By G. A. Finch
A liquidated-damages clause is a “contractual provision that determines in advance the measure of damages if a party breached the agreement.” Black’s Law Dictionary 949 (8th edition 2004). The benefit can be that the difficulty and necessity of calculating and proving damages in court or arbitration are avoided.
When in early April I began to see news articles about a company that routinely utilized liquidated damages clauses in its employment contracts, I was intrigued because 1) negotiating and drafting employment contracts for executives or for companies which hire them are a substantial part of my law practice and 2) I rarely come across liquidated damages clauses when reviewing or drafting employment contracts for clients.
I think it is an interesting tool in an employer’s employment contract box to protect its legitimate business interests. Generally, its enforceability will be driven by the particular facts of employment, the reasonableness of the agreed-upon damages, and the language of the particular provision.
Its apparently now controversial use by the company prompted me to review my considerable employment agreement files to assess the extent liquidated damages clauses were used. I did find a couple of them in two fields: media talent and physicians.
As I represent both employers and employees, depending on the particular client – employer or employee – I would advocate for or against such a clause on behalf of that client.
Although liquidated damages could be onerous for an employee, other clauses like non-compete, non-solicitation, confidentiality, payment-of-prevailing party’s-attorney’s-fees-if-party-loses-in-litigation, and out-of-town and mandatory arbitration, among others clauses, can be just as problematic for an employee.
I cannot be too sympathetic to employees who are penny wise and pound foolish in not paying for an employment lawyer to negotiate better employment agreement provisions for them including liquidated damages. It is akin to “buyer’s remorse” and the employee can only look to himself for signing an unsatisfactory employment contract.
An employer has the right to protect its business interests and an employee has the right to advance his or her own economic and legal interests. Everything is negotiable.
Now that I have your attention, you may want to know what exactly makes up a liquidated damages provision in a contract. Although not ordinarily seen in employment contracts, they are frequently used in commercial and real estate contracts.
The law concerning liquidated damages may vary depending upon the state. Using Illinois as an example, its courts state that as “a general rule of contract law that, for reasons of public policy, a liquidated damages clause which operates as a penalty for nonperformance or as a threat to secure performance will not be enforced.” Jameson Realty Group v. Kostiner, 351 Ill. App. 3d 416, 423 (2004).
However, Illinois courts will uphold the validity and enforceability of a liquidated damages provision when it meets three elements:
(1) the parties intended to agree in advance to the settlement of damages that might arise from the breach, (2) the amount of liquidated damages was reasonable at the time of contracting, bearing some relation to the damages which might be sustained, and (3) the actual damages would be uncertain in amount and difficult to prove. Jameson, at 423.
A proposed liquidated damages clause in an employment contract could read something like this:
“If Talent leaves the company before the end of Talent’s employment term except for reasons set forth above in section __ of this agreement, Talent agrees to pay on demand to Employer one-half (1/2) of Talent’s annual salary as liquidated damages and not as a penalty, and the parties agree that such amount constitutes a reasonable provision for liquidated damages.”
This fictional provision is an amalgam of two employment contracts that contained proposed liquidated damage clauses with which I was involved and represented the employee. Now whether it would be acceptable to an employee is another matter. Again, whether this particular fictional provision would be enforceable will depend on the particular facts and the particular state jurisdiction.
Of course, such a provision is put forth by the employer as a disincentive to the employee from leaving the employer before the end of the employment term or from violating a restrictive covenant like a non-compete clause. It is up to the employee and employee’s attorney to negotiate the elimination or reduction of the liquidated damages amount.
Copyright © 2018 by G. A. Finch, All rights reserved.