In a recent decision, the Delaware Court of Chancery refused to enforce a liquidated damages clause in a non-competition agreement between an employer and its former employee.  In Lyons Insurance Agency, Inc. v. Kelly Wark, et al., C.A. No. 2017-0348-SG (Jan. 28, 2020) the clause mandated that the former employee, Ms. Wark, pay liquidated damages in the amount of 1.5 times the value of any business that moves from Lyons to the employee’s new employer.  Lyons’ argued that the clause applied regardless of whether the employee engaged in “Competitive Behavior” (a term defined in the agreement to include solicitation of or impairment of Lyons’ relationships with its customers).  In response, Wark argued that the liquidated damages clause constituted an unenforceable penalty.  The cause of action arose when a customer of Lyons, intending to find a new broker, selected Wark’s new employer after a competitive bidding process.

The facts, which were not in dispute, showed that Wark had taken no action to solicit the customer or to impair the customer’s relationship with Lyons.  On the contrary, when initially approached by the customer, Wark declined to have any involvement in the competitive bidding process or selection of her new employer by the customer.  Only after Lyons was eliminated from the bidding process did Wark engage with the customer.

The Court’s reasoning in declining to enforce the liquidated damages clause rested primarily upon its failure to adequately connect Lyons’ business loss to Wark’s conduct.  In a prior case (Lyons Ins. Agency, Inc. v. Wilson, 2018 WL 4677606 (Del. Ch. Sept. 28, 2018)) the court enforced a similar clause where the operative language required a causal relationship between the customer’s transition and the former employee’s actions: “should Employee accept employment with another broker . . . and as a result, some or all of Employee’s Book of Business moves to the Employee’s new employer.”  That causal language was absent from Wark’s contract, such that the liquidated damages were imposed regardless of any action, or inaction, on the part of Wark.

This distinction was critical in the Wark decision.  The court determined that the liquidated damages operated “as a penalty untethered to Lyons’ reasonable interests in preventing competition by ex-employees because the harm to Lyons . . . is unrelated to any action taken by Wark.”

While Delaware courts will continue to enforce non-competition clauses, including those with liquidated damages provisions, the damages must be found to be connected to the employee’s actions.  Prudent employers wishing to impose and enforce such restrictive covenants should seek guidance from counsel when drafting such agreements, with care taken to ensure that a causal connection exists between the employee’s actions and the alleged damages.

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