Increasingly, employers in Texas have been inserting what might be called “liquidated damages” clauses into employment agreements like non-competes or severance agreements. At a basic level, a liquidated damages clause is an agreement that a party to a contract will pay a specific amount if they breach some part of the contract.
There is such thing as a proper liquidated damages clause, and there are situations (especially in commercial contracts) where clauses like that are appropriate. However, when used in the employment context often they can be wildly inappropriate, and may even cross the line into being penalty clauses that you might then have to fight to overturn. Employers may even try to demand that you agree that these damages are reasonable and not a penalty, even when that is not true. The purpose of this article is to give employees a basic idea of the things they should look out for—at least, when it comes to “liquidated damages”—before signing a contract with their employer
Generally, in a lawsuit over breach of a contract the party that breached the agreement does not have to pay any more than the amount of harm they actually caused the other side. Usually the parties would need to fight over exactly what that number would be as part of the lawsuit. But in Texas, if that number would be difficult or impossible to estimate, parties to a contract are allowed to agree to a “reasonable forecast” of those damages, just in case one party does breach the agreement. To put it another way, in situations where it would probably be prohibitively expensive or flat out impossible to put an exact dollar value on how much a party would be harmed by a breach of contract, the parties can negotiate “just compensation” ahead of time. A proper liquidated damages clause should make it so the parties do not need to argue over their actual damages at all, rather than piling on top of actual damages.
On the other hand, Texas does not allow a contract to have a penalty clause as an extra threat to “encourage” a party to comply with the contract. Scare tactics are not supposed to be part of a valid contract. The point of liquidated damages is to make things easier for both parties in the event of a dispute, not to punish one party beyond the actual harm they might cause by a breach.
Usually, in the employment context it is the employer writing the contracts. Employers in Texas may try to attach what they call liquidated damages to things like breach of confidentiality, or to a situation where it claims you are working for a competitor.
It may genuinely be hard to estimate how much the company might be harmed by a breach of contract in that situation. But the problem more often comes from the “reasonable forecast” part of the question. For instance, an employer might demand that their employees agree ahead of time to pay thousands—or even tens of thousands—of dollars for any and every breach of confidentiality, without making any effort to estimate how much the breach could actually harm them or considering how minor or accidental the breach might be.
Obviously the best policy is to comply with your agreements, but employers may put unreasonable expectations in these contracts, and penalties like this can create unnecessary financial hardship for employees. Texas courts may refuse to enforce a so-called liquidated damages clause that is not a reasonable forecast, but is actually just there to threaten employees into obedience. The problem is that you would then be in a position of having an expensive fight to overturn that penalty clause no matter how minor your breach might be.
Whether a particular liquidated damages clause is really just a disguised penalty depends on many things, like how the parties decided on the damages or what sorts of things can trigger the clause. No matter what, seeing a liquidated damages clause in a contract your employer sent you ought to make you pause and think. Is this a fair estimate, or is it meant as a penalty? Would the employer also pay liquidated damages if it breached the contract in a way that could cause harm to you that is difficult to estimate, or is it one-sided? These are things that you should think about before signing any contract your employer wrote.
If you are concerned about liquidated damages, penalties, or other terms in a contract your employer wants you to sign, you should talk to an employment attorney like those at Rob Wiley, P.C.