A Supreme Court ruling on how so-called “negotiating damages” should be assessed could have major implications for disputes over restrictive covenants.
The court has clarified that negotiating damages should only be applied in “exceptional” cases – though developers may still have questions on what the ruling may mean for them, a lawyer has warned.
The Supreme Court allowed an appeal in the context of a share sale, which Lord Reed said raised “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?”
He said that damages assessed on this basis – sometimes described as Wrotham Park damages, after the case of Wrotham Park Estates Co v Parkside Homes Ltd [1973] 229 EG 617 – have “attracted considerable debate, both judicial and academic,” reflecting a lack of clarity as to the “theoretical underpinning” of such awards, and uncertainty as to when they are available. This is the first time the issue has come before the highest court.
Emma Humphreys, partner at Charles Russell Speechlys welcomed the clarity the Supreme Court has now brought to the issue in the case of Morris-Garner v One Step (Support) Ltd [2018] UKSC 20.
Differing approaches
She said: “Over the years, the courts have taken differing approaches as to whether “release fee” or “negotiating” damages should be a remedy reserved for exceptional cases of breach of contract. In One Step, the Supreme Court has brought some much-needed clarity to an area where case law has been at best unclear and at worst confused.
“Since the Court of Appeal’s decision in One Step in 2016, developers and others have expressed concern at the potentially increased availability of this type of damages – for example in cases where restrictive covenants are breached.
“Today’s judgment from the Supreme Court makes it clear that negotiating damages should be reserved for ‘exceptional’ circumstances.”
But she said that the court has confirmed that damages based on a hypothetical negotiation between the parties can still be appropriate where a defendant has “taken something for nothing”, for which the complainant was entitled to require payment.
She added: “Developers may be less than pleased to see that breaches of restrictive covenants are referred to as one of the potentially relevant scenarios where such damages may apply.”
“There may be disappointment that the decision in One Step does not set out any strict ‘tick box’ approach to either the availability of release fee damages or how to calculate them. This means that a strong element of discretion will remain with trial judges when it comes to deciding on whether to award release fee damages and, if so, how much.
Revised principles
“No doubt, the courts will continue to develop the revised principles which have been set out by the Supreme Court in One Step and so it may be some time before developers and others have a clearer picture as to the courts’ likely approach to release fee damages.
Lord Reed ruled that lower courts had erred in their approach to the assessment of damages in One Step – a dispute that arose out of the sale of shares in a business providing support for young people leaving care, founded by Karen Morris-Garner. When she was bought out of the business for £3.15m in 2006, she and her partner Andrea Morris-Garner agreed to be bound for three years by restrictive covenants prohibiting them from competing with One Step or from soliciting its clients. However, in 2007 their new company, Positive Living, began trading in competition with One Step.
The Morris-Garners sold their shares in Positive Living for £12.8m in 2010, and One Step brought a claim for damages alleging breaches of the restrictive covenants. The High Court judge found that One Step was entitled to damages to be assessed “on a Wrotham Park basis” to reflect the amount the parties would have negotiated for release of the restrictions. The Court of Appeal later upheld that decision.
Allowing the Morris-Garners’ appeal, the Supreme Court ruled that the true measure of damages should be One Step’s actual financial loss, and sent the case back to the High Court for assessment on that basis.
Economic value
Giving the main judgment, Lord Reed said: “There are certain circumstances in which the loss for which compensation is due is the economic value of the right which has been breached, considered as an asset. The imaginary negotiation is merely a tool for arriving at that value. The real question is as to the circumstances in which that value constitutes the measure of the claimant’s loss.”
He said that 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”, giving as one example cases concerned with the breach of a restrictive covenant over land.
The important characteristic in these cases is, he said: “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 asset in question. The defendant has taken something for nothing, for which the claimant was entitled to require payment.”
But in the case before him, he said that the substance of One Step’s case is that it suffered financial loss in the form of lost profits and goodwill. Though “difficult to quantify”, he said that it is nevertheless “a familiar type of loss” and that it is possible to quantify it in a conventional manner.
