Measuring damages for breach of a business sale agreement

Publication December 2018

Agreements for the sale of a business often contain prohibitions preventing the seller from competing with the business, or soliciting clients or employees of the business for a period of time following the sale. Breach of any of these covenants by a seller can be extremely harmful to the buyer and will accordingly give rise to a claim for damages.

However, while the buyer may be able to adduce evidence to demonstrate the seller’s breach, establishing the buyer’s own loss can often be problematic. For example, how much greater turnover would the buyer have had, had the seller not been in breach of covenant in setting up a rival business? Is the buyer entitled to a proportion of the seller’s profits from the rival business achieved as a consequence of breaching the covenants in question? Or is the buyer entitled to a hypothetical fee for the release or relaxation of the covenants in question?

This issue was considered by the Supreme Court in the case of Morris- Garner and another v One Step (Support) Ltd [2018] UKSC 20.

That case involved the sale of a 50 per cent share in a business providing support for young people leaving care, which sale was subject to restrictive confidentiality, non-compete and non-solicitation covenants. The High Court found that the defendants had breached the restrictive covenants and the claimant was entitled to damages to be assessed “on a Wrotham Park basis (for such amount as would notionally have been agreed between the parties, acting reasonably, as the price for releasing the defendants from their obligation), or alternatively ordinary compensatory damages”. The Court of Appeal concurred. Both courts noted the difficulty the claimant may have in identifying the financial loss it had suffered by reason of the defendants’ wrongful competition. The claimant elected for damages to be assessed on the so-called Wrotham Park basis.

“Wrotham Park damages” (albeit this expression was rejected by the Supreme Court in favour of “negotiating damages”) were traditionally available principally in a property context (in relation to invasion of property or IP rights). Nevertheless, more recent cases have suggested that such an award may be more widely available.

The issue to be considered by the Supreme Court was: “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”. In giving the main judgment, Lord Reed noted that this was the first occasion on which this “important question in relation to the law of damages” had been brought before the highest court for decision and noted that the “confused state of the authorities, have reflected a lack of clarity as to the theoretical underpinning of such awards, and consequent uncertainty as to when they are available.”

Lord Reid considered the key authorities on this issue in two phases, beginning with Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798. The two phases are said to be divided by Attorney General v Blake [2001] 1 AC 268, a case for which negotiating damages was not at issue, but is said to have sown the “seeds of uncertainty” as to when such damages are available.

The Supreme Court unanimously reversed the earlier decision of the Court of Appeal; finding that the lower courts were mistaken in their approach to the assessment of damages, and determined that the case should return to the High Court for a hearing on quantum to measure the claimant’s actual financial loss.

The Supreme Court confirmed that damages for breach of contract are not a matter of discretion nor is the basis on which damages are awarded. They are claimed as of right, and they are awarded or refused on the basis of legal principle.

Lord Reed stated that 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”. Examples given by the court of cases where such circumstances might exist were breach of a restrictive covenant over land, an intellectual property agreement or a confidentiality agreement. The court said it was “not easy to see” other circumstances when negotiation damages might be an appropriate measure of loss but declined to describe these examples as exhaustive.

However, outside of those circumstances, damages should be assessed in the ordinary way. Damages are intended to compensate the claimant for loss or damage resulting from the non-performance of the obligation in question. They are therefore normally based on the difference between the effect of performance and non-performance upon the claimant’s situation.

Negotiating damages would not normally be available for breaches of non-compete and non-solicitation covenants. While this claim also involved breach of a confidentiality covenant, which in isolation might have been considered to be of a character to attract such damages, the court determined that the claimant’s loss was a cumulative result of breaches of a number of obligations, of which the non-compete and nonsolicitation had been treated as the most significant.

In this case, the effect of the defendants’ breach of contract was increased competition for the claimant and loss of profits and good will. While recognising that the loss may be difficult to quantify precisely in some circumstances, the court described this as a familiar type of loss for which damages are frequently awarded and possible to quantify in a conventional manner. According to Lord Reed, where the breach results in economic loss, “that loss should be measured or estimated as accurately and reliably as the nature of the case permits. The law is tolerant of imprecision where the loss is incapable of precise measurement, and there are also a variety of legal principles which can assist the claimant in cases where there is a paucity of evidence”.

As such, the lower courts were mistaken in considering that the claimant had a right to elect how its damages should be assessed and supposing that the difficulty in quantifying the claimant’s loss justified the abandonment of any attempt to quantify it.

The Supreme Court also confirmed that common law damages for breach of contract cannot be awarded merely for the purpose of depriving the defendant of profits made as a result of its breach, other than in exceptional circumstances (following Attorney General v Blake).

Lord Sumption agreed with the result but differed from the majority with regard to the reasoning.

Conclusion

The Supreme Court’s decision purports to restore orthodoxy to the principles regarding calculation of damages.

While the court did not overturn any prior cases awarding negotiating damages, it is clear from the judgment that negotiating damages are not the norm and will not be awarded by way of discretion. Nevertheless, the precise circumstances in which negotiating damages may be appropriate remain somewhat unclear.

For cases arising from breaches of covenant in a business sale context, it is clear that the courts will have to assess damages in the usual way: that is by determining losses suffered by the buyer attributable to the breach. This will often be difficult to ascertain, so businesses will need to think from the outset about what evidence will be required and whether an expert will need to be engaged. Although the decision in Morris-Garner acknowledges that there may be imprecision in calculation of damages and courts will have to do the best they can, the clearer and more comprehensive the evidence a claimant has been able to collate, the greater the chance that the level of damages awarded will reflect the claimant’s expectations.


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