The Indiana Supreme Court recently decided a case that involved non-compete agreements. Consequently, Indiana employers should think twice about how they address damages in such agreements.

Liquidated Damages and Non-Compete Agreements

Some Indiana employers require certain employees to sign non-compete agreements. Such agreements often restrict the right to solicit customers and employees for a period of time after employment ends. When a former employee violates a non-compete agreement, the employer may not be able to establish the amount of its loss with certainty. Therefore, some employers try to avoid having to prove actual loss by negotiating a liquidated damages clause.

Liquidated damages clauses generally result from the parties negotiating a sum of money due for breaching the contract. The sum, which may be more or less than the employer’s actual loss, is like a pre-arranged settlement. The catch is that the amount must be reasonably related to actual losses. Otherwise, it might be deemed an unenforceable penalty.

Indiana Supreme Court Refuses to Enforce Employees’ Agreement to Liquidated Damages

In American Consulting, Inc. v. Hannum Wagle & Cline Engineering, Inc., the Indiana Supreme Court struck down an employer’s liquidated damages clause as an unenforceable penalty. Key allegations from the case follow (nothing in this post is intended to suggest whether or not such allegations are true):

• Breach of agreement to not solicit customers required Vice President of Sales to pay 45% of all amounts that employer billed customer during the 12 months prior to the breach.
• Violating agreement to not solicit employees required Vice President of Sales to pay 50% of the recruited employee’s pay during the 12 months prior to the breach and required each of two project representatives to pay 100% of such pay.
• Vice President of Sales and two project representatives successfully recruited seven of employer’s employees to a competitor. Vice President of Sales also signed contracts with several of employer’s customers.

What Concerned the Indiana Supreme Court?

The Indiana Supreme Court decided that the liquidated damages provisions were unenforceable penalties. The Court explained:

• The employer did not show how an employee’s annualized salary correlates to the employer’s loss. Further, it did not explain whether it could replace the employees or their billings.
• The employer did not demonstrate why a Vice President only had to pay 50% of the salaries of recruited employees when the project managers had to pay 100%. The Court noted that the identity of the person who recruits an employee should not impact the value of the recruited employee or the loss caused by that person leaving.
• With respect to employees who all three former employees improperly solicited, the employer sought payment of 250% of the departing employees’ salaries.
• The agreements required payment of the same amount for a broad range of conduct.
• As for customers, the employer did not connect the liquidated damages to actual loss. The Court illustrated how the employer could claim a right to $450,000 in damages even if its actual loss was only $100.

The Court ruled that the employer could seek its actual damages, subject to its ability to prove them.

Consult an Indiana Employment Lawyer About Your Non-Compete Agreements

For Indiana businesses, your best bet is to consult with an experienced Indiana employment lawyer who can help you prepare non-compete agreements. This recent Indiana Supreme Court case is a good example of the need to be thoughtful when drafting such agreements. A non-compete that is enforceable in one context might not be in another. As for liquidated damages, it is important to be able to show how the chosen sum is reasonably correlated to actual losses.

The employment attorneys of Wooden McLaughlin LLP can assist with these and all of your employment law needs. Call us at 888-639-6151 or visit our offices in Indianapolis, Evansville, or Bloomington to schedule a consultation.

(This post is not legal advice.  Consider consulting with a lawyer about specific situations.)