Lately, I've witnessed an increasing trend towards companies using (or, more accurately, trying to use) liquidated damages clauses in their employment agreements, particularly when it comes to breaches of the restrictive covenant or confidentiality portions of the contract.
What is a "Liquidated Damages" Clause?
In the employment context, (bearing in mind that the vast majority of the non-compete agreements that I've seen still do not have such a provision), there are some employers who've gone to the trouble of inserting a clause in the contract stating that in the event that the employee breaches the non-solicitation provision of the agreement, say, by poaching a particular client of the employer, she may be liable for a lump sum of money, typically a multiple of the billable work generated by the client for the (former) employer that over the past year.
Are Liquidated Damages Clauses Enforceable as a Matter of Law?
The short answer, although not terribly gratifying, is .... it depends.
Unfortunately, there really isn't a clear-cut answer, or bright-line test because each such clause turns on its own unique facts. That said, New York State's highest court has weighed in on the factors that the courts must look to in order to determine whether the particular liquidated damages clause is enforceable or not, stating:
"Liquidated damages provisions, under our precedents, are valid if the "damages flowing from a breach are difficult to ascertain [and under] a provision fixing the damages in advance * * * the amount is a reasonable measure of the anticipated probable harm" (City of Rye v Public Serv. Mut. Ins. Co., 34 NY2d 470, 473). On the other hand, if "the amount fixed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced" (Truck Rent-A-Ctr. v Puritan Farms 2nd, 41 NY2d 420, 425)."
For employers considering including liquidated damages provisions in their agreements, there is a clear double-edged sword: on the one hand, if applied in appropriate circumstances, if affords you an opportunity to eliminate many of the typical challenges (which can be quite substantial) of proving your actual damages sustained as a result of a disloyal (former) employee's breach of their employment agreement.
On the other hand, if such a clause is used somewhat indiscriminately, i.e., without an eye towards fairly estimating the employer's actual damages sustained due to the breach, then the employer runs a significant risk that a New York court will hold invalid as a matter of law the liquidated damages provision.
Thus, at the risk of stating the obvious, employers should make sure to consult with an attorney that is knowledgeable in this area of the law before drafting and including such a provision in their employment agreements.