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What is the price of a breach of covenant?

jacques and adamJacques Algazy QC and Adam Ohringer consider the recent Supreme Court case of Morris-Garner v One Step (Support) Ltd [2018] UKSC 20, which examined the availability of so-called Wrotham Park damages in claims for breach of contract.  The facts of the case were startlingly simple, as was the legal issue which arose; the Judgment of the Court less so.

The defendants were subject to non-competition and non-solicitation covenants, contained within an agreement to purchase a business from the claimant.  This was breached when the defendant went into direct competition with the claimant and diverted business away from it.

The Claimants sought damages on the basis exemplified in Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798, often referred to as Wrotham Park damages, which are not based on demonstrated losses but ‘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’.  In other words, they are based on the price which the parties would, hypothetically, have agreed to at the date of breach for the defendant to buy from the claimant the right to do that which was in fact prohibited.

Awards on this basis are usually reserved for cases involving breaches of propriety interests such as the unlawful use of land, chattels or intellectual property rights, even where (or especially where) the claimant has suffered no actual damage.  It is easy to see why.  The claimant in such cases has been unlawfully deprived of the fee which he could have commanded for the defendant’s use of the property. 

In Morris-Garner both the trial judge and the Court of Appeal considered Wrotham Park damages were available, despite the case concerning contractual obligation and not property rights, largely because of the difficulties in proving the loss of profit and goodwill which the claimant business suffered as a result of the breach. 

Claimants and prospective claimants were enthusiastic about this result.  Even where there is an easy-to-prove or admitted breach of contract, proving loss of business as a result is particularly arduous and is often practically impossible.  There may be a myriad of overlapping reasons why a business has failed to meet expectations or suffered a downturn.  The financial consequences of the breach of contract may be very difficult to isolate.  If Wrotham Park damages were available, this evidential swamp could be neatly avoided and damages could be claimed on a hypothetical basis.  In practice, this would have meant claimants recovering more than their provable losses—and more easily.

That enthusiasm however was short-lived.  The Supreme Court allowed the appeal and remitted the case for damages to be assessed on the orthodox basis under the law of contract.  The claimant must demonstrate the loss of profit and goodwill caused by the breach.

Lord Reed, giving the Judgment on behalf of the majority, analysed the development of Wrotham Park-type damages, noting that the term was compendious, as awarded in different types of claim.

User damages in tort

Wrotham Park damages were available where unlawful use of property cannot be measured in terms of cost of repair or diminution of value.

‘In such circumstances, the person who makes wrongful use of the property prevents the owner from exercising his right to obtain the economic value of the use in question and should therefore compensate him for the consequent loss. Put shortly, he takes something for nothing, for which the owner was entitled to require payment.’ (para. 30)

Breach of contract

Lord Reed observed that, in contrast to tort, damages for breach of contract were to place the claimant in the position he would have been in had the contract been honoured by the defendant.  It might appear therefore that there was no room for Wrotham Park damages.  However, the authorities, despite their inconsistencies, have shown instances were Wrotham Park damages have been awarded, or an account of profits ordered, where the claimant has suffered no loss or no loss can be proved.  Lord Reed found there was nothing inherently incompatible between Wrotham Park damages and the principles of damages for breach of contract.  Where the breach of contract involves the loss of an economic right which can be described as a valuable asset, Wrotham Park damages can compensate for that loss.  Importantly, Lord Reed considered this could arise when considering rights to the control of the use of land, intellectual property or confidential information but would not arise in respect of non-compete or non-solicitation obligations. He stated:

Negotiating damages can be awarded for breach of contract where the loss suffered by the claimant is appropriately measured by reference to the economic value of the right which has been breached, considered as an asset. That may be the position where the breach of contract results in the loss of a valuable asset created or protected by the right which was infringed. The rationale is that the claimant has in substance been deprived of a valuable asset, and his loss can therefore be measured by determining the economic value of the right in question, considered as an asset. The defendant has taken something for nothing, for which the claimant was entitled to require payment. (para. 95(10))

Lord Reed continued to explain that awards depriving the claimant of profits gained as a result of him acting in breach of contract (an order for an account of profits) should not be made outside of the wholly exceptional circumstances considered in Attorney General v Blake [2001] AC 268.

Damages in Equity

The primary remedy in equity is an injunction.  However, where it would be unjust to grant an injunction the court will move to consider damages in lieu.   Damages can be awarded on a Wrotham Park basis but, in keeping with the equitable approach, may be adjusted where fairness so demands in the circumstances of the case.  Damages are to reflect what has been lost by the court’s refusal to give injunctive relief.  It is the ‘price payable for the compulsory purchase of a right’ and is to be assessed at the date of trial (because it is in lieu of an injunction) rather than the date of breach.

Lord Reed’s conclusions

The judge at first instance and the Court of Appeal had been in error in their conclusions that Wrotham Park damages were available in cases of breach of contract on the basis that it would lead to a just result or because damages on the normal basis would be difficult to quantify.

The case did not involve ‘the loss of a valuable asset created or protected by the right which was infringed.’  Damages should be awarded to reflect the loss of profit and goodwill resulting from the breach despite the difficulties of quantification.  Wrotham Park damages could not be used as a short-cut. As Lord Reed put it:

This is a case brought by a commercial entity whose only interest in the defendants' performance of their obligations under the covenants was commercial. Indeed, a restrictive covenant which went beyond what was necessary for the reasonable protection of the claimant's commercial interests would have been unenforceable. The substance of the claimant's case is that it suffered financial loss as a result of the defendants' breach of contract. The effect of the breach of contract was to expose the claimant'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, and some elements of it may be inherently incapable of precise measurement. Nevertheless, it is a familiar type of loss, for which damages are frequently awarded. It is possible to quantify it in a conventional manner, as is demonstrated by Mr Hine's report. (para.98)

A loud but dissenting voice

Lord Sumption took a different approach. He preferred to develop the law by looking to where it ought to go rather than where it had been.  He thought the jurisprudence was incoherent and that the attempt to categorise the authorities, as demonstrated by Lord Reed, led to the drawing of artificial distinctions and resulted in unjustifiable differences in outcomes from one case to the next. 

He stated boldly that Wrotham Park is not a measure of damages at all.  It should be seen as one of many methods for assessing loss.  Whether that method is helpful or appropriate will depend on the specifics of the case.  In other words, the notional release fee—to be assessed at the date of breach—may be an accurate reflection of the value of the claimant’s actual loss.  It may therefore be useful evidence of what loss has actually suffered.

Lord Sumption’s Judgment was the subject of a stinging reply by Lord Carnwath who expressed his support for Lord Reed’s majority Judgment and then went into a detailed explanation as to why Lord Sumption was wrong.  The intention was clearly to impose legal certainty, which Lord Sumption was threating to upset, without which parties would be entering litigation without any reliable measure of the value of their claims and therefore what is at stake.

Analysis 

The Supreme Court has brought some order to this area of law and has explained how, when and why Wrotham Park damages are available as a measure of loss in different types of claim.  The orthodox view has remained largely intact and Wrotham Park damages are confined to cases involving breaches of proprietary rights.  The only extension is that purely contractual rights, which nonetheless create something which amount to a valuable asset, will also fall into this category.  Lord Reed declared that contractual rights requiring confidentiality created a valuable asset but non-competition and non-solicitation clauses did not.  Why there should be such a distinction is unclear.  Obviously, a business’s confidential information is a valuable asset—it can be bought and sold.  But the same surely applies to a business’s client base and to its team of employees.  Restrictive covenants protecting businesses from the poaching of clients or employees are enforceable precisely for this reason: see Lord Wilberforce in Stenhouse Ltd v Phillips [1974] AC 391, at p.400E).

This creates a difficulty for employment lawyers.  Many cases concerning breaches of post-termination restrictive covenants involve breaches of confidence as well.  Often the defendant has misappropriated the claimant’s confidential client list and then used that to go into competition with the claimant.  On what basis are damages to be assessed?  Lord Reed’s analysis would suggest that Wrotham Park damages are available for the breach of confidence but damages for breach of the non-compete covenant are to be assessed on a different basis; by reference to provable losses.  However, the losses resulting from the two breaches essentially overlap.

Without the useful short-cut of claiming Wrotham Park damages, claimants will have to engage in the difficult and intensive process of proving their actual losses.  Despite the doctrinal attraction of this approach, the reality is that it will not help address the huge levels of uncertainty involved in litigating this issue.  A cautionary tale is to be found in Marathon Asset Management LLP v Seddon [2017] EWHC 479 (Comm) where the successful claimant was significantly penalised in costs where its claim valued at £15m attracted an award of £2, in large because there was no evidence of any actual loss.

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