Skip to main content

Are Liquidated Damages Clauses Legal and Enforceable?

By September 7, 2023September 29th, 2023Employment Law

Sometimes, in associate agreements, we find these clauses that say: if the associate solicits a former staff, they owe some amount of money as “liquidated damages” to the principle. That amount of money may vary, but we’ve seen it go from $20k per violation all the way up to $200k+ per violation. So what are these clauses all about, and are they even legal and enforceable?

Liquidated Damages

Did you know that you can contractually agree to pay a specified amount of money in the event of a contractual breach? That’s the beauty of having a private agreement with someone. You don’t necessarily need to prove damages. Both sides can just come to an agreement. This takes away all the time, money and effort the court system would need to expend trying to determine the damages if an associate solicits an employee in violation of a legal non-solicit clause. I wrote “legal” in the last part because there’s a whole other story as to whether non-solicits can be legal and enforceable. But let’s just assume we have a legal non-solicit clause and a clear violation, and now we’re dealing with the damages part.

As a rule, Courts will NOT typically enforce a penalty clause. Penalty clauses are unreasonable, unconscionable and one-sided. They are not proportionate to the damages that could be suffered. They are egregious and just meant to teach someone a punitive lesson. And that’s why courts don’t like to enforce them. But if the clause in question is more of an “agreement on damages” that reflects a reasonable amount of actual damages that could be suffered in real life, then courts may actually enforce them.

So, no to enforcing a penalty clause and possibly yes to enforcing a “liquidated damages” clause (also referred to sometimes as a “genuine pre-estimate of damages and not a penalty” clause).

2016 BC Court Case: Liquidated Damages = Not Enforced!

In the case of IRIS The Visual Group Western Canada Inc. v. Park, 2016, the BC Supreme Court had to determine whether a liquidated damages clause found in an employment agreement with an optometrist was legal and enforceable. It was not.

Background

By way of background, Dr. Hannah Park was an employee of IRIS, the Visual Group Western Canada Inc. Those parties entered into two written agreements that contained restrictions. In one of those agreements, Dr. Park agreed that if her employer wanted her to transfer her patient records and didn’t, she would have to pay a chart fee of $100 per chart. And there was another clause that said that if Dr. Park does violate a non-compete, non-solicit or transfer of patient records clause, then she’d be on the hook for some hefty amounts owed to her employer – namely, the higher of $75,000 OR $50,000 multiplied by the number of years/partial years that Dr. Park practices optometry from the location after starting with her employer up to $250k! That’s a lot of $$$ to be paid for a single violation!

Legal Principles

The Court cited various legal principles that courts should use to interpret whether a clause is an illegal penalty or a genuine pre-estimate of damages (liquidated damages) which can be enforceable.  An amount will be considered a penalty if the amount is greater than the greatest loss that could conceivably be proved to have followed from the breach.   The Court noted that an illegal penalty is extravagant, unreasonable, and unconscionable (one-sided, unfair, egregious) and penal in nature.  If a clause is found to be a penalty, the court may go on to ask if SOME other kind of relief should be imposed on the perpetrator (but in this case, the Court didn’t even get there).

Liquidated Damages

Dr. Park didn’t pay too much attention to the liquidated damages clause when she signed. She was concerned with her hours, compensation, etc. But when she got to court, she argued that the liquidated damages clauses were actually ILLEGAL penalties and NOT a LEGAL genuine pre-estimate of damages. The Court noted that the provisions allowed Dr. Park to end up paying, at the maximum, $250k if she violates the failure to pay $100 per chart/non-compete/non-solicitation clauses discussed above. The Court found it “extravagant and unconscionable that a single breach of section 6, which would result in a $100 payment under that section, could also expose Dr. Park to a claim for $250,000 in damages under section 7. In light of this, I conclude that section 7 provides for a penalty and not liquidated damages”.

2017 Quebec Court Case: Liquidated Damages = Enforced!

In the case of Groupe SL inc. c. Groupe ABS inc., 2017, a Quebec Superior Court penalized a former employee and former customer of a business in an amount of over $100,000.00 for breaching a non-solicit clause regarding employees.

Background

The employee, in this case, had signed an agreement that prohibited him (while working for the employer) from soliciting any of the employer’s customers. The employee eventually gave notice of resignation of his job and then later agreed to continue working past this notice period (as an independent contractor) to allow the employer to have a better transition for the employer with the same non-solicit continuing during the contractor phase of employment.

Unbeknownst to the employer, the employee attended an interview with a customer of the employer during the notice period. Unbeknownst to the employee, the customer and the employer had previously agreed to a non-solicitation clause and corresponding penalty regarding the employer’s employees.

The employee worked for a short period of time as an independent contractor and then finished working for the employer. Two months later, the employer learned that the employee was working for its customer.

Liquidated Damages

The Quebec Superior Court ruled that both the employee and the customer were jointly and severally liable to pay the penalty provided in the employer/customer agreement, which equalled $104,751.96 (which was actually two years of the employee’s salary).

First, the Court found that the customer broke its agreement with the employer by soliciting its employee while the agreement was in place because the employee had been interviewed by the customer while he was still working for the employee (notwithstanding that the employee only started working for the customer after the resignation was complete).

Then, the Court found that the employee did, in fact, assist the customer in breaking its promise under the employer/customer agreement and thus was liable for the damages. The Court stated the employee had breached his contractual obligation to “behave loyally” (as that Court said) and to maintain a duty of good faith (which Ontario Courts have upheld).

The Court further stated that the employee and customer breached their obligation of good faith by not acting transparently during the entire process; the Court wrote that it believed the employee and customer agreed to make the employee become an “independent contractor” to avoid breaching the employee’s non-solicit agreement.

When it came to the employer’s damages, the Court looked to the employer/customer penalty clause and found that the two parties had already agreed on the liquidated damages to which the employer would be entitled.

The Court noted that the penalty clause was clear (based on the 2x the employee’s salary as provided for in his T4s) and that the damages would be twofold: requirement to find and train a new person while losing output at the same time. Both the employee and the customer were aware of the penalty risks of having the employee come over. The clause was not ambiguous or abusive. Since the damages were pre-determined by contract, and in this case justifiable, the Court proceeded to enforce them.

Why Does This Matter?

Neither the BC nor the Quebec Court cases are recent or precedential for an Ontario court to follow. So, it will all come down to the facts of the case as to whether a court will feel inclined to enforce a “liquidated damages” clause.

So, should a principle try to enforce a liquidated damages clause against an associate who leaves and takes an assistant or admin staff? Generally speaking, I’d say ‘think twice about going to court’. Why? First, it’s a lot of time, money and energy to try to find out if a liquidated damages clause is enforceable. And since the quantum of the damages may only be a few tens of thousands of dollars (e.g. $20k or $30k per solicitation of this type of employee), it may not make much sense to spend it on lawyers or paralegals in court over the course of many years. You’re probably better off taking that money and putting it into marketing to attract new patients or your team or reinvesting in your practice’s equipment.

What about a high-producing hygienist or associate who is being solicited to go elsewhere by a former associate? Well, if those key persons DO make up an integral part of the dental practice, production and profitability and the quantum of the liquidated damages is reasonable/proportionate to what the actual damages may be, then a court MAY be inclined to enforce it. So if the liquidated damages amount is, let’s say, $50k-$100k per violation and the principle is confident that they would actually and reasonably suffer those damages because of needing to find and retrain someone to get to the other hygienist’s or associate’s level, then it might actually be worthwhile to take it to court.  Again: we’re operating in a grey zone so you need to tread carefully.

A judge could make a decision based on the actions of the associate who left (did they enter into the contract freely and voluntarily, did they breach the contract knowing about the risks of the liquidated damages clause, and did they do everything with unclean hands so to speak?). The court may look at whether it’s reasonable to assume that the principle would suffer that quantum of damages based on the importance of the person who who was solicited. This somewhat goes against the principle of two equal parties coming to a meeting of the minds and agreeing in writing to a penalty clause.  So the principle would argue that they don’t need to prove damages because it’s already agreed upon.  But at the same time, the court must assess whether the liquidated damages clause is proportionate enough to the actual damages that may suffered such that it is NOT an unenforceable penalty.  So even the courts need to tread carefully.

If there’s evidence that the person was a key/integral part of the practice’s overall production and profitability, then a court may be more inclined to enforce a reasonable liquidated damages clause. A bargain is a bargain so long as it’s not unconscionable, perceived as a penalty, or overly egregious.

The best bet, if you’re a principle dentist and you want to rely upon a liquidated damages clause, is to submit evidence to the Court that you would ACTUALLY and REASONABLY suffer the damages that the liquidated damages clause is now trying to recoup.

Bottom Line

All this is to say that you need to tread carefully!

Don’t make decisions based on vendettas or principals (but rather based on good business sense), and don’t expend your energy and hard-earned dollars unwisely. If you have an opportunity to go after someone in court, think about reinvesting in your practice first to attract and retain the best team members and patients. That’s my best advice for dentists!

Parting Thoughts: if you’re a principle and you happen to have a long-term employee who’s being solicited to go elsewhere, and THEY resign on their own, there could be a saving grace in all of it: you won’t owe them any notice of termination or payment in lieu of notice. So if someone has been with you for 20 years and they’re lacklustre, and they get solicited to go elsewhere and if they don’t have a proper employment agreement in place, then you as the principle may have just saved about 20+ months of notice or payment in lieu of notice to let them go (if they resign voluntarily). Something to think about in the grand scheme of things, eh?

The Content of this post is provided for informational purposes only. It is not intended to be legal, financial, tax, or other professional advice of any kind. You are advised to contact DMC (or other counsel) to seek specific legal advice concerning your individual situation.