COVID-19 Notice: We Remain Here For You. Learn More.

Punishment or compensation? Indiana Supreme Court decision guides enforceability of liquidated damages provisions in employment contracts

The Indiana Supreme Court recently provided important guidance for employers looking to hold employees accountable for breaching non-solicitation clauses in employment agreements by providing for liquidated damages. In its December 18, 2019, majority opinion in American Consulting, Inc. d/b/a American Structurepoint, Inc. v. Hannum Wagle & Cline Engineering, Inc. d/b/a HWC Engineering, Inc. et al. (“ASI”),[1] the Court found that the liquidated damages provisions in employees’ employment agreements were facially unreasonable and unenforceable and were not correlated to the employer’s actual loss.[2]

In ASI, the relevant contract provisions for one former employee provided as follows:

• For two years after employment, the employee will not sell, provide, try to sell or provide or assist any person or entity in the sale or provision of any competing products or services to the employer’s customers with whom the employee had any business contact on behalf of the employer during the two years prior to his separation from employment. A breach of this provision that results in the termination, withdrawal or reduction of a client’s business with the employer will result in liquidated damages equal to 45% of all fees and other amounts that the employer billed to the customer during the 12 months prior to the breach.
• The employee will not cause another employee to end their employment with the employer. A breach of this provision will result in liquidated damages equal to 50% of the employee’s pay from the employer during the 12 months prior to the breach.[3]

The relevant contract provision for two other former employees provided that the employees could not hire or employ the employer’s other employees; a breach of this provision would result in liquidated damages equal to 100% of that employee’s pay during the 12 months prior to the breach. All of the contracts provided that the liquidated damages provisions were considered reasonable estimates of the damages the employer would suffer and did not constitute a penalty.[4]

The employer sued its former employees for breach of contract and tortious interference with the employer’s contractual and business relationships.[5] The trial court granted summary judgment for the former employees on the issue of the contractual liquidated damages, finding that they were unenforceable as a matter of law.[6] The Indiana Court of Appeals reversed, finding that these provisions were enforceable.[7] The Indiana Supreme Court affirmed the trial court, holding that the liquidated damages provisions were unenforceable because they were facially unreasonable and the employer had not shown that the liquidated damages correlated to its actual loss.[8]

The Court cited well-settled case law finding that reasonable liquidated damages provisions are permitted but that contractual provisions that constitute penalties are not.[9] The issue is a question of law for the courts to decide.[10] The Court then went on to explain why the liquidated damages provisions in the contracts at issue were facially problematic. First, the Court stated, it was not clear how a recruited employee’s salary in the prior year correlates to the employer’s damages suffered from the loss of that employee, as salary alone is not reflective of revenue to the employer. The Court found that salary is not the only variable that determines revenue, and the employer could hire other employees.[11] The Court also found no explanation for why lower-ranking, lower-paid employees breaching their employment agreements were liable for 100% of a recruited employee’s salary, while the higher-ranking, higher-paid employee was liable for only 50%.[12] Finally, the Court noted that if all three employees at issue were held liable for the recruitment of one employee, the employer would be entitled to a total of 250% of the recruited employee’s salary as liquidated damages – an amount that the Court found highly unlikely to cost to replace the recruited employee.[13]

The Court cited case law finding that, in general, where liquidated damages have been enforceable in an employment context, the sum was certain and reasonably tied to the employer’s actual losses.[14] Conversely, liquidated damages have not been enforceable in an employment context where the provision applied the same punishment for a broad range of conduct and served to punish the breaching employee to secure performance of the contract rather than to compensate the employer for its actual losses.[15] When liquidated damages are grossly disproportionate to or unconscionably in excess of the loss, they will be treated as an unenforceable penalty.[16] Ultimately, the Court held that the liquidated damages provisions in this case relating to solicitation of employees were meant to secure performance and punish the breaching party, not to compensate the employer for its actual losses; the provisions, therefore, were unenforceable.[17]

Justices Slaughter and Massa concurred and dissented to the Court’s majority opinion, finding that the employees did not meet their burden to show that the liquidated damages provisions were unenforceable penalties and that the employer could not prove even a correlation with actual damages.[18] The dissent cited four considerations that constituted issues of fact not ripe for summary judgment: (1) the liquidated damages provisions contained causation requirements; (2) a recruited employee’s salary is, in fact, reflective of that employee’s value to the employer; (3) the Court did not determine what reasonable damages would have been, so it could not have determined that the liquidated damages provisions in this case were “grossly disproportionate” to reasonable damages; and (4) there is nothing inappropriate about a high-level employee having contractual obligations that are different from those of a lower-level employee.[19]

Finally, the dissent argued that the Court’s decision defied Indiana’s heightened summary judgment standard set forth in Hughley v. State, which “consciously errs on the side of letting marginal cases proceed to trial on the merits rather than risk short-circuiting meritorious claims.”[20] The dissent argued that the Court’s decision creates uncertainty and calls into question which liquidated damages clauses will be enforced and when disputes over their enforceability will survive summary judgment.[21]

_______________________________________________________

[1]No. 18S-PL-00437, 2019 Ind. LEXIS 935 (Ind. Dec. 18, 2019).
[2]Id. at *14.
[3]Id. at *2-3.
[4]Id. at *3.
[5]Id. at *4.
[6]Id.
[7]Id.
[8]Id. at *14.
[9]Id. at *6 (citing Skendzel v. Marshall, 301 N.E.2d 641, 645 (Ind. 1973); Weinreb v. Fannie Mae, 993 N.E.2d 223, 232-33 (Ind. Ct. App. 2013)).
[10]Id. (citing Corvee, Inc. v. French, 943 N.E.2d 844, 847 (Ind. Ct. App. 2011)).
[11]Id. at *8.
[12]Id.
[13]Id.
[14]Id. at *8-9 (citing Raymundo v. Hammond Clinic Ass’n, 449 N.E.2d 276, 284 (Ind. 1983); Harris v. Primus, 450 N.E.2d 80, 85-86 (Ind. Ct. App. 1983)).
[15]Id. at *9-10 (citing Hahn v. Drees, Perugini & Co., 581 N.E.2d 457 (Ind. Ct. App. 1991); Seach v. Richards, Dieterle & Co., 439 N.E.2d 208 (Ind. Ct. App. 1982)).
[16]Id. at *11 (citing Art County Squire, LLC v. Inland Mortg. Corp., 745 N.E.2d 885, 891 (Ind. Ct. App. 2001)).
[17]Id. at *14.
[18]Id. at *17 (Slaughter, J., dissenting).
[19]Id. at *19 (Slaughter, J., dissenting).
[20]Id. at *29 (Slaughter, J., dissenting) (citing Hughley v. State, 15 N.E.3d 1000, 1003 (Ind. 2014)).
[21]Id. at *30 (Slaughter, J., dissenting).

Aleasha Boling is an associate in the law firm of Parr Richey Frandsen Patterson Kruse with offices in Indianapolis and Lebanon, Indiana. She advises business, utility and municipal clients in the areas of corporate compliance, corporate governance, employment, real estate, commercial transactions and regulatory law.

The statements contained herein are matters of opinion and general information only and are not to be considered legal advice and should not be construed to form an attorney-client relationship. If you have any questions regarding this article, please contact an attorney.

 

Contact Information