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Breach of Share Purchase Covenants – How Should Damages Be Assessed?

When businesses are sold, restrictions are often imposed in order to prevent sellers simply pocketing the money and setting up in competition – but how should compensation for breach of such restrictions be assessed? The Supreme Court considered that issue in an important test case.

The case concerned a company that provided support for young people leaving care. It was 50 per cent owned by the businesswoman who founded it and 50 per cent by a couple who had bought into the business. After relations between them worsened, the couple issued a deadlock notice and the businesswoman eventually agreed to sell her stake in the company to them for £3.15 million.

The share purchase agreement contained a restrictive covenant that banned the businesswoman and a colleague from competing with the company for three years, or soliciting its clients. However, unbeknown to the couple, they had incorporated a new business long before the share purchase was agreed and, the following year, began competing with the company. They subsequently sold their shares in that business for £12.8 million.

After the company launched proceedings, a judge ruled that the businesswoman and her colleague had breached the covenant. He found that damages due to the company should be assessed on the basis of the amount that would notionally have been agreed between the parties, acting reasonably, as the price for releasing the businesswoman and her colleague from the covenant. That method – which relied upon an assessment of the value of a hypothetical release fee – was subsequently approved by the Court of Appeal.

However, in allowing the businesswoman’s and her colleague’s appeal against the latter ruling, the Supreme Court found that the correct measure of damages was the company’s actual financial loss. That was in line with the established principle that damages for breach of contract are intended to place injured parties in the same position that they would have been in had the contract been performed.

The substance of the company’s claim was that, rather than being deprived of an asset, it had suffered financial loss in the form of lost profits and goodwill. That was a familiar type of loss that could be quantified on the evidence in the conventional manner. The case was sent back to the judge for the company’s damages to be assessed on the basis of the financial loss it had actually sustained.

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