Arizona Court of Appeals Division Two holds that a court should analyze the reasonableness of a liquidated damages provision based on the facts known at the time of contract formation.

Two veterinarians worked at an animal hospital for more than five years.  When the veterinarians began working with that hospital, they both signed a non-compete agreement that forbid them from practicing veterinary medicine within five miles of the animal hospital for a year following the end of their employment.  The agreement provided that the damages for any violation of the non-compete clause was $60,000. 

The two veterinarians left the animal hospital and immediately started practicing at another animal hospital.  As a result, the first animal hospital sued for a violation of the non-compete clause.  The hospital sought as damages $60,000 from each veterinarian as provided for by the contract.  The two veterinarians argued to the trial court that the damages were grossly disproportionate to the actual revenue they received from performing veterinary services during this time (approximately half of the liquidated damages amount), that those damages could be determined with precision (by calculating the revenue they obtained), and so the liquidated damages provision should be held unenforceable.  The trial court agreed with the veterinarians and held that the liquidated damages provision of the contract was an unenforceable penalty and limited the recovery to the amount of revenue obtained by the veterinarians for performing services.

The court of appeals reversed.  A liquidated damages provision is reasonable if it approximates either the loss anticipated at the time of contract creation or the loss that actually resulted.  There is more latitude if the difficulty of proof of loss is great.  In evaluating the difficulties of proof of loss, the court should consider the facts at the time the contract is made, not at the time of the breach.  In a non-compete agreement, therefore, a liquidated damages provision should be upheld if it was difficult to predict the amount of loss at the time the parties signed the non-compete agreement. 

Here, the court of appeals relied in part on unrebutted deposition testimony from an executive from the first animal hospital, who testified that the $60,000 penalty was a conservative estimate of the average financial loss to the hospital when a veterinarian leaves to practice at a nearby hospital.  The court of appeals further explained that because the amount of anticipated damages was difficult to predict at the time the contract was formed, the animal hospital was entitled to “considerable latitude” in setting an amount for its liquidated damages provision.

Judge Staring authored the opinion for the Court; Judges Espinosa and Eckerstrom concurred.