competition provisions, even when they involved significant financial stakes. The court ruled that employees could either refrain from competing and receive benefits or compete and forfeit those benefits, thereby providing a structured yet enforceable alternative to traditional non-competes.

In summary, Delaware courts will enforce non-competes but apply strict scrutiny to ensure they are reasonable. Employers seeking enforceability should draft tailored agreements and consider alternative structures, such as forfeiture-for-competition provisions to enhance their legal standing.