Wednesday, January 23, 2013

South Carolina Appellate Court: Physicians' Liquidated Damages Clauses Enforceable

I have written frequently on this blog concerning the subject of liquidated damages. A pre-determined formula or amount of damages is particularly appropriate for non-compete disputes for three primary reasons.

First, proving lost profits can be difficult and requires a company to develop a sustainable, sensible damages model (in my experience, too many plaintiffs never think about this until it's too late).

Second, it eliminates the transaction costs associated with proving lost profits. This requires company time and effort, and often the retention of an expert in the field.

And third, liquidated damages helps solve the time-tested riddle of whether pursuing non-compete litigation is an economically viable outcome for a company. By pre-setting damages, a plaintiff can eliminate some inherent risk and uncertainty surrounding a traditional damages presentation.

Of course, there's a downside. Liquidated damages clauses aren't easy to uphold and are frequently struck down by courts as penalties.

The Court of Appeals of South Carolina just upheld a liquidated damages provision in a physician shareholder agreement that was unlike any I've ever seen. It had several components:

If the physician violated a 20-mile non-compete tied to his or her interventional cardiology practice, then the physician:

(1) forfeited $60,000 in deferred compensation (the payment meant to provide fresh consideration for the new contract);

(2) owed 100 % of the physician's prior year's income with the medical practice;

(3) was divested of a defined share of accounts receivable owed the medical practice; and

(4) was divested of earned but unpaid salary.

If the physician paid the amounts, then he or she was free to compete.

The amounts subject to the liquidated damages clause, as might be expected for the profession, were several hundred thousand dollars per physician. But the Court of Appeals upheld the contract, reasoning that the economic impact from competing in violation of the contract was inherently difficult to calculate and further reasoning that the formulas were tied to what the practice could have expected to receive had the physicians complied with the terms of the agreement.

The kicker for the Court of Appeals seemed to be the impetus behind the non-compete in the first place. The medical practice took out a $5 million loan to finance construction of a new medical office. After the physicians left to compete, the office was not fiscally sustainable - and closed.

The lesson to be learned for corporate counsel is that it is worth considering a robust liquidated damages clause and - more importantly - developing a rationale for why the formula approximates lost profits upon competition. Well thought-out clauses can add a great deal of value to actual or threatened litigation and mitigate the risk associated with developing a damages model.

The case is Baugh v. Columbia Heart Clinic, P.A., 2013 S.C. App. LEXIS 5 (S.C. Ct. App. Jan. 16, 2013).

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