Monday, June 22, 2009
Intellectual Laziness Threatens Most Liquidated Damages Clauses (Coffman v. Olson & Co.)
Two summers ago, I authored an article in the Illinois Bar Journal concerning liquidated damages provisions in non-compete agreements. My research at the time revealed that most provisions which courts voided as an impermissible penalty were the product of sloppy lawyering.
The black-letter law concerning liquidated - or agreed - damages clauses is fairly consistent from state to state. Actual damages must be difficult to calculate, and the fixed damages must be a reasonable forecast of the damages likely to occur. Failure to satisfy both conditions means the clause is an unenforceable penalty.
The exercise in drafting an enforceable liquidated damages clause is not rigorous, nor should it be. But judging by some of the clauses that end up getting litigated, one would think writing a legally compliant liquidated damages provision is a herculean challenge.
In Coffman v. Olson & Co., the Court of Appeals of Indiana found a liquidated damages clause in a non-compete agreement to be an unenforceable penalty. The case generally involved an accountant who breached a client non-solicitation provision in his employment agreement. That agreement contained a liquidated damages clause requiring the employee to pay the employer as fixed damages the sum of two times the previous year's billings for any client taken in violation of the non-compete. For some unknown reason, the clause trebled the amount if the employee failed to notify his ex-employer of the breach.
The court had little trouble in finding the clause was an unenforceable penalty. The reason: the shotgun clause increasing the damages from two times gross revenues to three times gross revenues bore absolutely no relationship to actual damages and was intended strictly to penalize the employee for a breach.
This is a common, though still inexcusable, mistake, and it's either the product of overlawyering or underlawyering a contract. Interestingly, the court cited a number of past Indiana cases where liquidated damages clauses were void when the fixed sum of damages did not vary with the type of breach. For instance, if the same damages penalty applies to both a breach of a client non-solicitation provision and a provision requiring an ex-employee not to contact former co-workers (clearly a less severe breach), then the clause is inherently punitive, not to mention nonsensical.
In my practice, I frequently review or litigate liquidated damages clauses where this problem occurs. The clause will relate to any breach of post-employment covenants, but will make no distinction between the type of breach. I have seen a capitalization of revenue clause similar to that in Coffman, which was intended to redress an improper client solicitation, apply with equal (and still quite unconvincing) force to a non-disparagement or non-disclosure covenant. Invariably, they defy logic.
Attorneys don't need to invest a lot of time to get this right, but few do. The result is that many types of liquidated damages clauses get thrown out.
Court: Court of Appeals of Indiana
Opinion Date: 5/18/09
Cite: Coffman v. Olson & Co., P.C., 906 N.E. 2d 201 (Ind. App. Ct. 2009)