Key Takeaways

  • A liquidated damages clause in a confidentiality agreement sets a predetermined financial remedy for breach, offering clarity but requiring careful drafting.
  • Courts enforce such clauses only if damages are hard to estimate and the amount is a reasonable forecast of potential loss.
  • Factors like goodwill, reputation, trade secrets, and client relationships may justify liquidated damages when properly tied to legitimate business interests.
  • Overly harsh or punitive clauses risk being deemed unenforceable as penalties.
  • Sample clauses should outline scope, calculation method, and dispute resolution procedures to strengthen enforceability.
  • Arbitration can help preserve confidentiality and limit public exposure of sensitive information.

Liquidated damages clause in confidentiality agreement obligates one party to pay the other party a predetermined amount of money if there is a breach of contract. While the purpose is to avoid possible litigation and to quickly handle any breaches, the reality has not shown this to be true. Estimating losses due to a breach can be difficult because future earnings are unknown. What is known is that any future breach will hurt and damage the business.

Liquidated Damages in the Cavendish Judgment

The Supreme Court determined in the Cavendish judgment that when assessing the liquidated damages clause, the fine paid cannot be out of proportion to any business losses that have been incurred and should protect legitimate interests. Legitimate interests include intangibles, such as:

  • goodwill
  • brand reputation
  • confidential information
  • trade secrets
  • customer loyalty
  • employee relationships
  • licensee relationships

The Court also found that the contract was between well represented and knowledgeable entities. The entities were also of similar stature and, therefore, competent to determine the terms of the contract and that the court didn't need to interfere. The judgments in Cavendish offered brand owners a wider range for determining liquidated damages when a contract breach occurs. This is important to the survival of the business because determining damages caused by a breach is difficult. The liquidated liability clause is beneficial when applied to brand licensing. In instances where the brand owner is the dominant party, the liquidated damages clause may not be as easy to enforce.

Key Elements of a Liquidated Damages Clause

When drafting a liquidated damages clause, several elements must be clear for the clause to be effective and enforceable:

  • Clarity of Triggering Events: The agreement should specify what constitutes a breach, such as unauthorized disclosure of confidential information.
  • Reasonable Forecast of Losses: The amount should reflect a fair estimate of potential damages rather than a punishment. Courts scrutinize whether the number is proportionate to the harm expected.
  • Difficulty of Actual Calculation: These clauses are most defensible where damages—such as harm to reputation, loss of customer trust, or exposure of trade secrets—are difficult to measure with precision.
  • Balance of Bargaining Power: Courts may uphold clauses more readily if both parties were sophisticated and equally represented during negotiations.

By focusing on these aspects, parties can draft provisions that have a better chance of withstanding judicial review.

How to Limit a Breach

The liquidated damages clause acts as a deterrent but will not fully prevent a breach of contract. The clause should make anyone considering violating the terms of the contract rethink that decision based on the financial penalties. The penalties may include the clause damages and attorney and legal fees incurred.

In the instance of a breach of a confidentiality agreement, specifically celebrities, the clause should include language that discourages third parties to encourage a violation of the contract. By stating liability and associated costs that will be placed on the third party, it will limit the possibility of a breach. In relation to a celebrity, this can occur when a newspaper or magazine attempts to have the celebrity's employee share confidential information.

Employees working for celebrities will often not have legal representation and, therefore, may not fully understand the clause. To avoid this being an issue in possible future legal proceedings, the celebrity should strongly encourage the employee to seek their own representation prior to signing. The celebrity can also offer to pay any attorney's fees that may be incurred.

Liquidated Damages Clause Sample

Businesses often ask for a liquidated damages clause sample to understand how such terms are structured. While each agreement should be tailored to the specific relationship, a sample provision might look like this:

"If Employee discloses or misuses Confidential Information in violation of this Agreement, Employee shall pay to Employer the sum of $50,000 as liquidated damages, representing a reasonable estimate of the losses likely to result from such breach, including harm to Employer’s business reputation and goodwill. The parties agree that actual damages would be difficult to ascertain and that this amount is not intended as a penalty."

This sample illustrates important drafting features:

  • The damages amount is tied to anticipated harm.
  • It references the difficulty of measuring actual damages.
  • It clearly states the clause is compensatory, not punitive.

Employers may adjust the dollar figure or calculation method to reflect their industry and risk profile, but the logic should always be consistent with enforceability standards.

What Happens If a Breach Occurs

Even the best-written clause may not prevent a breach of contract. To secure information that may be leaked, the drafter of the clause should include language that ensures privacy to prevent entering public records. Privacy may only be possible during the negotiation process.

Once the case reaches litigation, it will be difficult to prevent information from the public. In situations where arbitrators are used to finding a resolution between parties, there is a higher likelihood of the details of the case being kept private. Arbitration is a recommended course of action in order to limit how much information reaches the public and the ability to choose what evidence will be considered.

Judicial Treatment of Liquidated Damages

Courts often examine liquidated damages clauses closely to determine if they are enforceable. The key considerations include:

  1. Proportionality: If the damages far exceed the anticipated harm, courts may strike down the clause as an unenforceable penalty.
  2. Commercial Reasonableness: In business-to-business agreements, especially where both sides had legal counsel, courts tend to respect negotiated damages provisions.
  3. Public Policy Concerns: Clauses that attempt to silence whistleblowers or conceal unlawful behavior are unlikely to be upheld.
  4. Contextual Factors: Industry practices, company size, and the relative sophistication of the parties may all influence enforceability.

Case law shows that while courts are willing to uphold liquidated damages clauses, they must be carefully drafted to reflect actual business risks rather than impose punitive burdens.

Enforcing Liquidated Damages

If the liquidated damages clause acts as a penalty, the clause cannot be enforced. Instead, as determined in Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex. 1992), criteria must be met including:

  • "harm caused by the breach is incapable or difficult of estimation"
  • "the amount of liquidated damages is a reasonable forecast of just compensation"

In relation to non-compete agreements, a set amount will be listed because determining the effect of the breach is difficult. It should be noted that in noncompete agreements, the liquidated damages clause cannot be based on the employee's salary.

If the reputation of a person has been harmed, the damages will be harder to calculate. In a celebrity case, if the confidential information has not been leaked to the public but may be, the celebrity can ask for higher damages as the information will negatively impact their reputation.

Practical Tips for Drafting Effective Clauses

Business owners and attorneys can improve the strength of their liquidated damages provisions by considering these drafting practices:

  • Tie Damages to Specific Harms: Reference potential harm such as loss of trade secrets, disruption of customer relationships, or reputational damage.
  • Avoid Arbitrary Numbers: Base the damages on industry norms, past disputes, or reasonable financial modeling.
  • Include Dispute Resolution Options: Arbitration or mediation clauses can preserve confidentiality and reduce litigation costs.
  • Review State Law: Some jurisdictions apply stricter scrutiny to liquidated damages, especially in employment or consumer contracts.
  • Update Regularly: As business circumstances change, revisit damages clauses to ensure amounts remain realistic and defensible.

By following these practices, businesses reduce the risk that a court will invalidate their clause and increase the likelihood that the predetermined amount will be enforceable if a breach occurs.

Frequently Asked Questions

  1. What is the purpose of a liquidated damages clause in a confidentiality agreement?
    It provides a predetermined financial remedy for breach, helping avoid uncertainty and lengthy litigation.
  2. Can a liquidated damages clause be unenforceable?
    Yes. If the amount is excessive or punitive rather than a reasonable forecast of loss, courts may strike it down.
  3. Why include a liquidated damages clause instead of relying on actual damages?
    Because reputational harm, trade secret loss, or client disruption can be hard to calculate, liquidated damages provide clarity and predictability.
  4. How much should be listed in a liquidated damages clause sample?
    The amount should be tied to anticipated harm and based on reasonable business estimates, not arbitrary or inflated figures.
  5. Does arbitration help in enforcing liquidated damages?
    Yes. Arbitration can keep disputes private and streamline enforcement, making it a strong option for confidentiality breaches.

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