Liquidated Damages Clause Doesn’t Hold Water

In Brief: The method for calculating liquidated damages isn’t simple math.

Here’s What Happened:

SIS, LLC was about to bid on a project that required certain software packages. To prepare the bid, SIS approached Stoneridge Software, Inc. as a possible subcontractor. SIS and Stoneridge executed a confidentiality agreement, prohibiting any party who receives confidential information from “accessing, reproducing, disclosing, or using that information for purposes unrelated to the business relationship between the parties.” The agreement also had a liquidated damages clause penalizing a breaching party by requiring “an accounting and payment [to the non-breaching party] of all forms of compensation or benefits [that the breaching party] directly or indirectly realizes as a result of the breach.”

SIS won the bid. But SIS didn’t hire Stoneridge.

The customer ended up terminating the contract with SIS. Then it hired Stoneridge.

SIS sued Stoneridge for breach of contract and misappropriation of trade secrets, among other claims. The district court held that Stoneridge did not misappropriate SIS’ trade secrets, but it was liable for breach of the confidentiality agreement. Despite the breach, the district court refused to enforce the liquidated damages provision.  Instead, the court awarded $85,000 in nominal damages to SIS. SIS appealed, and Stoneridge cross-appealed the award of nominal damages.

The 11th Circuit Court of Appeals affirmed. The Court held that the liquidated damages clause was unenforceable. A liquidated damages clause is supposed to be a reasonable estimate of a party’s damages in the event of a breach. Instead of calculating the potential loss, the parties used the breaching party’s profits as a formula for the damages. The Court held that liquidated damages clauses need to state: (1) a temporal benchmark, limiting the computable loss to a fixed period of time; (2) a revenue benchmark, computing the pre-estimate by identifying specific profits that the non-breaching party would not be able to realize if the contract is breached; and (3) a focus on what the non-breaching party would have been paid, instead of contemplating what the breaching party may earn.

Why You Should Know This: The breach of the confidentiality agreement couldn’t be denied. So the fight had to be about damages. Usually, liquidated damages are a fixed number. But, coming up with a fixed number is sure to disadvantage the parties as either being too much or too little. So using a formula to compute liquidated damages makes sense. But the clause has to meet the three criteria identified by the Court.

Case Information: SIS, LLC v. Stoneridge Software, Inc., No. 21-13567, 2023 U.S. App. LEXIS 748 (11th Cir. Jan. 12, 2023)(Unpublished)