Indiana Supreme Court Defines Use of Liquidated Damages Clauses in Employment Contracts

Employment contracts frequently include restrictions on an employee’s ability to work for a competitor (non-competition clause) or to solicit the employer’s employees or customers (non-solicitation clause) for a period of time after the employee’s employment ceases. An employer’s remedies for an employee breaching these contract provisions often include: 1) the right to seek injunctive relief for enforcement of the contract;and 2) damages in a pre-determined amount, referred to as “liquidated damages.” Employment contracts with these provisions specify the amount of damages and state that the non-breaching party can recover that amount of damages from the breaching party without needing to prove the actual amount of damages.

Recently, the Indiana Supreme Court ruled in American Consulting, Inc d/b/a American Structurepoint, Inc. v. Hannun Wagle & Cline Engineering, Inc. d/b/a HWC Engineering, Inc., et al., that, among other things, the specific liquidated damages provision in the employment contract governing the relationship between the parties was unenforceable.

In general, Indiana law permits liquidated damages provisions to be included in employment contracts; however, the amount of the liquidated damages must be “reasonable,” and if the Court finds the amount to be unreasonable, the Court will not enforce the provision. Generally, this determination requires the Court to analyze whether the amount of liquidated damages is reasonably related or somehow tied to the actual losses caused by the breach. In American Consulting, the contract required an employee who breached a non-solicitation provision in his employment agreement to pay 50% of his earned wages over the last year; a similar contract required other two employees to pay 100% of their prior years’ salaries.The Supreme Court ruled that these payments were not a reasonable consequence for breaching the contract. The Court also noted several other problems with the liquidated damages provisions, such as the liquidated damages provisions failing to state a defined amount. In other words, the Court found the use of a percentage formula for damages to be evidence of unreasonableness.

Liquidated damages provisions can be a valuable component of an employment agreement, but only if drafted in a way that a Court is likely to enforce the provision. The American Consulting decision provides important guidance on this topic and should be the starting point for a review of a company’s employment contract.

Liquidated damages are only one aspect of a solid employment agreement, and can be used in conjunction with a variety of other provisions that are appropriate and beneficial for you or your company. Barrett McNagny's labor and employment attorneys can assist you with an analysis of your current employment agreements, preparing new agreements, or any related issues related to employment matters. 

About the author: 

William A. Ramsey concentrates his practice in the areas of appellate law, litigation and medical malpractice defense. He is a member of the Allen County Bar Association (ACBA) , the Indiana State Bar Association (ISBA), and the Defense Trial Counsel of Indiana. He is a past co-chair of the ISBA’s written publications committee and is vice-chair of the ACBA’s appellate section, and is a member of the ACBA trial lawyers section’s executive committee. He can be reached at (260) 423-8824. 

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