Liquidated Damages Provision
As is the case in every type of lawsuit, those involving breaches of a contract abide by the principle of “no harm, no foul.” That is, if a plaintiff suffered no damages due to the defendant’s alleged failure to follow the agreement’s terms, they simply have no claim. Courts are generally not in the business of vindicating principles, they are in the business of making wronged parties whole.
But proving the amount of actual damages incurred by a plaintiff due to a defendant’s breach of contract can often be harder than proving the breach itself. Demonstrating lost profits, missed opportunities, costs incurred, and other monetary consequences of the breach may require expert witnesses, extensive discovery, and other complicated economic evidence. All of this costs money and may or may not convince a judge or jury that the plaintiff should receive the amounts they claim they lost because of the breach. That is why many contracts, including employment agreements, contain what are called “liquidated damages” provisions.
What Is A Liquidated Damages Provision?
A liquidated damage provision in a contract is an agreement by the parties that a specified sum will constitute damages in the event of a breach, thus alleviating the need for the non-breaching party to prove actual damages.
In a dental employment agreement, for example, a provision may require the associate dentist to provide the practice owner with 90 days' notice of their intention to leave. The agreement may then include a liquidated damages clause in which the associate dentist agrees to pay the practice owner $500 a day for each day less than 90 that the dentist gives notice. It doesn’t matter whether the practice owner actually suffers any damages - that is what the associate agreed to pay for breaching the contract by providing late notice.
Reasonable Estimate Or Punishing Penalty? When Does a Liquidated Damages Provision Cross The Line?
Every state takes its own approach to the validity and enforceability of liquidated damages provisions, but no state prohibits liquidated damages entirely. Instead, judges in most states, including Illinois, analyze such provisions using a seemingly esoteric distinction: damages v. penalty. That is, does the agreed-upon sum constitute a reasonable estimation of hard-to-calculate damages that would arise from the breach, or is the amount a penalty designed to punish the breacher and deter violations? If a judge finds that the clause is the former, it is usually enforceable. But if it is deemed a penalty, it will likely be thrown out.
Illinois cases are generally illustrative of how judges make this critical distinction. In Illinois, courts will generally find a liquidated damages provision to be valid and enforceable so long as three requirements are met:
- The parties intended to agree in advance to the settlement of damages that might arise from the breach;
- the amount of liquidated damages was reasonable at the time of contracting, bearing some relation to the damages which might be sustained; and
- actual damages would be uncertain in amount and difficult to prove.
Whether these criteria are met inherently involves a case-by-case analysis, but most challenges to the enforceability of a liquidated damages provision are based on the second listed factor: reasonableness and relation to what the actual damages caused by the breach might be. If a liquidated damages amount would result in a windfall for the plaintiff or is wildly disproportionate to any conceivable damages that could flow from the breach, it is likely to be considered a penalty and thus invalid.
Going back to the dental employment agreement with its $500 per day in liquidated damages for late notice of resignation, it is questionable whether such a sum bears a sufficient relation to the actual damages the practice owner would sustain for losing a few days’ notice. On the other hand, if the associate left with only one day’s notice, the practice would have to cancel appointments and thus lose revenue as it spent time scrambling to find a new dentist to handle the caseload the departing dentist left behind (and the costs that go with that urgent effort). Could that amount to $44,500 in damages (89 days x $500/day)? Conceivably.
Regardless of whether a proposed liquidated damages clause will ultimately be found valid and what type of breach the provision relates to, both practice owners and dentists should consult with experienced counsel before entering into an employment agreement containing a liquidated damages provision.
We Focus on You So You Can Focus on Your Patients
At Grogan Hesse & Uditsky, P.C., we focus a substantial part of our practice on providing exceptional legal services for dentists and dental practices, as well as orthodontists, periodontists, endodontists, pediatric dentists, and oral surgeons. We bring unique insights and deep commitment to protecting the interests of dental professionals and their practices and welcome the opportunity to work with you.
Please call us at (630) 833-5533 or contact us online to arrange for your free initial consultation.
Jordan Uditsky, an accomplished businessman and seasoned attorney, combines his experience as a legal counselor and successful entrepreneur to advise dentists and other business owners in the Chicago area. Jordan grew up in a dental family, with his father, grandfather, and sister each owning their own dental practices. This blend of legal, business, and personal experience provides Jordan with unique insight into his clients’ needs, concerns, and goals.
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