Friday, December 3, 2010

Liquidated Damages Formula Needs a Sound Rationale (Cottingham & Butler Ins. Svcs., Inc. v. Jacoway)

I've often written on the topic of liquidated damages, because I believe if properly drafted, those clauses provide the most sound, definitive calculation of damages in non-compete/non-solicit disputes. However, the key word is "properly drafted." This is an area of non-compete law riddled with examples of drafting errors.

Simply by way of brief background, "liquidated" damages is legal concept indicating an agreed calculation of damages before a breach happens. The calculation normally provides for a formula to be applied rather than a fixed sum of money, and it must be exclusive of other damage remedies. That is, it has to be a true liquidation - no additional sums can be owed on top of what the contract provides.

A recent case out of Iowa in the insurance brokerage context illustrates exactly how employers ought to be thinking of what should go into a liquidated damages calculation. As is common in many brokerage-agent relationships, the liquidated damages clause provided for payment to the ex-employer of a multiple of gross receipts per misappropriated customer. In this case, the multiple was 2.25 times average client remuneration over the two years preceding the employee's termination of employment.

The employer offered a very sound reason for why the calculation was set forth this way in the contract. An officer of the brokerage testified that the company had a valuation conducted every year, and that the valuation at the time the contract was signed revealed that the fair value of the company was 2.25 times revenue. Hypothetically, then, if the agency were to lose a customer, it would translate into a reduction of the firm's going concern value by a factor of 2.25 times gross receipts attributable to that customer.

Depending on what judge draws a case, he or she may have perceptions of how fair liquidated damages clauses are. Because they can be abused, some judges have negative feelings about applying those clauses and tend to default to the rule that they are disfavored as penalties. But testimony like that offered above enables a court to find that a liquidated damages clause is reasonable and proportionate to the anticipated monetary harm caused by a breach.


Court: Court of Appeals of Iowa
Opinion Date: 11/24/10
Cite: Cottingham & Butler Ins. Svcs., Inc. v. Jacoway, 2010 Iowa App. LEXIS 1393 (Iowa Ct. App. Nov. 24, 2010)
Favors: Employer
Law: Iowa

No comments:

Post a Comment