Thursday, July 8, 2010

Liquidated Damages Clauses in the Professional Services Context and General Drafting Considerations (Palekar v. Batra)

Liquidated damages clauses are common in restrictive covenant agreements, particularly in those for accountants, physicians and other professionals. One reason for their prevalence is the view some courts and legislatures have taken with regard to restraining professionals' ability to compete. It is highly disfavored and impacts the public interest to a much greater degree than ordinary sales businesses, so by substituting a liquidated damages clause for an actual prohibition on competition, employers can mitigate compelling arguments against enforcement.

Delaware is no exception. It has a statute in place that prohibits any agreements restricting the right of a physician to practice medicine in a particular locale. However, it does not prohibit agreements that put a price on such competition. Courts in Delaware have held that a liquidated damages clause in a physician's contract which may discourage competition, but which does not prevent it, are consistent with the statute.

Of course, the clause itself must still be legally compliant. The standards of enforceability are fairly uniform from state to state. As the Superior Court of Delaware recently noted, however, liquidated damages clauses are presumptively valid and the burden rests on the party challenging it to show it is unenforceable. (This is not true everywhere - some states flip the burden of proof).

Drafting liquidated damages clauses requires attorneys to take into account a number of different considerations:

(1) It is important to have a number of recitals to show that the parties intend to fix damages ahead of time in the event of a breach.
(2) Those recitals should include an acknowledgment that the parties agree damages in the event of breach would be difficult to calculate.
(3) The clause cannot, in most jurisdictions, allow for the simultaneous recovery of actual damages - or else it is not a true liquidation at all.
(4) The liquidated damages clause must provide some clear or readily ascertainable amount accruing on breach. If the amount cannot be determined, it won't be enforced.
(5) If the clause applies to multiple covenants, attorneys ought to consider whether the clause makes any sense at all by applying hypotheticals. For instance, it would seem unreasonable to apply the same damages to a breach of a major covenant (i.e., a client non-solicitation covenant) as it would to a relatively minor one.

My experience has shown that courts are often receptive to liquidated damages clauses in non-compete arrangements, particularly if the agreement is well-drafted, contains proper recitals and appears to be designed to compensate the employer rather than to punish the employee. In addition, if the clause is a proxy for an actual restriction, then courts seem more inclined to view them as enforceable.

On the other hand, I have also had success in invalidating covenants that were hopelessly vague, cumulative of other remedies, and which appeared designed to forfeit previously-earned benefits. It is a very difficult area of the law and demands that attorneys have an intimate understanding of the law governing the agreement.


Court: Superior Court of Delaware, New Castle
Opinion Date: 5/18/10
Cite: Bhaskar S. Palekar, M.D., P.A. v. Batra, 2010 Del. Super. LEXIS 257 (Del. Super. Ct. May 18, 2010)
Favors: Employer
Law: Delaware

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