26 October 2018

“Wrotham Park” or “Negotiating Damages”, and damages for Breach of Restrictive Covenants

Breaches of restrictive covenants, whether contained in a contract of employment, share sale agreement or otherwise, commonly occur. Often the most effective course of action to prevent damage is (the threat of) an application for an interim injunction. However, there may be many reasons why an injunction cannot be obtained; and even when one is obtained, damage may already have been done, with a residual damages claim to be addressed.

This article considers the position on damages for breach of restrictive covenants in light of the recent Supreme Court judgment in Morris-Garner and another v One Step (Support) Ltd [2018] UKSC 20. It also considers the circumstances where so called “Wrotham Park” or “Negotiating Damages” may be relevant.

Finally, we look at practical tips for In-House Lawyers dealing with breaches of restrictive covenants.

Facts of Morris-Garner and another v One Step (Support) Ltd

Karen Morris-Garner had established a business providing support for young people leaving care. She later agreed to sell a 50% interest in this business to Mr and Mrs Costelloe. One Step (Support) Ltd (“One Step”) was incorporated as a vehicle for this transaction: it acquired the business from Ms Morris-Garner and Morris-Garner and the Costelloes each took a 50% shareholding, subject to a shareholders agreement.

After time the relationship between Ms Morris-Garner and the Costelloes soured. Mrs Costelloe gave notice of her intention to serve a deadlock notice under the shareholders agreement, which would have required Ms Morris-Garner to either sell her shares in One Step or buy the Costelloes’. Not long after, Ms Morris-Garner incorporated another company, Positive Living Limited (“Positive Living”) with her civil partner Andrea Morris-Garner, the second appellant, who was an employee of One Stop. Mrs Costello proceeded to serve the deadlock notice and Ms Morris-Garner agreed to sell her shares in One Stop for £3.15m.

The parties entered into a buy-out agreement under which Ms Morris-Garner sold her shares and resigned as a director. Her partner resigned as an employee of One Stop and both agreed to be bound by restrictive covenants preventing them from using One Stop’s confidential information, soliciting its clients or competing with it without consent for a period of 3 years.

Around 8 months later, Positive Living started competing with One Stop. Not long afterwards, One Stop’s business went into a dramatic decline. One Stop threatened the Morris-Garners with an injunction but this was not pursued.

After the restrictive covenants had expired, the Morris-Garners sold Positive Living for £12.8m.

Around two years later, One Stop finally issued a claim against the Morris-Garners for breach of their restrictive covenants and related claims, seeking damages on various bases including an account of profits.

Expert evidence was adduced at trial on the question of losses. One expert estimated the loss by reference to an assumed gross margin on sales which would have been achieved by One Stop but for the competition of Positive Living, a figure of between £3.4 and £4.6m. A second expert estimated a hypothetical release fee which the Morris-Garners would have paid One-Stop to be released from their restrictive covenants, based on a hypothetical negotiation where both parties were acting reasonably.

At the trial the judge decided to deal with the question of liability and entitlement to damages first of all. It was found that the Morris-Garners had breached their restrictive covenants. On the question of losses, the Judge noted that it may be difficult for One-Stop to prove actual losses, and said that in addition to damages on the ordinary measure, what he called “Wrotham Park” damages were available to One Stop, that is, the amount it would reasonably have been paid at the time for releasing the Morris-Garners from their restrictive covenants.

One-Stop elected to have its damages assessed on the “Wrotham Park” basis, and a hearing was listed to determine quantum. The Morris-Garners appealed. The Court of Appeal held that the trial judge was correct to hold that “Wrotham Park” damages were available generally, and were suitable in the present case.

The Morris-Garners appealed to the Supreme Court.

The common law measure of damages for breach of contract

The Judgment of the Supreme Court reviewed the history of what the trial judge had referred to as “Wrotham Park” damages and its relationship with the usual common law position.

In-House Lawyers will be aware that the common law measure for damages is to put the claimant in the same position it would have been in had the contract been performed. This is usually based on the (financial) difference in the Claimant’s position based on performance as against non-performance. For anything other than nominal damages to be awarded, it is necessary to show that the Claimant has suffered (financial) loss.

In a case of breach of restrictive covenants, the common law measure would require the claimant to establish the loss it made because of the defendant’s non-performance, that is, because the defendant breached the restrictions. For One Stop, this would mean demonstrating the profit it would have made had the Morris-Garners complied with their restrictive covenants, and calculating the difference between this and the profit it actually made.

The original trial judge recognised that this was not an easy task, particularly where as is often the case with restrictive covenants, the activities in breach and their consequences are deliberately kept secret. However, expert evidence had been adduced on this point such that One Stop was able to suggest a significant figure representing its losses. The Supreme Court acknowledged that calculation of lost hypothetical profits is difficult and may not be so much calculated as estimated. It also made it clear that the common law has developed a number of techniques to assist with calculation of a figure and will permit a degree of imprecision. The fact that losses cannot be calculated with complete certainty will not preclude a claimant who has suffered loss making a recovery.

The question then is whether “Wrotham Park” damages or any other means of calculating damages is available to a claimant for breach of contract, and in particular breach of restrictive covenants.

What are “Wrotham Park” or “Negotiating Damages” anyway?

The Supreme Court was at pains to point out that “Wrotham Park” damages is something of a misleading term, which doesn’t necessarily mean what it is frequently understood to mean. The Supreme Court suggested that the term “Negotiating Damages” should be used instead.
Negotiating Damages are, in a nutshell, the price which the claimant and defendant would be held to have reasonably agreed to be paid for the defendant depriving the claimant of a valuable right.

The concept first arose in tort, where it is known as “user damages”, as a means of calculating the wrongful use of the claimant’s property by the defendant. It can be simply illustrated. Without the knowledge of the proprietor and without making any payment, a defendant takes a bicycle from a bicycle hire shop. He rides 50 miles and returns the bicycle at the end of the day. It is a cold day and no-one else would have hired the bicycle. Any wear and tear is negligible. The proprietor of the shop does not therefore appear to have suffered any real loss: the bike is returned undamaged, and he was not prevented from hiring it out to anyone else. But the law says that in spite of this, the proprietor of the shop is entitled to an amount equal to what a reasonable person would have paid to hire the bicycle for the day. This concept applies equally to real property. A defendant who trespasses on the claimant’s land by erecting advertising hoarding without permission will be liable to pay what the claimant would reasonably have charged him to do so. Likewise with intellectual property where, for example, a defendant uses the claimant’s patent without permission.

The concept also arose in the fairly niche area whereby the Court was given a statutory discretion to award damages in equity in lieu of an injunction or order for specific performance. If the court is entitled to exercise its direction to order an injunction but declines to do so, it is able to provide monetary compensation for withholding this remedy. Over the years, the compensation has frequently been calculated by reference to the amount of money which the claimant would have reasonably demanding for releasing the defendant from its obligation. It was in fact on this basis that an award was calculated in the case of Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798.

Following Wrotham Park, a series of cases considered this measure of damages and it was expanded, on reasoning which was not always clear, so as to be thought to be an alternative measure for any breach of contract if, for example, the breach was deliberate or the defendant benefitted from the wrongful conduct. The hypothetical release fee appears particularly appealing where it is not clear that the claimant has suffered any actual or meaningful loss. The prima facie appeal in cases of a breach of restrictive covenant is clear: the defendant will almost certainly have acted deliberately and will almost certainly have profited as a result, yet it will not necessarily be straightforward for the claimant to show losses. It would certainly appear to save the claimant significant time if it could just provide the figure it would reasonably have charged the defendant.

It was presumably for such reasons that One Stop elected, when offered by the trial judge, to have its damages assessed on a “Negotiating Damages” basis.

So what did the Supreme Court conclude?

The Supreme Court did not agree that it was so simple. Just because damages may be difficult to calculate on the usual common law basis, it does not mean that they cannot be calculated. If the calculation suggests that the claimant has not suffered any real loss, the starting point is that there is nothing for which it should be compensated. Searching around for another means to “punish” the defendant for its unlawful behaviour is inconsistent with the underlying common law position on damages.

Likewise, the hypothetical negotiation leading to the hypothetical reasonable release fee is fraught with difficulties and assumptions such that it cannot be regarded as the easy option.

The Supreme Court accepted that “Negotiating Damages” may be available for a breach of contract where the right which has been breached can be classified as an “asset”, and the damages are the economic value of this right. The hypothetical negotiation may be a tool to reach this figure. Lord Reed giving the majority judgment pithily summarised that “The defendant has taken something for nothing, for which the claimant was entitled to require payment”.

However, the rights which may be considered “assets” for this purpose are primarily proprietary or akin to proprietary rights. Rights in respect of confidential information may be quantified as an asset and therefore able to be compensated by “Negotiating Damages”.

The Supreme Court concluded that ordinary commercial restrictive covenants as a covenant not to compete or not to solicit clients do not create or protect a right which can be classified as an asset. Accordingly, negotiating damages should not be available as a means of calculating damages, and the common law means of calculating actual losses should be used.

The Supreme Court also concluded, effectively in passing, that an account of profits, being a means to deprive the defendant of the benefit of its unlawful conduct, cannot be awarded except in very exceptional circumstances, which are unlikely to occur in connection with breaches of commercial covenants.

What does this mean for claimants dealing with claims for breach of restrictive covenants?

Often the best relief to prevent damage when faced with a breach of restrictive covenants will be an application for an interim injunction. In many cases any such application will be preceded by a request to provide voluntary undertakings where appropriate.
Where an interim injunction is unlikely to be obtained for any reason and an order for damages is the only likely relief, careful thought will need to be given at an early stage as to how the damages will be evidenced.

In short, where there has been a breach of a restrictive covenant prohibiting competing, dealing or soliciting, “Negotiating Damages” no longer appears to be a viable basis for the claimant to claim damages.

This would seem to shut the door on the prospect of obtaining sizeable damages where the evidence of actual loss is weak.

If a claim is to be commercially viable, the claimant must be confident of quantifying a loss by reference to evidence. As set out above, the court will necessarily allow a degree of imprecision in this calculation, and may adopt what could be regarded as a broad brush approach. Therefore the claimant’s task though difficult should not be impossible. However, if the evidence cannot sustain a realistic assessment of a financial loss then there is a risk that whilst the Court may find there has been a breach, nominal or no damages are awarded. A claimant in this position would be risking an adverse costs order, particularly if any settlement proposals have been made by the defendant.

Steps should be taken sooner rather than later to identify what documentary evidence can be obtained to show loss and collate all such relevant evidence. It may be that losses will not accrue for some time and a decision will need to be made (assuming there is no application for an interim injunction) as to whether to delay in issuing proceedings whilst the losses and supporting evidence are investigated. If it transpires that losses cannot be evidenced, it may be preferable to discover this before issuing proceedings, rather than during the course of litigation.

As part of this process, it may be sensible to identify an expert accountant (if applicable) to review the evidence as part of the decision making process.

If a decision is made not to proceed with a damages claim, it will nevertheless be sensible to monitor the activities of the former employee. As Morris-Garner and another v One Step shows, it may be years until losses caused by a breach of restrictive covenants come to light, and it may be necessary to revisit a potential claim after some time has passed (bearing in mind the usual six year limitation period running from the date of the breach).

This article does not constitute legal advice. Specific legal advice should be taken before acting on any of the issues covered.

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About the Author
Elizabeth Beatty, Partner
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