Can Your Business Use Forfeiture Provisions to Replace Controversial Non-Competes?

by Prof. Robert Bloink and Prof. William H. Byrnes

With or without the Federal Trade Commission (FTC) ban on non-compete agreements, nearly every state will refuse to enforce non-compete agreements that do not satisfy a reasonableness standard (some states refuse to enforce non-compete agreements regardless of whether they are considered “reasonable”). Recently, the Seventh Circuit issued a ruling that highlights the distinction between a non-compete agreement and a forfeiture-for-competition provision—noting that the forfeiture-for competition may not be subject to the reasonableness test. Understanding the facts, however, is key to determining whether any given forfeiture agreement will be enforced.

Non-Compete vs. Forfeiture-for-Competition

In the most general terms, a non-compete agreement prevents an employee from working for their employer’s competitors for a certain period of time within a certain geographic area. States that limit the use of non-compete agreements generally require the agreement to be reasonable both with respect to time and geographic location. Most states also require the non-compete to serve a legitimate business purpose and generally be equitable and fair.

The Seventh Circuit recently found that a forfeiture-for competition provision was not subject to the same reasonableness review. In this case, a plant manager resigned and went to work for a competitor. As a part of his overall compensation package, he had been awarded restricted stock units (RSUs) over the years. The RSUs, which were governed by Delaware law, stated that he would forfeit (or be forced to return) the RSUs if he went to work for a competitor within nine months of leaving employment. Each RSU was subject to its own nine-month forfeiture period, so that the nine-month periods were overlapping.

When the employer sought to enforce the forfeiture-for competition provision, he sued. An Illinois court initially found for the employee because the provision failed the typical reasonableness test. On appeal, the Seventh Circuit found that the Delaware Supreme Court had distinguished forfeiture-for competitions provision from typical non-compete agreements.

However, the Delaware Court case was based on a forfeiture-for competition provision contained in a limited partnership agreement that had been negotiated between sophisticated parties. In the current case, the contract had been the subject of little or no negotiation.

The Seventh Circuit found that the Delaware rule was not restricted to the limited partnership context. Further, the forfeiture could take on a variety of forms, including RSUs and a range of agreements.

According to the court, forfeiture-for competition provisions may require an employee to forfeit certain benefits if they decide to work for a competitor, but they do not actually prevent the employee from working for the competitor. The court was, however, careful to note that some forfeiture-for competition provisions may be so extreme as to have the effect of preventing an individual from working.

In the current case, the employee’s salary was $109,000 per year. He voluntarily accepted the RSUs, which were only available to key persons that included less than 2% of the employer’s workforce. The RSUs themselves were valued at between $130,000 and $340,000. The court found that, while the value of the RSUs was substantial, forfeiting them did not rise to the level of an “extraordinary hardship” that would require the reasonableness review.

FTC Ban on Non-Competes: Background

In 2024, the FTC issued a final rule that banned the use of nearly all non-compete agreements nationwide. The ban was sweeping and applied to both prospective and existing non-compete agreements. The ban classified non-compete agreements between employers and workers as unfair methods of competition and was expected to have a wide-ranging impact on business owners who rely on these agreements to protect their business interests, value and trade secrets.

On August 20, 2024, a federal district judge in the Northern District of Texas officially set aside the FTC's non-compete ban as unlawful, and exceeding the FTC's authority. The judge found the rule to be unconstitutional and arbitrary and capricious in violation of the Administrative Procedures Act. Absent the nationwide ban, which remains in effect, the FTC rule would have gone into effect September 4.

Conclusion

While forfeiture-for competition provisions are subject to much less restrictive standards than non-compete agreements, employers should note the court’s emphasis on the “extraordinary hardship” issue. There may be some types of extreme burdens that would, in reality, prevent the employee from working—and thus make the agreement subject to the typical reasonableness standard.