A liquidated damages clause is a contractual provision that specifies at the outset of a business relationship the monetary damages to be awarded in the event of a contractual breach. Liquidated damages are typically included in contracts to avoid the need to prove actual damages in the event a party breaches the contract. Such provisions can save time and money by establishing an issue that would otherwise be disputed and perhaps litigated.
But this is not always the case. A recently filed lawsuit by a university against a former basketball coach shows that a liquidated damage clause itself can be the center of a legal dispute.
Nature of UH Lawsuit
Gibson Arnold is the former men’s head basketball coach at The University of Hawaii at Mānoa (“UH”). On November 3, 2011, Arnold entered into a Head Coach Employment Agreement (“Employment Agreement”) with UH for a three year term, terminating on June 30, 2014. The Employment Agreement entitled Arnold to an automatic one-year extension if he accomplished certain benchmarks, which he did. Thus, Arnold received an automatic one-year contract extension.
The Employment Agreement included a liquidated damages provision that provided payment to Arnold in the event of a termination by UH without cause. Specifically, the liquidated damages provision stated:
“This Agreement may be terminated by the University at any time without cause upon ninety (90) days written notice to Coach. In such event, University will pay Coach as liquidated damages, a lump sum amount equal to the total amount of compensation earned under the terms of this Agreement as of the date of the termination (incentives and extensions are not included in liquidated damages).”
On October 28, 2014, UH issued Arnold a termination letter advising him that he was being terminated without cause, and that his position as head coach of the basketball team would officially end on January 26, 2015. UH terminated Arnold in response to an NCCA investigation into UH’s basketball program that resulted in seven Level I and II violations. Arnold was named in all seven violations.
UH paid Arnold $148,545.48 shortly after his termination, which was the total amount remaining under his Employment Agreement. However, Arnold claimed he was entitled to $1.4 million dollars under the liquidated damages provision in the Employment Agreement.
According to the complaint, Arnold’s attorney sent UH two demand letters regarding his right to payment under the liquidated damages provision. Arnold also instituted internal grievances against UH seeking arbitration of the dispute.
UH did not want to pay the $1.4 million. UH, therefore, filed a lawsuit seeking a declaratory judgment that the liquidated damages clause in Arnold’s employment agreement is an unenforceable penalty since the $1.4 million amount is well in excess of any actual or anticipated damages incurred by Arnold as a result of the termination. The lawsuit also asserts tort and equitable claims against Arnold based on allegations that he breached his fiduciary duty to UH, fraudulently concealed NCAA violations, and defrauded the state by submitting false claims for payment stemming from a stay in Las Vegas.
Will Liquidated Damages be the Pot of Gold at end of this Rainbow?
Although UH seems to have a compelling defense to Arnold’s claim, the outcome is uncertain. Liquidated damage provisions are not uncommon in NCAA coaches’ contracts and the courts have enforced them, even against breaching coaches. For example, in Vanderbilt University v. Dinardo, 174 F.3d 751 (6th Cir. 1999), the university filed a lawsuit against its former head football coach, Gerry DiNardo, seeking liquidated damages for the coach’s alleged breach of his employment contract. The contract contained reciprocal liquidated damage provisions. Vanderbilt agreed to pay DiNardo his remaining salary should Vanderbilt replace him as football coach, and DiNardo agreed to reimburse Vanderbilt should he leave before his contract expired. In particular, DiNardo agreed that:
“in the event he resigns or otherwise terminates his employment as Head Football Coach (as opposed to his resignation or termination from another position at the University to which he may have been reassigned), prior to the expiration of this Contract, and is employed or performing services for a person or institution other than the University, he will pay to the University as liquidated damages an amount equal to his Base Salary, less amounts that would otherwise be deducted or withheld from his Base Salary for income and social security tax purposes, multiplied by the number of years (or portion(s) thereof) remaining on the Contract.”
The Court held that the liquidated damage clause was enforceable because the stipulated damage amount was reasonable in relation to the amount of damages that could be expected to result from the breach. More specifically, the court found that both parties understood and agreed that DiNardo’s resignation would result in Vanderbilt suffering damage beyond the cost of hiring a replacement coach.
As the UH lawsuit and the Dinardo case above point out, liquidated damages clauses can be very important provisions, particularly in employment agreements for key employees. Georgia employers, therefore, should implement such provisions with careful thought and with full understanding of their consequences.
Georgia Law and Liquidated Damages
Under Georgia law, a liquidated damages provision in a contract will be upheld if it is truly in nature of liquidated damages and is not a penalty. See O.C.G.A. § 13-6-7. The courts consider three elements in determining the enforceability of a liquidated damages clause.
1. The injury must be difficult or impossible to estimate accurately ahead of time.
2. Liquidated damages must be compensatory rather than punitive in nature.
3. The agreed amount of damages must be a reasonable pre-estimate of the injury that would be suffered by the non-breaching party.
Each of these elements must be met, otherwise the liquidated damage provision will be unenforceable as a matter of law. For example, in AFLAC, Inc. v. Williams, 264 Ga. 351 (1994), an in-house attorney had an agreement specifying that his employment would last for seven years and then automatically renew for another five-year term. In the event of early termination by the employer, the attorney was to receive 50% of his salary for the remainder of the entire twelve-year term. The Supreme Court of Georgia found this liquidated damages provision unenforceable, noting that the decision to award damages for up to twelve years to the attorney could not possibly have been based on the amount of time he would need to find new work.
Similarly, in Allied Informatics, Inc. v. Yeruva, 251 Ga.App. 404, 554 S.E.2d 550 (2001), the court held that the liquidated damages provisions in an employee’s contract with a computer consulting company were unenforceable. The contract contained a non-solicit covenant and several liquidated damages provisions in the event of a breach. The court found that the damages were not difficult to calculate, the stipulated sums were not reasonable estimates of probable loss, and the liquidated damages provisions were intended to be penalties. In short, the court determined that damages could be calculated based on discrete values and the evidence did not show that the sums identified in the contract bore any relation to the actual damages that could be incurred from a breach.
Liquidated Damages in Employment Agreements
If implemented properly, a liquidated damage provision in an employment agreement can help an employer more easily and efficiently recover damages caused by an early termination or breach. To increase the likelihood that such a clause will be enforced, employers should use language whereby the parties agree that actual damages are difficult to estimate and that the amount of the liquidated damages is a reasonable estimate of the probable loss. Making a liquidated damage provision mutual will also help show that the provision is reasonable and not a contract of adhesion. An employer should also document its efforts to estimate the potential harm caused by the breach, because this will help satisfy the three prong test that (1) the injury was difficult or impossible to estimate accurately ahead of time; (2) the liquidated damages are not punitive; and (3) the liquidated damages are a reasonable pre-estimate of the injury that would be suffered by the non-breaching party.
Even if the stakes are not as high as damages caused by a breaching NCAA coach or university, liquidated damage provisions can be useful for employers who wish to avoid disputes and possible litigation over the issue of damages. Before incorporating a liquidated damages provision, however, careful thought should be given; otherwise, the liquidated damage provision itself may be the source of a lawsuit.