Policing restrictive covenants is a notoriously difficult task, whether in the context of corporate transactions, employment / service contracts or otherwise. Proving loss flowing from a breach of restrictive covenant is often difficult and sometimes impossible. Injunctions can provide an answer. Where the breaching party has managed to conceal their activities, though, by the time the innocent party finds out it may be too late to obtain an injunction. It may also be difficult or impossible to establish what financial loss has been sustained, which is the usual basis for awarding damages.
The recent Court of Appeal case of Morris-Garner v One Step clarifies when the court will award damages on an alternative “Wrotham Park” basis. That is, based on a hypothetical negotiation between the parties, for example to relax covenants. Although the court was at pains to emphasise that this should not become the norm for breach of restrictive covenant claims, the decision is likely to lead to awards on this basis being sought, and made, more often.
Morris-Garner v One Step: what was the dispute about?
Ms Morris-Garner was a founding member, major shareholder and the “public face” of One Step – a business providing supported living services, including to young people leaving care. After relationships with the other major shareholder broke down, Ms Morris-Garner entered into an agreement to sell her shares in the business.
As is common for business sales of this nature, as part of the deal, Ms Morris-Garner agreed to be bound by certain restrictive covenants. In essence, she agreed for a period of three years not to compete with One Step’s business or solicit any of One Step’s significant clients.
Following the sale, Ms Morris-Garner pursued a new venture, Positive Living. One Step claimed that, in breach of those restrictive covenants, Positive Living had been competing with it for some time and had solicited several of its significant clients. One Step argued that it would be very difficult for it to quantify and prove its loss, so sought either:
- an account of Positive Living’s profits; or
- damages assessed on the Wrotham Park basis.
At first instance the High Court found in favour of One Step. It dismissed the claim for an account of profits, on the basis that the circumstances were not exceptional enough to justify this, but awarded Wrotham Park damages. This decision was appealed.
What did the Court of Appeal decide?
The Court of Appeal found in favour of One Step. Having agreed with the first instance court that the restrictive covenants had been breached, Clarke LJ, giving the leading judgment, went on to consider the appropriate remedy.
As with the first instance court, Clarke LJ concluded that it would not be appropriate to order an account of profits. This, he held, was a remedy only available in “truly exceptional” cases – which he considered this was not.
The judge went on to review the authorities on Wrotham Park, or “negotiating damages”. The principle behind this remedy is that, where the claimant cannot identify its loss, but justice demands that the claimant should be compensated, the court can award damages on an alternative basis. That basis is the price that would have been paid following a hypothetical negotiation between the parties. In this case, this would have been the amount that might reasonably have been demanded by One Step to relax its covenants. It does not matter if the parties are unlikely to have in fact reached such an agreement.
Ms Morris-Garner had argued that an award of Wrotham Park damages required three elements, which were not present in this case, namely that:
- the claimant must be unable to demonstrate identifiable financial loss: not simply have difficulty proving such loss;
- an award of Wrotham Park damages must be necessary to avoid manifest unjustice; and
- there must be some special circumstances to justify an exceptional remedy.
The test for Wrotham Park Damages
Although Clarke LJ conceded that he was “initially attracted by [these] submissions”, he concluded that the case law did not support this test for an award of Wrotham Park damages. Taking each of these elements in turn:
- although previous cases had referred to an absence of identifiable loss, this had not actually been decided in an appellate court. Since the point of Wrotham Park damages was to provide a flexible response to the need to compensate a claimant, it is enough to show that it would be “very difficult for the claimant to establish “ordinary” compensatory damages“;
- the need to avoid “manifest injustice” was putting the bar too high. The first instance judge in this case had concluded that an award on the Wrotham Park basis was “the just response in this case.” This was the correct test;
- an award on the Wrotham Park basis does not require special circumstances, or an exceptional case. Rather, as with the test above, it depends on what justice requires.
Both Clarke LJ and Longmore LJ, who also gave a reasoned judgment, had some sympathy for the argument that if Wrotham Park damages were awarded in this case, they might become the norm in this type of case. Both judges considered that this was an untypical case. For Longmore LJ, the key point was that the “subterfuge and furtiveness to which [Ms Morris-Garner] resorted” meant that One Step was unaware of the breaches for some time, and lost the opportunity to protect itself by obtaining an injunction. He therefore considered that part of the test for whether Wrotham Park damages should be awarded is that: “the result of the defendant’s breach has been that it is doubtful that interim relief could be obtained.”
What does this mean for claimants and defendants?
The clarification of when Wrotham Park damages will be awarded is welcomed. As Longmore LJ observed from a review of the authorities prior to this case: “it is not easy to set out the principles by which it is possible to decide that Wrotham Park damages, as opposed to conventional damages should be awarded.”
Whilst both he and Clarke LJ were at pains to portray this as an unusual case, though, breaches of restrictive covenants are often entirely deliberate, and committed with as much stealth as possible. The difficulty of proving financial loss, particularly when it comes to the impact on future business, is one of the main reasons why innocent parties will frequently apply for, and be granted, interim injunctions; to prevent damage occurring in the first place.
It may therefore be that Longmore LJ’s additional test – that it must be doubtful that interim relief could be obtained – will be key. Where a party believes that restrictive covenants have been breached, the preferred option is likely to remain an injunction, to prevent or limit damage being done in the first place. Where this is not an option, for example because the breaches have been hidden and the damage has already been done, the innocent party will need to bring a claim for damages. If it is having difficulty demonstrating its financial loss, following this case, a court is more likely to be willing to award it damages on the Wrotham park basis instead.