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What Financial Remedy is Available for Breach of Restrictive Covenants?

Solicitor Rachel Mulvany, in our Employment team, highlights how a breach of restrictive covenant clauses in a business sale should be compensated for in an employment context.

Summary
In the recent case of Morris-Garner and another v One Step (Support) Ltd the Supreme Court considered whether “Wrotham Park” damages (i.e. the sum hypothetically due in return for being released from an obligation) were an appropriate remedy in a business sale context for breach of restrictive covenant clauses.  Although not an employment case, the case is a good indication of how similar breaches should be compensated for in an employment context.

Facts
The First Defendant (“D1”) and the Mrs Costelloe had jointly owned a company (“C”) providing support for young people leaving care.

The relationship between the parties started to deteriorate, during which time D1 sent confidential market research to her personal email account and incorporated a new company with the Second Defendant (“D2”).  D2 had formerly been a manager at C.

The other owner of the company, Mrs Costelloe served a deadlock notice requiring either D1 to buy her out or to sell her shares to Mrs Costelloe.  In October 2006, D1 agreed to sell her shares and a buyout agreement was reached.  It included clauses requiring D1 to keep certain information confidential, prohibited her from engaging in a competing business and from soliciting C’s clients for a period of three years. D2 also terminated their employment contract which had similar clauses.

In August 2007, D1 and D2 started trading in competition with C and in September 2010 they sold their shares in their new company for £12.8million.

Trial Judge
In the initial decision the Judge believed it was hard for the Claimant to identify their financial loss because of the Defendant’s wrongful competition and therefore decided it was just to recover “Wrotham Park” damages i.e. for such amount as would notionally have been agreed between the parties, acting reasonably, as the price to release D1 and D2 from their obligations.

Court of Appeal (“CA”)
The CA dismissed the Defendants’ appeal; whether or not damages on the “Wrotham Park” basis was the just response was a matter for the trial judge to decide on a broad brush basis and they were entitled to consider the difficulties C would have in establishing damages.

Appeal to the Supreme Court (“SC”)
The CA decision was appealed on two bases:

  1. Under what circumstances, if any, was a party entitled to seek negotiating damages (the term preferred by the SC over “Wrotham Park” damages) for a breach of contract?
  2. Was the Court of Appeal correct to uphold the trial judge’s finding that such damages were available? 

SC’s Decision
The Judge had been wrong in his belief that C could decide how their damages would be assessed.  Further, he had been mistaken that the difficulty in quantifying C’s financial loss justified abandoning any attempt to quantify it.  Further the basis for calculating damages for breach of contract cannot be a matter for the trial judge’s discretion.

In this instance the natural result of the breach of contract was a loss of profits and possibly also of goodwill.   Although it can be hard to precisely measure these losses, they a familiar type of loss and can be quantified.

Reasoning and Relevant Principles
Damages in a breach of contract are in essence a substitute for the performance of the contract.

It is not for the court to prevent or punish self-interested breaches of contract when the other party can be adequately protected by a damages award.

The Court either enforces the primary obligations to perform the contract, or the secondary obligation to pay damages as a substitute for performance.  In exceptional circumstances an account of profits may be made if other remedies are inadequate.

It may be under certain circumstances that the loss sustained is the economic value of the right which has been breached (the right being considered an asset) and the imaginary negotiation between the parties to release a party of their obligations is just a tool to arrive at a value of that asset.  Historically an example given of such an asset is the right to charge someone for the use of a horse; if someone uses your horse, which has been standing ideal, without permission or payment and the horse is returned none the worse, in theory there would be no resultant financial losses. However, the owner of the horse has lost the opportunity to charge for the use of their horse and therefore the recoverable damages would be the hypothetical amount they would have charged.

In assessing the damages to award the judge should first seek to quantify the financial loss actually sustained.  The judge can then determine the relevance, if any, of any evidence put forward regarding a hypothetical negotiation to be released from the obligations.  However, in this case C suffered a loss of profits and goodwill rather than simply the loss to charge for the use of an asset.

Comment
Although the case related to breaches of restrictive covenants in a business context, the principles are analogous to breaches of restrictive covenants, confidentiality agreements and intellectual property clauses found in an employment context. 

The case suggests that the formerly “Wrotham Park” damages or herein referred to as “negotiating damages” are appropriate if the valuable asset is one created or protected by a right which was infringed; the defendant takes something for nothing for which the claimant was entitled to require payment.

By way of an example, in an employment context this could be if a former employee breaches their duty of confidentiality and shares trade secrets with their new employer.  The former employer does not suffer any direct financial losses (e.g. no loss of profit, goodwill or otherwise) and there would be no value in any other remedy (e.g. an injunction would come too late).  This case would suggest the tribunal could then consider negotiating damages as the employer has lost of the value of releasing the former employee from their confidentiality clauses and the value of the relevant trade secrets.

For more information or legal advice, please contact Rachel Mulvany or a member of our team.

This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.