Coach's contract dispute is a lesson in liquidated damages

Earlier this year, the 11th District Court of Appeals (Ohio) ruled in favor of Kent State University over a liquidated damages clause in the personal services contract of former basketball coach Gene A. Ford, who left the university in the midst of a five-year contract.

Liquidated damages are damages agreed upon in a contract in the event it is breached. They are included in all types of agreements, often in real estate and construction. This case (Kent State University v. Gene A. Ford) has an interesting story, and also offers an opportunity to discuss the broader issue of liquidated damages clauses in contracts.

The story begins with Gene A. Ford, who became the basketball coach for KSU in April, 2008. He signed an employment contract for a period of four years, with an option for a fifth year. The contract included his salary, supplemental salary and various incentives based on performance.

The contract also stated that Ford recognized that KSU was making a highly valuable investment in his continued employment, an investment that would be lost if Ford terminated his employment prior to the expiration of the contract. Accordingly, the contract stated, the coach would pay to KSU as liquidated damages an amount equal to his base and supplemental salary, multiplied by the number and portion of years remaining.

In April, 2010, Ford and KSU re-negotiated and executed a new contract for a term of five years, with a $100,000 increase in compensation, for a total salary of $300,000. This contract contained the same liquidated damages provision, changing only the number of years under the contract.

During early 2011, Ford accepted the position of head basketball coach at Bradley University at an annual salary of $700,000. KSU hired a new coach shortly thereafter.

The judge at the trial court level entered an order granting summary judgment and finding that Ford owed KSU $1.2 million under the liquidated damages clause. Ford appealed this order, but the Court of Appeals upheld it by a split decision, 2-1.

In analyzing the facts, all three judges began with a 1984 Ohio Supreme Court opinion, Samson Sales Inc. v. Honeywell Inc. Liquidated damages that are consistent with the principle of defining a fair compensation to the injured party are permitted. Penalty clauses are not permitted. The enforceability of a liquidated damages clause must be determined in light of the knowledge of the parties at the time they entered into the contract and in light of an estimate of the actual damages caused by the breach.

The Samson opinion established a three-part test. The liquidated damages would be allowed, and not struck down as an unenforceable penalty, if the damages would be: (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not unconscionable and disproportionate in amount so that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach.

The differences between the two majority judges and the dissenting judge revolved around the enforceability of the liquidated damages clause. The two majority judges stated that KSU had presented sufficient evidence to satisfy the three legal elements, but the dissenting judge concluded the opposite.

The dispute between the majority and the dissenting judge related to the first and third elements. Essentially, the majority accepted KSU's evidence that the measure of liquidated damages bore a reasonable relationship to the actual damages, although the actual damages were uncertain. The dissent, on the other hand, found "no reasonable relationship" between the liquidated damages and the actual damages sustained. For example, the dissent argued that the formula for the damages, that is, the number of years left on the contract multiplied by the annual salary, produces a higher valuation of damages if the contract is breached in the early years of the contract rather than the later years. This formula did not make sense under KSU's argument that it was determining damages for the investment in Ford's position.

The dissenter would have overruled the summary judgment motion and required the trial court to hear evidence at trial.

In the broader sense, this case illustrates several principles relating to liquidated damages provisions:

  1. The contract language itself should be drafted to explain the reasoning that leads to the liquidated damages provision.
  2. This reasoning must have a reasonable relationship to the amount of the damages. In other words, the parties should explain in some manner the expected range of damages and, in light of the uncertainty of exact measurement, the method of arriving at the liquidated damages number.
  3. A court will not uphold a penalty provision.
  4. The parties should establish a record as to the data that forms the basis of the expected damages so that, if there is a dispute, there will be evidence of what the parties were thinking at the time of entering into the contract.

—Jim Juliano
juliano@nicola.com