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Negotiating Damages for breach of Restrictive Covenant – One Step too far?

  • Global
  • Litigation and dispute management

30-04-2018

In the recent judgment of Morris-Garner and another v One Step (Support) Ltd [2018] UKSC 20, the Supreme Court considered an important question in relation to the law of damages: in what circumstances can damages for breach of contract be assessed by reference to the sum that the claimant could hypothetically have received in return for releasing the defendant from the obligation which he failed to perform?

This is an important decision, the result of which is, there is no longer scope to claim negotiating damages (historically known as Wrotham Park damages) where there has been a breach of a restrictive covenant and it is possible to quantify the loss.

Background

One Step (Support) Ltd (the “Respondent”) provided supporting-living services to children leaving care and vulnerable adults. Mrs Karen Morris-Garner (the “Appellant”) had been a director and 50% shareholder of the Respondent. In December 2006, the Appellant sold her shareholding in One Step and resigned as a director. As part of the transaction the Appellant agreed not to compete with or solicit clients or customers of the Respondent for three years (the “Restrictive Covenant”). Unbeknownst to the Respondent, the Appellant had already established another company to provide competing services to those provided by the Respondent’s business.

The Respondent commenced proceedings against the Appellant for breach of the Restrictive Covenant. The trial judge accepted that it would be difficult, but not impossible, for the Respondent to identify its financial loss, particularly given the Appellant’s secrecy in setting up the new business. He therefore allowed the Respondent (and claimant in the claim) to elect to seek damages on a Wrotham Park basis instead, by reference to what sum would have been reasonable for the Appellant (and defendant in the claim) to pay in a hypothetical negotiation scenario.

On appeal the Court of Appeal upheld the first instance decision to award damages on the Wrotham Park basis.  The Court of Appeal confirmed that the only real test the Court should consider is whether an award of Wrotham Park damages is the “just response”.

The Appellant appealed to the Supreme Court on the question of damages.

Supreme Court’s decision

The Court provided a detailed overview of the development of the law in relation to damages assessed by reference to the value placed on a hypothetical release fee. In reaching its decision the Court came to the following key conclusions:

  • Negotiating damages can be awarded for breach of contract where the loss suffered by a claimant is appropriately measured by reference to the economic value of the right which has been breached, which right could be considered as an asset.
  • Such circumstances can exist in cases where the breach of contract results in the loss of a valuable asset created or protected by the right which was infringed, for example in cases concerned with the breach of a restrictive covenant over land, an intellectual property agreement or a confidentiality agreement.
  • Importantly the contractual right is of such a kind that its breach can cause an identifiable loss equivalent to the economic value of the right. The breach of a restrictive covenant may cause a claimant to suffer pecuniary loss resulting from the wrongful competition, such as loss of profits and goodwill, which is measurable by conventional means. However in the absence of such loss it is difficult to see how the claimant has suffered any other loss.
  • The effect of the breach of contract in this case was to expose the Respondent’s business to competition which would otherwise have been avoided. The natural result of that competition was a loss of profits and possibly of goodwill. The loss is difficult to quantify but it is possible to quantify it in a conventional manner.
  • This case is not one where the breach has resulted in the loss of a valuable asset which was created or protected by the right which was infringed. Accordingly, the case should be remitted for the judge to measure the financial loss which the Respondent has actually sustained.
  • It would be a matter for the judge to decide whether, in the particular circumstances, evidence of a hypothetical release fee was relevant and, if so, what weight to place upon it.

Comment

This judgement from the Supreme Court has the effect of making “negotiation damages” to compensate a party by reference to a hypothetical negotiation, following a breach of obligations owed, the exception to the rule of the normal measure of damages.

To the extent that the position may have been unclear before, damages by reference to a hypothetical bargain are only available where a valuable asset is lost and not where there has been a breach of restrictive covenant. This is on the basis that the Court views that such damages can be quantified in the normal way. 

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