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The BUSKLAW October Newsletter: Liquidated Damages Must be Reasonable to be Enforceable

                                                   This Photo by Unknown Author is licensed under CC By-SA

In last month's newsletter, we determined that Michigan law doesn't recognize the concept that "unreasonable" or adhesion contracts are unenforceable. But there is a caveat: a liquidated damages contractual provision must be reasonable to be enforceable. 

A liquidated damages provision is a term of art in the legal world. It applies when, according to Professor Bryan Garner, the parties to a contract agree in advance on the measure of damages to be assessed if a party defaults. Liquidated damages provisions are common in employee non-competition agreements, and it was that clause in one such agreement that Kent County Circuit Court Judge Christopher Yates examined in the case of Alpha Automotive v Cunningham Chrysler of Edinboro.

The facts of the case are simple. Cunningham is a car dealer who contracted with Alpha to conduct promotional events to sell Cunningham's cars. The agreement contained mutual non-solicitation provisions that barred each side from poaching the other's employees. After the promotional events ended, Alpha accused Cunningham of taking two of its employees in breach of the contract. After Judge Yates found that Cunningham had indeed breached the contract by hiring Alpha's employees, Alpha asked the Court to enforce the following liquidated damages provision for each employee that Cunningham "stole" from Alpha:

[Cunningham will pay Alpha] an agency or recruitment fee of $100,000, such amount representing the reasonable value of said individual's specialized training and by potential earnings to Alpha.

Judge Yates cogently summarized Michigan law on the enforceability of liquidated damages provisions:
  • The amount of the liquidated damages must be reasonable in relation to the possible injury suffered and not unconscionable or excessive. If the liquidated damages number is excessive, the provision is a penalty and thus unenforceable. 
  • A liquidated damages provision is particularly appropriate where actual damages are uncertain and difficult to ascertain.
In concluding that Alpha was entitled to $200,000 in liquidated damages from Cunningham, Judge Yates examined Alpha's profit and loss statements proving that Alpha earned around $113K from its work for Cunningham in 2014, but that income evaporated after Cunningham hired the two Alpha employees and then decided to perform promotional events itself in 2015. 

And just to close the loop, Judge Yates found that although the Rory decision (see my September post) rejected the concept that "unreasonable" or adhesion contracts are unenforceable, the same analysis doesn't apply to liquidated damages provisions based on an unpublished (thus having no precedential value) Michigan Court of Appeals case decided after RoryBut the premise that an unpublished appellate court decision holding that Rory doesn't apply to liquidated damages provisions is weak. How can judges get away with this? There are two answers. First, they can and do because the law - like everything else in life - is messy imprecise! Second, the doctrine affirmed in Rory that a contract is "made to be kept" despite being "unreasonable" is just as enshrined in U.S. contract law as the concept that a liquidated damages clause must be reasonable in amount to be enforceable.   

Do your contracts contain liquidated damages provisions? Have you hired expert legal counsel to make sure that they are valid?   
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