Safeguarding trade secrets is typically Rule No. 1 for many companies—particularly technology companies. Therefore, when a company needs to share its highly-guarded trade secrets with a subcontractor in order to complete a project together, most companies understandably require the subcontractor to enter into a confidentiality agreement that includes a non-disclosure provision. Many of those confidentiality agreements also include a liquidated damages provision that is triggered by the subcontractor’s breach.
The benefits of including a liquidated damages provision is obvious. Oftentimes it is extremely difficult—if not impossible—to calculate the precise, actual damages resulting from a breach. In these situations, a liquidated damages provision can be utilized to recover damages, so long as the provision is not determined to be an unenforceable penalty clause. The precise requirements vary from state to state, but generally speaking, the liquidated damages provision needs to be a reasonable estimate of the damages incurred by the non-breaching party.
Earlier this month, the 11th Circuit focused on this very issue in its non-published opinion from SIS LLC v. Stoneridge Software Inc. et al., Case Number 21-13567, a trade secret case involving two technology companies who once attempted to work together.
Several years ago, SIS entered into a confidentiality agreement with Stoneridge Holdings. Ultimately, SIS claimed that Stoneridge breached the parties’ confidentiality agreement, thereby causing SIS to lose a “multi-million dollar contract.” SIS filed suit and attempted to recover damages from Stoneridge based solely on the liquidated damages provision contained in the confidentiality agreement.
In 2021, a Georgia jury found that Stoneridge had breached the confidentiality agreement, but was not permitted to award liquidated damages because the court concluded that the liquidated damages clause in the parties’ contract allowed for disgorgement damages and was therefore unenforceable. Instead, SIS only recovered $85,000 in “nominal damages.”
SIS appealed the trial court’s ruling concerning the liquidated damages provision. The 11th Circuit upheld the trial court’s finding, holding that “[t]he formula employed in [liquidated damages provision] is not a reasonable method for approximating the probable loss because it is based entirely on the breaching party’s profits, and not on the injury suffered by the non-breaching party.” (Emphasis added.) It is well established in Georgia that a liquidated damages provision that is based entirely on the breaching party’s profits, and not the injury actually suffered by the non-breaching party, constitutes “disgorgement” under Georgia law and is unenforceable.
Understandably, therefore, the 11th Circuit held that because the agreement’s provision “mismatches” the damages awarded to SIS and the damages it actually suffered, the liquidated damages provision violated Georgia law. Instead of estimating SIS’s actual damages, the provision functioned more like a deterrence, which is unenforceable.
Compounding matters for SIS was the fact that SIS never produced any evidence at trial of its alleged lost profits. Therefore, once the court found the liquidated damages provision to be unenforceable, the jury had no basis to award SIS damages aside from their finding of $85,000 in “nominal damages” (which was also upheld on appeal).
Takeaway
In most instances, including a liquidated damages provision in a confidentiality agreement is a smart move. In doing so, however, it is critical—particularly in states like Georgia—that the liquidated damages calculation is based on the damages sustained by the non-breaching party and not the disgorgement of profits obtained by the breaching party.
