Delaware Supreme Court Holds That Restrictive Covenants That Forfeit an Employee’s Equity Units Are Still Enforceable

In a significant development for private equity sponsors and companies using equity-based compensation, the Delaware Supreme Court has issued a decision that directly impacts the enforceability of restrictive covenants tied to incentive equity. The decision in North American Fire Ultimate Holdings LP v. Doorly provides important guidance for structuring equity incentive plans and drafting restrictive covenants, ensuring that such arrangements remain enforceable even when equity units are subject to forfeiture upon termination for Cause. We summarize below the key facts and implications of the Court’s holding.

The dispute arose after the company separated the executive plaintiff for cause after discovering that he had formed a competing company and forfeited his vested and unvested incentive equity units under the terms in the executive’s unit grant agreement. After NAF filed suit seeking to enforce the restrictive covenants, the Delaware Chancery Court dismissed the action, holding that because the equity units were the sole consideration for the restrictive covenants, the contract became unenforceable once NAF declared them forfeited. In doing so, the Court of Chancery distinguished Delaware law in finding that an employee must retain some consideration to make the restrictive covenants enforceable after separation, even if that consideration has diminished in value.

The Delaware Supreme Court reversed and held that consideration is determined at the time the parties form the contract and not when they seek to enforce it. This decision reconciles with current structuring of profits interests and other forms of incentive equity used by private equity platforms and companies. As such, the Court’s decision confirms that employers may continue to enforce employee non-compete and non-solicit agreements that forfeit equity units upon termination of employment (of course, provided, that they can otherwise withstand scrutiny under applicable legal parameters, e.g., they are reasonable in scope). 

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