Non-Coms and Non-Solicitation Agreements: Liquidated Damages Provisions Questioned by Indiana Supreme Court

By:  Melanie Dunajeski

Non-Competition and Non-Solicitation Agreements are in the news again in Indiana. On December 18, 2019, the Indiana Supreme Court issued its sharply divided 3-2 opinion in American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc. et al,  136 N.E.3d 208 (Ind. 2019), examining the liquidated damages provisions found in non-competition and non-solicitation agreements signed by three American Consulting Inc. (“ASI”) employees prior to their defection to competitor Hannum Wagle & Cline (“HWC”). The Court concluded that as written in these particular agreements and these circumstances, the liquidated damages provisions were “unenforceable penalties”.

As I have previously written in this space, many employers use non-compete and non-solicitation/recruitment agreements to attempt to limit post-employment unfair competition and employee raiding by former employees. Employers must approach these agreements with care–non-competes have always been disfavored under Indiana law and subject to strict court construction against employers as a restraint of trade.  The landscape is now further complicated by the Indiana Supreme Court’s holdings with respect to liquidated damages. 

“Liquidated Damages” is a term used to describe a specific sum of money that has been agreed to by the parties to a contract as the amount of damages to be recovered by one party for breach by the other, whether that amount falls short of or exceeds the actual amount of damages suffered. Liquidated damages provisions are often used in circumstances where the actual amount of damages may be difficult or time consuming to calculate and prove. Indiana has long held that “reasonable” liquidated damages provisions calculated to compensate actual losses incurred are enforceable, but provisions that constitute a penalty or punishment are not.

The three ASI employees-the former VP of Sales and two former Resident Project Managers-all signed restrictive agreements containing liquidated damages provisions for breach of non-competition and/or non-solicitation clauses, but the various agreements were not consistent in the penalty assessed for breach. For example, the VP’s agreement provided for liquidated damages equal to 50% of the salary of any raided employee, while the agreements of the two project managers provided for 100% of the raided employee’s salary for the preceding year.  After these three employees resigned from ASI to join HWC,  ASI alleged that the three successfully recruited seven other ASI employees to join HWC, all in violation of the non-solicitation clauses found in their various agreements, and further alleged that the VP of Sales violated the non-competition provisions of his agreement by convincing his former ASI clients to book millions of dollars in business with HWC.  After a long and complicated history in the lower courts, the case finally reached the Indiana Supreme Court on the issue of liquidated damages.

The Supreme Court found the liquidated damages provisions of the non-solicitation agreements  “facially problematic”, noting that the non-solicitation restriction was different for the VP of Sales than it was for the two Resident Project Managers—which would result in liquidated damages of $272,165 for the VP, and $238,374 and $176,813 for the two Project Managers. The court further noted that it was not clear how an employee’s salary for the prior year correlates to value to ASI, nor was it clear why the higher-ranking VP of Sales was responsible for only 50% of the annual salary while the two Project Managers were responsible for 100%. The end result was with three former employees recruiting in violation of their non-solicitation agreements, ASI was essentially seeking 250% of the salaries of the raided employees.

The court observed that prior cases upholding liquidated damages provisions were tied to situations where the “sum was certain and reasonably tied to the actual losses”, but that the liquidated damages provisions in the present case did not. Instead, liquidated damages were tied to a percentage of a yet to be ascertained sum, the percentages provided were not tied to any measure of ASI’s actual lost revenue from loss of employees, and the liquidated damages were far in excess of the defendant former employee’s salaries.  The court also noted that, like prior cases holding liquidated damages provisions unenforceable,  the “liquidated damages provision applied the same punishment for a broad range of conduct and served to punish the breaching employee” so that the act of soliciting an ASI employee, assisting in such solicitation, or merely attempting to hire an ASI employee all bear the same penalty as actually hiring the ASI employee. The court concluded these provisions appeared to be intended to “secure performance and punish the breaching party, not to compensate for ASI’s actual losses.” The court further concluded that the non-solicitation liquidated damages provisions as written “are not correlated to the actual loss, and ASI offers no reasonable explanation or nexus between the two.” In the end, the majority concluded that all of the liquidated damages provisions were unenforceable penalties but allowed ASI to seek its actual damages against the defendants for its breach of contract claims.

Where does that leave employers who utilize liquidated damages provisions in their non-competition and non-solicitation agreements? We can be certain that there will be more cases coming on liquidated damages issues. Every liquidated damage provision contained in your agreements should be reviewed now and at least annually. Do the liquidated damages sought “correlate” to actual damages? What kind of evidence could you produce to show that the liquidated damages sought are “rationally related” to the loss actually sustained by the employer?  Does the same liquidated damages provision apply to a “broad range of breaches”?  If the provision looks like a penalty to secure performance rather than a proportional estimate of actual expected losses, it is likely unenforceable.  Are your liquidated damages provisions consistent across the spectrum of affected employees or do they differ by employee or by position?  Once again–your provision may not be enforceable. More importantly, it is important to assess whether you really need a liquidated damages provision in your agreement to get the protections that you seek. 

Stay tuned- we probably have not heard the last of this issue. 

For help on these issues and more, contact the employment lawyers at Drewry Simmons Vornehm LLP.