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Over the finish line? Wrotham Park damages

Posted: 19/06/2018


In the week that the London Marathon took place, the Supreme Court handed down a marathon judgment.  The case was Morris-Garner & Another v One Step (Support) Ltd [2018] UKSC 20, and the question to be determined was on 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?’ (paragraph 1).

In other words, where one party to a contract is in breach, when (if ever) will the other party be entitled to an award of damages which reflects the amount they might reasonably have sought from the first party to release them from the obligation which they breached?

Damages assessed on this basis (ie that of a hypothetical release fee) are often alluded to as Wrotham Park damages, after the case of Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] WLR 798. However, the Supreme Court, observingthat the term has been used loosely in past authorities, rejected it in favour of the term ‘negotiating damages’. Lord Reed, who gave the leading judgment, also indicated that Wrotham Park itself is a source of confusion, and should now be regarded as of little more than historical interest.

Limbering up

The claim concerned a former business partner and former employee setting up in competition, in breach of non-compete and non-solicitation restrictive covenants, and contractual and equitable duties of confidence, entered into upon the sale of a business to the claimant. After the establishment of the defendants’ competing business, the claimant’s business suffered a significant downturn, and ultimately the claimant sued.

The claimant sought an account of profits, or alternatively, what were described as restitutionary damages, in such sum as the claimant might reasonably demand as a quid pro quo for releasing the defendants from those covenants, or in the further alternative, what were described as compensatory damages for the loss it had suffered as a result of the defendants’ breaches.

In support of its damages claim, the claimant adduced reports by forensic accountants quantifying the loss it had allegedly suffered due to the defendants’ breach of the covenants, the benefits obtained by the defendants, and the hypothetical release fee.

Out of the starting blocks

The first instance judge, Phillips J, ordered a split trial and heard the case on liability.  Finding for the claimant, he held that the defendants were indeed in breach of contract through having breached the restrictive covenants and confidentiality obligations. 

Phillips J considered the case a prime example of one in which Wrotham Park damages should be available. It was difficult for the claimant to identify the financial loss it had suffered by reason of the defendants’ wrongful competition, and therefore just for the claimant to have the option of recovering damages in the sum it might have demanded for releasing the defendants from their covenants (not least because the covenants provided that the restraint was subject to consent, not to be unreasonably withheld).

Accordingly, Phillips J made a declaration that the claimant was ‘entitled to judgment for 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 obligations) or alternatively ordinary compensatory damages' (paragraph 19) and the claimant elected for the former. It appeared thus far that the claimant was off to a flying start.

Setting the pace

The defendants appealed, but the Court of Appeal unanimously sided with the claimant. Dismissing the appeal, Clarke LJ held that the correct test was whether an award of Wrotham Park damages was the just response in the particular case. That was a matter that the first instance judge was entitled to decide on a broad brush basis, taking into account the difficulties the claimant would face in establishing damages on the ordinary basis.  

Although Clarke LJ acknowledged that a Wrotham Park award might represent considerably more than the loss realistically suffered as the practical effect of the defendants’ competition, and that it involved the consideration of several imponderables, he nonetheless did not regard these points as justifying a denial of Wrotham Park damages.

King LJ and Longmore LJ agreed, although Longmore LJ confessed that it was not easy to set out accepted principles on which Wrotham Park damages should be awarded. He identified a three factor test which, he considered satisfied in this case:

  • that the defendants had deliberately breached their contractual obligations for their own reward;
  • that the claimant would have difficulty establishing its financial loss therefrom; and
  • that the claimant had a ‘legitimate interest’ (paragraph 22) in preventing the defendants’ profit-making activity in breach of contract.

The claimant was still on track.

Going for gold

The defendants stepped up the pace again and appealed to the Supreme Court.

  • The parties agreed that the issues to be decided by the Supreme Court were: ‘where a party is in breach of contract, in what if any circumstances is the other party to the contract entitled to seek negotiating damages, ie damages assessed by reference to a hypothetical negotiation between the parties, for such amount as might reasonably have been demanded by the claimant for releasing the defendants from their obligations’; and
  • ‘whether the Court of Appeal was correct to uphold the judge’s finding that such damages are available in this case’ (paragraph 23).

Lord Reed began his leading judgment by noting that the judicial and academic debate which has surrounded the issue of Wrotham Park damages, as well as the ‘confused state’ (paragraph 1) of the authorities, have all reflected a lack of clarity as to the theoretical underpinning of such awards, and consequently, uncertainty as to when they are available. This being the first time that the issue has come before the Supreme Court (or its predecessor) to decide, Lord Reed took the opportunity to analyse the previous case law in some detail. 

Running on empty

Unfortunately for the claimant, it began to flag as it approached the finish line. The Supreme Court unanimously held (albeit with some differences of reasoning) that in the present case, Wrotham Park / negotiating damages were not appropriate, and the appeal should therefore be allowed.

Lord Reed delivered a carefully reasoned judgment in which he considered relevant general principles relating to user damages in tort, damages in equity under ‘Lord Cairn’s Act’, ie section 2, Chancery Amendment Act 1858 (now replaced by section 50, Senior Courts Act 1981) and common law damages for breach of contract. He reviewed in detail the Wrotham Park line of authorities, splitting these into two phases. The first phase (starting with Wrotham Park itself) involved awards based on a hypothetical release fee made in exercise of the jurisdiction in Lord Cairn’s Act, in substitution for injunctions to prevent breach of restrictive covenants and interference with property rights. In the second phase, awards calculated in a similar way were made at common law, on a wider and more uncertain basis. The two phases were divided by Attorney General v Blake [2001]1 AC 268in which the House of Lords discussed Wrotham Park (although negotiating damages were not in fact sought in that case) and which signalled the wider availability of awards based on a hypothetical release fee but also sowed the seeds of uncertainty. 

Lord Reed concluded that:

  • Negotiating damages can be awarded for breach of contract where the loss that the claimant has suffered is appropriately measured by reference to the economic value of the right breached, considered as an asset. The rationale here is that the claimant has been deprived of a valuable asset, and that loss can be measured by determining the economic value of the right infringed.

    Such circumstances may arise where the breach results in the loss of a valuable asset created or protected by the right infringed, such as breaches of restrictive covenants over land, intellectual property agreements or confidentiality agreements.

    As Lord Reed explained, ‘The defendant has taken something for nothing, for which the claimant was entitled to require payment’ (paragraph 95 (10)) and ‘the imaginary negotiation is merely a tool for arriving at that value’ (paragraph 91).
  • The contractual right must be of such a kind that its breach can result in an identifiable loss equivalent to the economic value of the right, considered as an asset, even in the absence of any pecuniary / economic losses that are measurable in the normal way. Although this might be true of the circumstances referred to above, it will not be true of all contractual rights. Lord Reed gave the example of a breach of a non-compete obligation, which ‘may cause the claimant to suffer pecuniary loss resulting from the wrongful competition, such as a 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’ (paragraph 93). 
  • Where a breach has caused a claimant to suffer economic loss, that loss should be measured or estimated as accurately as possible. Nonetheless, ‘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’ (paragraph 95 (8)).

    Having said that, where the claimant’s interest in the performance of the contract is purely economic and he cannot establish any economic loss arising out of the breach, the usual inference will be that he has not suffered any economic loss and accordingly, he cannot be awarded more than nominal damages.  
  • Furthermore, common law damages for breach of contract cannot be awarded merely to deprive the defendant of profits that he made as a result of the breach, save in exceptional circumstances (as was the case in Attorney General v Blake). Nor are common law damages for breach of contract a matter of discretion – they are claimed as of right and are awarded (or refused) on the basis of legal principle. 

Applying those conclusions to the present case, Lord Reed held that the first instance judge and the Court of Appeal had both erred. In particular, the Court of Appeal was wrong to treat the deliberate nature of the breach, the difficulty of establishing the precise consequential financial loss or the claimant’s interest in preventing the defendants’ profit making activities as justifying a monetary award which was not compensatory. Moreover, both courts were wrong to find that damages based on a hypothetical release fee could be available whenever that was a ‘just’ response.

Morris-Garner was a case brought by a commercial entity, whose only interest in the defendants performing their obligations was commercial. The substance of the claimant’s case was that it suffered financial loss. Although that loss might be difficult to quantify and some elements might be inherently incapable of precise measurement, it was nevertheless a familiar type of loss, for which damages are frequently awarded, and possible to quantify in a conventional manner. It was not a case where the breach of contract resulted in the loss of a valuable asset created or protected by the right infringed, so as to be appropriate for the award of negotiating damages. 

On a different track

While Lord Sumption agreed that the appeal should be allowed, he took a somewhat different approach. He categorised the Wrotham Park line of case law into three types of case:

  • those where damages are not limited to pecuniary loss, because the claimant has an interest in the observance of his rights extending beyond financial reparation;
  • those where the claimant would be entitled to specific performance of his right, and the notional release fee is the price of non-performance; and
  • those where the claimant has suffered (or is assumed to have suffered) pecuniary loss, and the notional release fee is treated as evidence of that loss.

He opined that the authorities in the latter category suggest ‘…that the concept of treating a notional release fee as an evidential tool for assessing a party’s true loss in appropriate cases has been found valuable and is certainly not impractical. It is frequently employed’ (paragraph 123).

Lord Sumption concluded that he would modify the declaration of the judge to neither require nor exclude the use of a notional fee as evidence of the claimant’s loss.

In the third and final judgment, Lord Carnwath agreed that the appeal be allowed for the reasons given by Lord Reed. He described Lord Reed’s approach as ‘entirely orthodox’ (paragraph 128) compared to Lord Sumption’s reformulation, which he considered ‘more radical’ (paragraph 129) and not helpful in terms of improving the coherence of the law.     

At this point, both readers and authors would be forgiven for needing a rest at the water station before tackling the final sprint!

Photo finish

The Supreme Court’s landmark decision in Morris-Garner offers authority, at the highest level, on a sometimes confusing line of cases, and a conceptually tricky area of law. The effect of that decision is to narrow the circumstances in which negotiating damages may be claimed. Loss of profits arising out of breaches of covenants in non-compete clauses and non-solicitation clauses, as well as loss of goodwill, will not be considered the loss of a proprietary asset, created or protected by the right infringed, so as to be capable of attracting negotiating damages.  

These types of losses must be proved and quantified in the conventional way, even where quantification is difficult. In circumstances where there is a scarcity of evidence, there are legal principles to assist the claimant. Claimants seeking damages for such losses will therefore need to focus on quantifying the actual loss.

Having said that, the doors do not appear to have entirely closed on adducing evidence of a hypothetical release fee in such cases. On this, Lord Reed said: “It is not easy to see how, in circumstances other than those of the kind described in paragraphs 91-93 [ie breach of a restrictive covenant over land, an intellectual property agreement or a confidentiality agreement], a hypothetical release fee might be the measure of the claimant’s loss. It would be going too far, however, to say that it is only in those circumstances that evidence of a hypothetical release fee can be relevant to the assessment of damages. If, for example, in other circumstances, the parties had been negotiating the release of an obligation prior to its breach, the valuations which the parties had placed on the release fee, adjusted if need be to reflect any changes in circumstances, might be relevant to support, or to undermine, a subsequent quantification of the losses claimed to have resulted from the breach. It would be a matter for the judge to decide whether, in the particular circumstances, evidence of a hypothetical release fee was relevant and, if so, what weight to place upon it. However, the hypothetical release fee would not itself be a quantification of the loss caused by a breach of contract, other than in circumstances of the kind described in paragraphs 91-93 above.” (paragraph 94) And also: “The object of [the hearing on quantum] is that the judge should measure, as accurately as he can on the available evidence, the financial loss which the claimant has actually sustained. How that assessment is best carried out is, in the first instance, a matter for the judge to consider, proceeding in accordance with this judgment. If evidence is led in relation to a hypothetical release fee, it is for the judge to determine its relevance and weight, if any. It is important to understand, however, that such a fee is not itself the measure of the claimant’s loss in a case of the present kind, for the reasons which have been explained.”

On the podium

In conclusion then, although we now have some certainty on specific types of loss for which negotiating damages are or are not available, this remains a difficult area of law to advise with clarity on, and the extent to which evidence of a hypothetical negotiating fee may be admitted for the purpose of quantifying damages remains unclear. What does appear clear though, is that we still have a way to go before we reach the finishing line on this subject.

As for Morris-Garner, the case will now return to the High Court for a trial on quantum to determine the claimant’s actual financial loss sustained.

 

A version of this article was published in Commercial Litigation Journal in May 2018.


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