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Changes to damages for breach of restrictive covenants

Posted on 4 July 2018

Changes to damages for breach of restrictive covenants

Paramount to the success of any recruitment company is the protection of its main assets: its staff and its candidate and client database.  This protection often takes the form of restrictive covenants, which can prevent leavers from poaching clients, candidates and key employees and from competing for a reasonable period of time post-termination.  Where those restrictive covenants are breached, an employer is entitled to apply for injunctive relief to prevent damage from being done to its business.  It may also wish to seek damages to compensate it for any loss it has suffered.

In April this year, the Supreme Court handed down judgment on what is now the leading case regarding damages for breach of restrictive covenants.  With it, sees the departure of what has become known as "negotiating damages" (in the legal context this is often referred to as Wrotham Park Damages).  Prior to April, a wronged party could seek a sum of money equivalent to the amount it might reasonably have demanded from the ex-employee and/or competitor if the parties had negotiated a release of the restrictions before they were breached; -in other words, a hypothetical release fee. 

A hypothetical release fee can be a far easier way to assess damages than establishing the actual loss a breach of restrictions has caused a business.  By way of example, if the breach involves solicitation of key employees, it may be very difficult to establish which employees would have left despite the breach, and which left due to unlawful solicitation.  Similarly, whilst a straightforward calculation of the damage incurred by the loss of a candidate placement may be easy to establish and calculate, establishing consequential and indirect losses - losses that are not the natural result of the breach, but are likely to arise from the breach, is much more difficult.

The Supreme Court has reversed the development of the law in this area and held that a wronged party must establish, as accurately and reliably as possible, the actual loss suffered.  If one cannot establish any loss, then the wrongdoer will receive no more than nominal damages. 

Nevertheless, it is still worth considering negotiating damages as an assessment of loss in some unlawful competition cases.  The Supreme Court has confirmed that negotiating damages remain available in breach of confidentiality cases.  It has also left it open for judges hearing breach of restrictive covenant cases to decide whether to consider any evidence submitted relating to a hypothetical release fee and what, if any, weight and relevance to give it.  However, it has been made clear that a hypothetical release fee cannot itself be a measure of loss for breach of a restrictive covenant. 

This decision highlights the difficulty of assessing damages for breaches of restrictive covenants. However, clear, enforceable restrictions and decisive action to prevent damage when restrictions are breached remain the most effective ways of preventing loss from unlawful competition.  Here are some key points to remember:

  1. As ever, in the first instance, in order to ensure the restrictive covenants are capable of protecting your business, it is key to ensure that they do not go beyond what is reasonably necessary to protect an organisation's legitimate interests.  What is reasonable will depend on what protectable business interests the organisation is seeking to protect (such as preserving client and candidate connections, confidential information and maintaining a stable workforce) and the seniority and responsibilities of the leaver.  Anything that goes beyond what is reasonable in the circumstances will be unenforceable.   
  2. The case before the Supreme Court involved restrictive covenants entered into by a seller as part of the sale of a business.  Don't forget the importance of restrictive covenants in the event that you are looking to buy or sell a business.

An injunction is likely to be a far more effective remedy than suing for damages, particularly in light of this decision.  As soon as you become aware of a potential breach of restrictions, it is important to seek legal advice in order to prevent the damage from occurring/continuing.  If you do not deal with a potential breach promptly, any unexplained delay is likely to prevent you from being able to seek an injunction and place you in a position where damage may be difficult to calculate leaving you out of pocket.  Acting swiftly and obtaining an injunction is likely to avoid the requirement to resort to a complex assessment of loss, and the associated costs involved in doing so.

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