After a five-day jury trial, the jury agrees your former business partners breached the non-compete they signed. You have a $1,000,000 liquidated-damages clause to enforce. And then, at the moment of judgment, the trial court declares that clause an unenforceable penalty and enters judgment against you, for the distributions you withheld from the very partners who breached. Nor can your business be awarded other damages because the losses were sustained by subsidiaries versus the plaintiff itself. Nine years of litigation, a liability verdict in hand, and you walk out a net loser.
In a recent New York case, the jury found the non-compete had been breached. But it also found that the company had failed to pay the departing owners their distributions during the contested period. The case then turned on the damages clause, and that is where the plaintiff’s victory unraveled.
As my son would say: that sucked. As my clients would say: this is why we hire you.
A “fine,” not a forecast
New York—like most states—will enforce a liquidated-damages clause only if it is a reasonable estimate of anticipated harm at the time of contracting, made in circumstances where actual damages would be difficult to calculate. What New York will not enforce is a penalty: a sum designed to punish a breach or coerce performance, untethered from any genuine attempt to estimate loss.
The evidence was damning on the point. One of the plaintiff’s own directors testified that the $1,000,000 figure equaled the company’s entire pre-tax revenue for a recent year. The plaintiff himself testified that the number was chosen with, in effect, no mathematics—selected to discourage owners from violating the non-compete. That is the language of deterrence and discipline, not compensation. The appellate court also seized on the clause’s own structure: because it allowed the owners to recover the $1,000,000 plus actual damages, the fixed sum could not plausibly be a substitute estimate of loss. A provision that stacks a large fixed payment on top of actual damages looks like a penalty, because it is.
There was a second, equally painful holding. The plaintiff’s only other proof of damages—an exhibit itemizing losses—was excluded because those losses had been sustained by the company’s operating subsidiaries, which were not parties to the agreement or the lawsuit. With the liquidated-damages clause gone and the alternative damages proof excluded, the plaintiff had won liability and proven nothing recoverable. The breaching defendants kept their shares, and the judgment ran against the plaintiff for the unpaid distributions.
Practical takeaways
The lesson cuts two ways—one for the people who draft these agreements, and one for the people who litigate them.
Make it read like damages, not discipline. If you want a fixed-sum remedy to survive, the provision must look like a good-faith estimate of anticipated harm, not a number chosen to scare people. Document, at the time of drafting, why the amount is a reasonable forecast of the loss a breach would cause. Calling it a “fine” is not automatically fatal—but the more a clause looks punitive, cumulative, and untethered from any loss calculation, the more vulnerable it becomes.
Beware stacking. A clause that lets you collect a large fixed sum and all your actual damages is a red flag. The choice is liquidated damages as the remedy or actual damages proven at trial—not both piled together.
Pick a number you can defend. A liquidated sum equal to a company’s entire annual revenue invites exactly the scrutiny that sank this clause. Tie the figure to something—lost margin, replacement cost, the value of the protected relationships—and keep the reasoning.
Prove damages through the right plaintiff. Losses suffered by affiliated entities that did not sign the contract and are not in the lawsuit may not be recoverable by the party that did sign. Structure the agreement, and the litigation, so the entity that holds the contract is the entity that holds the loss.
Remember that liability is only half the battle. Aggrieved clients fixate on the wrongdoing. But proving damages can be as hard as proving breach. You can win the verdict and still lose the war.
A well-drafted remedy is worth more than a satisfying one. Draft for compensation, not for revenge. And then make sure that the damages were actually suffered by your client versus its subsidiaries or affiliates.
David Seidman is the principal and founder of Seidman Law Group, LLC. He serves as outside general counsel for companies, which requires him to consider a diverse range of corporate, dispute resolution and avoidance, contract drafting and negotiation, real estate, and other issues. He can be reached at david@seidmanlawgroup.com or 312-399-7390.
This blog post is not legal advice. Please consult an experienced attorney to assist with your legal issues.
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