The Supreme Court has overturned a Court of Appeal decision which had allowed the award of "Wrotham Park" damages for breaches of non-competition and non-solicitation restrictive covenants (Morris Garner and anor v One Step (Support) Ltd).
Wrotham Park damages - also known as "negotiating damages" - emerged from the seminal case of Wrotham Park Estate Co Ltd. Parkside Homes Ltd. In that case, a developer built 14 homes on the Wrotham Park estate in breach of a restrictive covenant which prohibited doing certain things on the land. Wrotham Park was awarded damages in lieu of an injunction, even though the value of the estate had not decreased by "one farthing". The purpose of the damages was to provide a just result by reflecting the sum that Wrotham Park and the developer would have agreed as the price for a release from the covenant.
In Morris Garner, the Supreme Court considered whether Wrotham Park damages were available for breaches of non-competition and non-solicitation covenants.
In 1999, the first defendant (and appellant), Karen Morris-Garner (KMG), established a business providing supported living services to vulnerable, young people. The second defendant (and appellant), Andrea Morris-Garner (AMG), was employed as the operations and area manager.
In 2002, KMG sold 50% of the business to Mr and Mrs Costelloe (the Costelloes). One Step (Support) Ltd (One Step) (the claimant company and respondent), was incorporated as a vehicle for the transaction. The shareholders' agreement contained 3-year restrictive covenants which prevented the shareholders from competing or soliciting key clients.
In 2004 the relationship between KMG and the Costelloes deteriorated. In 2006 KMG resigned as a director of One Step and sold her 50% shareholding to the Costelloes for £3.15 million. Both KMG and AMG entered into deeds of compromise which contained 3-year non-competition and non-solicitation restrictions.
However, unknown to the Costelloes, in 2004 KMG and AMG had already set up a competing venture called Positive Living. Positive Living provided the same services as One Step, but also obtained registration as a domiciliary care agency with the Care Quality Commission (CQC). Positive Living's marketing literature covered the same rented accommodation and support services as provided by One Step, but distinguished itself by its CQC registration and the ability to provide personal care.
In 2007, Positive Living began trading in the same area as One Step. By early 2008, One Step experienced a significant decline in its fortunes. This led to correspondence between the parties' solicitors in which KMG and AMG denied that they were competing with One Step. No further action was taken at that time. In 2010, KMG and AMG sold their shares in Positive Living for £12.8 million.
In 2012, One Step decided to issue proceedings against KMG and AMG for breaches of the restrictive covenants contained in the deeds of compromise. One Step sought either an account of profits or Wrotham Park damages, the latter being the reasonable amount that the parties would have agreed should be paid to secure the release of the restrictive covenants.
The High Court refused an account of profits. However, given the secret manner in which Positive Living had been set up, the judge accepted it would be difficult for One Step to identify its financial loss. Therefore, it was just to make an award of Wrotham Park damages. KMG and AMG appealed to the Court of Appeal.
Court of Appeal decision
The Court of Appeal upheld the High Court's decision and attempted to clarify the circumstances in which Wrotham Park damages would be awarded. It had been thought that Wrotham Park damages were confined to cases where the claimant had suffered no identifiable financial loss but where it would be wrong to allow the defendant to profit from their wrongdoing. However, the Court of Appeal decided that:
- There was no rule that Wrotham Park damages would only be awarded in such circumstances. Wrotham Park damages allowed the court to take a flexible approach where it was difficult, but not necessarily impossible, to show an identifiable financial loss.
- The correct test was whether Wrotham Park damages would be a just response to the breach. This was "quintessentially, a matter for the judge to decide" taking into account the difficulties that One Step would have encountered in establishing an ordinary damages claim given that Positive Living had been incorporated in secrecy.
- Wrotham Park damages were not exceptional. The test was "not whether the case is exceptional but what does justice require". In any event, the facts of the case were exceptional, with Positive Living having been established in secret before KMG and AMG signed up to lengthy restrictive covenants that they proceeded to disregard. This subterfuge meant that One Step had not been able to obtain interim relief in the form of an injunction. The Court of Appeal noted that the difficulty of obtaining interim relief in consequence of the breach of contract was another factor that could be taken into account.
- As to the amount of damages that can be awarded, the judge must guard against over-compensation. However, the Court acknowledged that: "the price that might reasonably be demanded for the relaxation of a covenant may necessarily exceed the loss that would have been suffered by the actual breach".
KMG and AMG appealed again to the Supreme Court.
Supreme Court decision
The Supreme Court upheld the appeal and overturned the High Court and Court of Appeal decisions. Lord Reed gave the main judgment in the case and began by setting out a reminder of the "first principles" relating to damages awards:
- User damages in tort: these damages are assessed by reference to the value of the use wrongfully made of property, measured by what a reasonable person would have paid for the right of use. Such damages are typically awarded for the breaches of tangible and intellectual property rights.
- Damages in equity under the Chancery Amendment Act 1858 (the "Lord Cairns' Act"): these damages can be awarded in place of an injunction or specific performance where the court has jurisdiction to grant such a remedy. One way of quantifying such damages is by reference to the amount the claimant might reasonably have demanded in return for the relaxation of the obligation in question.
- Damages for breach of contract: common law damages for breach of contract are intended to put the claimant in the same position as they would have been in had the contract been performed. The conventional approach to quantifying such damages is to look at the difference between the effect of performance and non-performance on the claimant. The claimant's loss should be measured or estimated as accurately or reliably as possible. Only in exceptional circumstances can contract law damages be awarded to deprive the defendant of profits flowing from the breach (i.e. an account of profits).
Turning then to the question of Wrotham Park damages – the Supreme Court preferring the term "negotiating damages" – Lord Reed reviewed the case law and considered that it fell into two phases. In the first phase of cases (starting with the Wrotham Park case itself), damages awards were made under the Lord Cairns' Act in cases concerning interference with rights over property and land and were based on a hypothetical release fee in place of an injunction. That measure of damages reflected the fact that the refusal of an injunction had the effect of depriving the claimant of an asset which had economic value. In the second phase of cases, similar awards were made at common law, but on a wider and less certain basis.
Lord Reed concluded that negotiating damages could be awarded for a breach of contract where the breach "results in the loss of a valuable asset created or protected by the right which was infringed, as for example in cases concerned with the breach of a restrictive covenant over land, an intellectual property agreement or a confidentiality agreement". In such cases, the claimant has been deprived of a valuable asset, and his loss can therefore be measured by determining the economic value of the asset in question.
However, in other types of breach of contract claim, such as breach of non-competition or non-solicitation restrictions, damages should be assessed in the conventional way. At paragraph 93 of the judgment it is said that: "…the breach of a non-compete obligation may cause the claimant to suffer pecuniary loss resulting from the wrongful competition, such as loss of profits and goodwill which is measurable by conventional means, but in the absence of such loss, it is difficult to see how there could be any other loss".
Was One Step entitled to negotiating damages?
Applying these principles to the present case, Lord Reed concluded that the High Court and Court of Appeal had been wrong to conclude that One Step was entitled to negotiating damages. Neither the difficulty of proving the loss nor the deliberate nature of the breach justified making an award of negotiating damages to One Step.
The substance of One Step's claim was that it had lost profits and goodwill as a result of KMG's and AMG's breaches of contract. This form of loss was capable of being quantified in the conventional manner for assessing damages for breach of contract i.e. accurately measuring or estimating the actual loss sustained. It could not be said that One Step had suffered a loss of a valuable proprietary asset created or protected by the rights which had been infringed.
Therefore, the case will now return to the High Court for a hearing on quantum to measure One Step's actual financial loss.
This decision confirms that where a former employee breaches a non-competition or non-solicitation covenant, the employer will be confined to an assessment of damages in the normal way: the mere difficulty in quantifying loss is not a gateway to an award of negotiating damages. Instead, the employer is required to demonstrate and/or estimate their actual loss as accurately or reliably as possible. Recognising that this may not always be straightforward, Lord Reed pointed out that "there are a variety of legal principles which can assist the claimant in cases where there is a paucity of evidence". For example,where the defendant had destroyed evidence, a claimant is able to ask court to make presumptions in their favour. Lord Reed also acknowledged that there may be limited circumstances in which a hypothetical release fee might be relevant to the conventional assessment of damages for breach of contact (e.g. if the parties had been negotiating a release fee prior to the breach occurring then the fee might be relevant to the quantification of loss). Negotiating damages may still be available as a remedy where the former employee has breached their duty of confidence as Lord Reed concluded such a duty to fall into the same category as a restrictive covenant over land or an intellectual property agreement.
Where does this leave employers? Where a former employee breaches a non-competition or non-solicitation restriction the employer must be ready to evidence the loss flowing from the breach. This involves proving that the contract in question would have been placed with the employer (rather than with the former employee's competing business). The challenge for the employer here is that it's not usually possible to show this would definitely have been the case. Accordingly, the loss is more likely to be treated as a "loss of chance", meaning that the court will evaluate the chance of which the employer has been deprived. This will usually be expressed as a fixed percentage chance of making a specified amount of profit.
Employers in this situation may be able to pursue an "account of profits" as an alternative remedy. An account of profits has the advantage that the employer is not required to prove loss. This remedy will be available where the former employee has improperly received or retained profits acquired from the use of the employer's property (which would include confidential information). In such circumstances, the court can order the former employee to surrender the profits in question. However, as was seen in the One Step case, such awards are exceptional in breach of contract cases.
Finally, employers should remember that where either confidentiality and/or intellectual property rights have been breached negotiating damages may still be available. In practice a dispute may well involve breaches of confidentiality as well as breach of a restrictive covenant making the task of assessing damages complex.