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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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Chancery Finds Liquidated Damages Clause for Breach of Non-Compete Unenforceable
In this decision on cross-motions for summary judgment, the Delaware Court of Chancery held that a liquidated damages clause for a breach of a covenant not to compete in an employment contract (the “Non-Compete”) was unenforceable on public policy grounds. The Court noted that while Delaware will enforce a non-compete that is “reasonably tied to the interests of the employer,” liquidated damages clauses that are “untethered to the losses caused by ex-employee competition,” are unenforceable contractual penalties.
Plantiff, Lyons Insurance Agency, Inc. (“Lyons”), brought this action seeking to enforce the liquidated damages provision of the Non-Compete entered into with its former employee, Defendant Kelly Wark (“Wark”). The Non-Compete provided that if Wark left Lyons to work for a competitor and any of her Lyons’ book of business moved to that competitor, she would have to pay Lyons “an amount equal to 1.5 times the Moved Business,” regardless of whether Wark’s conduct caused the business to move to such competitor.
After Wark left Lyons, she accepted employment at Lyons’ competitor, Riggs, Counselman, Michael & Downes, Inc. (“RCM&D”). Shortly thereafter, one of Lyons’ clients put out its insurance plans for a bid. While RCM&D participated in bidding process, Wark was not involved and there was no evidence that any of Lyons’ proprietary information was used in connection with the bid. Ultimately the client hired RCM&D.
The Court noted that while Delaware is a pro-contractarian state, there are “public policy exceptions to this general rule." One such policy consideration is the “policy against oppression in employment contracts." For this reason, Delaware imposes limits on liquidated damages clauses in non-compete agreements and will not enforce them if they function as coercive penalties. Because the liquidated damages provision in this case obligated Wark to pay damages “even when no prohibited competitive behavior” pursuant to the terms of the Non-Compete had occurred, the Court found that the provision functioned as the type of causally untethered “coercive penalty” that Delaware policy considerations prohibit. The Court accordingly granted Wark’s motion for summary judgment.