A Non-Compete Damages Overview

Companies that enforce restrictive covenants against ex-employees often face an uphill battle in proving damages resulting from a breach. It is for this reason that in the vast majority of cases a plaintiff focuses primarily on securing an injunction right away. It also is fairly clear that unless a new employer has aided the breach in some respect (for which it could be liable to an equal extent as the breaching employee) that an individual likely does not have the ability to pay a monetary judgment.

Still, it is important for plaintiff's counsel to understand the damages landscape and how to value a case. In this regard, the following damages theories might be available in a non-compete dispute:

1. Lost profits - The conventional method of proving contract damages is through a showing of lost profits. By definition, lost profits are speculative to a degree because they seek to project a model of economic activity in a counter-factual world. Put another way, but for the breach of the restrictive covenant, what profits would the employer have earned? Lost profits claims are delimited by the "reasonable certainty" rule, which means that a plaintiff must establish loss to a reasonable degree of certainty. Many courts confuse this rule's application. Generally speaking, it applies to the fact of damage. And once a plaintiff shows some damage, it is entitled to greater latitude in quantifying the harm - particularly where the employee's conduct has impeded quantification. In non-compete cases, a party may attempt to prove lost profits by projecting a picture of future sales from diverted or impaired customers.
2. Restitution - Although lost profits is likely the preferred route to establish damages, the concept of restitution also may apply in non-compete suits. Many courts hold that if a plaintiff's lost profits (or reliance) damages are unavailable due to the uncertainty in measuring the loss, a plaintiff can recover in restitution. The term simply refers to the plaintiff's interest in having restored to it any benefit the defendant achieves. Non-compete cases present an obvious case for restitution damages when a new employer has benefited from an employee's breach. The damages simply may be the new employer's own profits that are tied to the employee's breach, not those the ex-employer would have earned absent the breach.
3. Liquidated Damages - I have written extensively, both in this blog and in published journals, regarding the benefits of using liquidated damages clauses in non-compete agreements. The idea is that an employer can predetermine its damages by setting forth a formula in a contract. That formula then would apply if (a) it's a reasonable measure of damages, (b) the potential loss is difficult to quantify, and (c) it is not intended as a penalty to coerce contractual performance. Many cases find that non-compete contracts are well-suited to liquidated damages clauses. The reason is that the interest a non-compete protects is largely intangible. Therefore, proving specific, monetary loss always will be difficult. Drafting is essential, with the employer bearing a significant burden to show that its damages formula is reasonable. Employers would be well-advised to create a working damages model based on objective criteria that will stand up in court to the inevitable defense challenge.
4. Goodwill Impairment - The concept of "goodwill" is intrinsically tied to non-compete cases because many times the contract protects this intangible business interest. Goodwill is nothing more than a company's expectation that its customers will remain with the firm. Since a non-compete violation can result in a permanent loss of customers beyond the covenant's duration, a damages analysis relying on goodwill impairment is another possible means of recovery. In some respect, it overlaps with a projection of future profits so the two analyses shouldn't result in a duplicate damages claim. Although expert testimony is not needed to prove lost profits, it likely would be required if a plaintiff sought to prove goodwill impairment. The reason is that any goodwill impairment analysis should incorporate some sort of regression analysis to explore the relationships among variables that may affect a business's going-concern value.

Assessing damage in a non-compete case frequently is an afterthought. Counsel for both plaintiff and defendant should examine exposure as quickly as possible, even if the facts concerning liability will be the initial focus in the case.