Liquidated Damages

As I have counseled many clients, a non-compete provision is different than most other contractual terms, because simply having mutual consent and consideration will not automatically render it enforceable for reasons of public policy. Thus, even in states like Massachusetts that are known to enforce non-competes, such restrictions will be deemed invalid unless they are reasonable in time and scope and also are necessary to protect against unfair competition – which occurs when the employee uses the company’s confidential information, trade secrets or goodwill to compete against it. As oxymoronic as it may sound, a non-compete that merely prevents “ordinary competition” will be deemed unreasonable and unenforceable.

While some businesses try to make an end-run around this law by requiring an employee to forfeit some benefit or pay liquidated damages if he/she competes against his/her company, any such requirement will be viewed through the same public policy lens used to scrutinize a formal non-compete provision. Indeed, as the Supreme Judicial Court of Massachusetts noted long ago in Cheney v. Automatic Sprinkler Corp.:

If forfeiture for competition provisions were enforced without regard to the reasonableness of their terms while covenants not to compete were subjected to such a

Keep reading

Two weeks ago, I participated on a panel for a webinar on liquidated damages with three other panelists from New Jersey, Florida and Texas. In preparing with the other panelists, I was surprised to learn that while there are many common threads running through the law of liquidated damages across the country, there also are some startling differences depending upon which jurisdiction’s law controls.… Keep reading

When thinking about liquidated damages, most people focus on the fact that a properly drafted liquidated damages provision will enable the non-breaching party to recover a set amount without ever having to prove how much, if any, actual damages were incurred. What people often forget to consider, however, is that a liquidated damages clause also sets a ceiling for damages.… Keep reading

More than once, an in-house counsel has called me up wanting to sue a former employee because s/he has been “bad-mouthing” the company despite having agreed not to disparage the company as part of a settlement or severance agreement.  Nevertheless, I Often have had to give the client the bad news that, in light of the actual contractual language, there would be little chance of prevailing and/or, even if we did prevail, the legal fees probably would exceed the damages we might reasonably expect to recover.  The good news for those of you reading this post, however, is that there are three simple steps you can take to greatly enhance the effectiveness and enforceability of any non-disparagement clauses you would like to implement in the future. … Keep reading

As suggested in “The Effective Use of Liquidated Damages Provisions,” there can be a fine line between an enforceable liquidated damages provision and an unenforceable penalty clause.  Thus, when drafting an agreement, it is important to keep in mind that a payment-for-breach provision will only be enforceable if, at the time of drafting:

  1. It would be difficult to determine the damages that would be caused if the contemplated breach were to occur; and 
  2. The amount of the of the liquidated damages is a reasonable estimate of the actual damages that your company would suffer if there were a breach.

In light of these overarching principles, be sure that the contract expressly states that:

  1. All parties agree that if a breach were to occur, it would be difficult to determine actual damages;
  2. Based on what the parties presently know (include specifics if you can), they agree that $X is a reasonable estimate of the damages that would accrue if a breach occurred in the future; and
  3. All parties agree that the amount of liquidated damages is fair and reasonable and would not act as a penalty to the breaching party.
Keep reading

The Basics of Liquidated Damages Provisions

A liquidated damages provision fixes the amount of money one party will pay to the other if a breach occurs.  Because the law of contracts is designed to be compensatory, however, a payment-for-breach-clause that is penal will not be enforceable (Some reasons for this are discussed in “Why Not Enforce ‘Penalty’ Liquidated Damages Clauses?”).  Accordingly, even if a contract conspicuously says: “If the purchaser is one second late to the closing, it shall pay the seller $10,000,000,” that clause very likely will be deemed to be an unenforceable penalty.

So what makes for a valid liquidated damages provision?  There are two essential conditions:

  1. At the time the contract was executed, it must have been the case that it would have been difficult to determine the damages caused by a breach.
  2. At the time the contract was executed, the amount of the monetary payment designated must have appeared to have been a reasonable estimate of the expected damages for the contemplated breach. 
Keep reading