We want to share an important decision by the United States Fifth Circuit Court of Appeals upholding a liquidated damages (“LD”) clause in a maritime contract. Bland & Partners serves as counsel for Delta in this matter.

On January 8, 2013, the Fifth Circuit issued an opinion upholding the enforceability of a non-compete LD provision in a vessels sales agreement between International and Delta. Case: 12-30280, Document: 00512105709. The Fifth Circuit found the LD provision to be enforceable under maritime law as International failed to prove that the per-occurrence damage amount in the contract did not reasonable relate to Delta’s anticipated damages.

In 2006, Delta sold two tugboats to International under a Vessels Sales Agreement (“VSA”). The sales price was $4 million for both vessels, which price the parties specified was below fair market value in partial consideration for the non-compete provision. The VSA included a covenant that International would not charter out the vessels unless it first provided Delta the opportunity to do so. In the event Delta declined to charter out the vessels, International was free to do so, but was required to pay Delta 10% of the total charter. In the event that International breached the non-compete provision by chartering out the vessels, International was obligated to pay Delta $250,000 in LDs per violation, a figure that had been heavily negotiated by the parties.

Approximately two years after the sale, Delta notified International that Delta discovered breaches of the non-compete provision of the VSA and made demand for the LDs under the VSA. The parties then filed competing claims in the Eastern District of Louisiana, where the district court ruled that the LD provision was not an unenforceable penalty; thereafter, International appealed this certified issue to the Fifth Circuit.

The Fifth Circuit recognized that the VSA, and particularly its LD provision, was preceded by several months of negotiations, during which Delta expressed its concerns over competition. Additionally, the Fifth Circuit acknowledged that International was clear during negotiations that the vessels were for “in house” use and would not be used to compete with Delta.

With the above facts anchoring the Fifth Circuit’s analysis, the Fifth Circuit then applied its two factor test for determining the enforceability of an LD clause, i.e.: (1) the reasonable relation of the LDs to anticipated or actual loss caused by the breach and (2) the difficulty of proof of loss. In examining the second factor first, the Fifth Circuit found here that it is difficult to calculate/prove covenant-not-to-compete damages, such as those anticipated by Delta, so the Court has “more leeway” in determining whether the first factor — reasonable relation of liquidated damages to anticipated damages — is met.

The anticipated damages viewed by the Fifth Circuit here were, most importantly, those potentially flowing from Delta’s inability to prevent competition. In reaching its decision that the first factor was met, the Fifth Circuit found persuasive that the district court judge assessed expert testimony on potential charter contracts and rates and, as a result, determined that it could not bicker with the LD amount agreed by the parties as a reasonable per occurrence forecast of damages.

This Fifth Circuit decision is an important one in maritime law for the enforceability of liquidated damages provisions where the losses incurred due to breach of contract are inherently difficult to prove, such as in the context of non-compete agreements. In such situations, the Fifth Circuit will give “more leeway” in determining whether the liquidated damages provision is reasonably related to anticipated or actual losses. In non-compete agreements, in the context of buying and selling vessels or otherwise, actual damages are almost always difficult, or even impossible, to prove. As such, when applying the two-factor test, courts in the Fifth Circuit will likely look to the reasonableness of anticipated damages.

Businesses entering into maritime non-compete agreements, whether for the buying and selling of vessels or otherwise, should take this case into consideration when including a LD provision. LD amounts are likely to be enforced where the parties negotiated the terms and the LD amount bears a relation to anticipated damages.