by Ariane M. Janz

Liquidated damages provisions are supposed to simplify non-compete cases, but disputes over the enforceability of such provisions can have the opposite effect, complicating the matter and adding uncertainty. If a court determines that the liquidated damages are grossly disproportionate to the employer’s actual loss, the court may refuse to enforce the liquidated damages provision as an impermissible penalty. 

The recent Indiana Court of Appeals’ decision in American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc.[1] will be interesting to employers because it upholds the liquidated damages provisions used by the employer in that case, reversing the trial court’s holding that the provisions were void as penalties.

After Indiana civil engineering firm (“ASI”) lost seven key employees and eleven clients to its competitor (“HWC”) over an approximate span of one year, ASI sued HWC and certain former employees, alleging an improper poaching scheme. Three of these former employees had signed employment agreements containing non-solicit/service provisions and/or non-recruit provisions that provided for liquidated damages to ASI in the event of breach.

Employee #1 (Knowles). Knowles was ASI’s former Vice President of Sales Administration and holder of an equity interest. He signed an employment agreement containing a 2-year non-solicit/service clause and a 2-year non-recruit clause. The agreement provided that if Knowles breached the non-solicit/service clause and it resulted in a client of ASI terminating, withdrawing, or reducing its business with ASI, then Knowles would pay liquidated damages to ASI of 45% “of all fees and other amounts that [ASI] billed to such customer during the [twelve]-month period immediately preceding such breach.” Knowles’ Agreement also provided that if Knowles breached the non-recruit clause, he would pay ASI liquidated damages equal to 50% “of such terminating employee’s total compensation from [ASI] for the twelve (12) months immediately preceding such employee’s termination of employment.”

Employees #2 & #3 (Lancelet & Day). Lancelet and Day were former resident project managers for ASI. They each signed an employment agreement containing a 2-year non-recruit clause with liquidated damages equal to “100% of such [terminating] employee’s annual salary for the preceding calendar year.”

The trial court held that the liquidated damages provisions were unenforceable as a matter of Indiana law. The appellate court disagreed, finding that the trial court erred in granting summary judgment in favor of the HWC parties on ASI’s liquidated damages claims. Here is why, according to the appellate court, the liquidated damages provisions were not unenforceable as a matter of law:

1. Individually negotiated agreements.

According to the court, “these were individually negotiated agreements.” Furthermore, the agreements contained language that the liquidated damages were reasonable estimates of the damages that ASI would incur and the provisions were intended to compensate ASI, and not penalize the employee.

2. Agreements contained restrictions appropriate for each employee’s position.

Higher-level employees faced increased restrictions than lower-level employees. The Court stated: “[T]he liquidated damages provisions were not just boilerplate language inserted mechanically into every ASI contract but appear to be a fair consideration of the rights and responsibilities of each employee, the information with which each was entrusted, and the damage that could be done to ASI from a particular employee’s breach.” For example, when Lancelet was demoted, his employment agreement was revised to include only the non-recruit provision (non-solicit/service was removed).

3. Actual damages were difficult to compute.

The Court reasoned that it was difficult to calculate ASI’s incurred damages for two reasons. First, civil engineering firms obtain business by winning an award of a percentage of a project; typically, one project employs several firms. It is difficult to establish what percentage of the project(s) ASI lost due to breaches. Second, ASI was forced to recruit and train numerous new employees. Again, the actual loss associated with this recruitment and training was hard to calculate, as was the loss of business that might have been caused by the defection of the employees.

4. All damages provisions contained a causation element.

The liquidated damages provisions only applied when a breach resulted in a customer reducing, terminating, or withdrawing its business with ASI, or when the breach resulted in an employee terminating his or her employment with ASI. Thus, the court found this causation element to further support that the damages provisions were proportional damages and not unenforceable penalties.

Then the court remanded the issue of ASI’s liquidated damages claims to the trial court for further proceedings.

Key take-away for clients

It is best to tailor each employment agreement to each employee to the extent possible. If the employee is a high-level employee with access to trade secrets and client information then broad restrictions make sense. If the employee is a low-level employee with no access to trade secrets then a broad restriction appears disproportional and untailored. Remember to include a causation element in the agreement to ensure that the agreed-upon liquidated damages are proportional to any actual loss possible.

[1] No. 49A02-1611-PL-2606, 2018 BL 182421 (Ind. App. Ct. May 23, 2018).

Ariane M. Janz is an associate at Howard & Howard’s Chicago, IL, office. She concentrates her practice in civil litigation with an emphasis on commercial disputes and business & corporate law.