Introduction
1
Introduction
It has been suggested that disgorgement damages for breach of contract are unorthodox and potentially disastrous for contract law.1 The aim of this book is to create a workable interpretive theory of the law of disgorgement damages according to which parties to a contract can predict with reasonable accuracy the remedy which a court will award if they breach their obligations. It is preferable if parties are aware of each other’s intentions at the outset of a contract, and the threat of disgorgement remedies ensures that contractors do not make idle promises which they do not intend to keep. In some circumstances compensatory damages and specific relief are not adequate to protect the claimant’s interest in performance of the contract. The award of a remedy in private law is intended to vindicate the claimant’s right, in the sense that the claimant’s right is made good. Disgorgement damages fill a gap in the law, as they allow for an appropriate recognition of the claimant’s rights in those cases where specific performance would have been available but it is no longer possible, and where compensatory damages are inadequate. They also serve to deter defendants from breaching contracts, particularly as there is no possibility of stipulating liquidated damages to ensure performance.
I use the term ‘disgorgement damages’ to describe the remedy for stripping profits from a wrongdoer for breach of contract.2 Gain-based damages for breach of contract have sometimes been called ‘restitutionary damages’3 or an ‘account of profit’.4 ‘Restitutionary damages’ is an inapposite label because ‘restitution’ is an ambiguous term with two mutually exclusive meanings, either a ‘giving back’ of a benefit unjustly received or a ‘giving up’ of a benefit made at the expense of the claimant because a wrong has been committed against her.5 It was for this reason that Lord Nicholls in Blake preferred not to use the term ‘restitutionary damages’, calling it an ‘unhappy expression’.6 ‘Account of profits’ is also an inappropriate label. It is laden with historical baggage, as it is traditionally awarded for equitable wrongs, and not for common law wrongs.7 By contrast, ‘disgorgement damages’ is a jurisdictionally neutral term which jettisons the historical baggage of the label ‘account of profits’ and sidesteps the ambiguity of the label ‘restitutionary damages’.8
My theory of disgorgement damages is intended to be overarching, and to be used in any common law country. Accordingly, I will use cases from England, Australia, New Zealand, Canada and the United States to draw a general overarching doctrine.
I Method
The methodology adopted by this book is interpretive. It attempts to enhance our understanding of the existing law of disgorgement damages for breach of contract. 9 It also suggests the directions in which the law should develop, as this area of the law is still nascent.
Stephen Smith outlines four useful criteria which must be considered if a particular interpretive theory is to be comprehensive and persuasive:
1. Fit (the extent to which the theory ‘fits’ the data it is trying to explain);
2. Coherence (the extent to which the theory is consistent and intelligible);
3. Morality (the extent to which the theory justifies the law’s claim to be a legitimate or morally justified authority); and
4. Transparency (the extent to which the theory explains the legal reasoning of legal actors themselves).
The benefit of this framework is that it can be adapted, and different emphases can be placed on each criterion. Unlike Professors Smith, Beever and Rickett, I do not adopt a corrective justice interpretation of private law, nor do I seek to establish an ordered taxonomy which explains private law generally. My aim is more modest: to establish a workable, coherent set of criteria for awards of disgorgement damages which fits (by and large) with existing law, and which reflects the competing justifications for private law remedies,10 and for contract law in particular. My view as to the relative importance of each criterion is also different. I place less importance on morality, for example, than would Smith, Beever and Rickett.
I now turn to the way in which my theory of disgorgement damages meets each criterion.
A Fit
Courts acknowledge that disgorgement damages are available for breach of contract in at least some, but not all, common law countries.11 In Blake, Lord Nicholls argued that courts would award disgorgement damages according to a two-part test: first, the claimant must have a ‘legitimate interest’ in performance of the contract, and secondly, compensatory damages must be inadequate.12 Nonetheless it has been said with some accuracy that, even after a number of cases where judges have applied Blake, ‘the legitimate interest test remains hopelessly ill-defined and difficult to apply.’13
This book seeks to fit the theory of disgorgement damages to the existing law, and to clarify the way in which the ‘legitimate interest’ test can be applied. An analysis of existing case law discloses two broad categories of cases where disgorgement damages for breach of contract have been awarded:
2. ‘Agency problem’ cases.14 Boris promises Alice he will not do a specific thing which relates to Alice’s best interests, but Boris breaches the contract and does the very thing which he has contracted not to do, making a profit as a consequence. Breaches of fiduciary duty concurrent with breach of contract form the core of this category, but breach of negative covenant cases on the margin between contract and fiduciary duties also fit into this category in some circumstances.
Chapter four will focus on the ‘second sale’ cases. The concept of substitutability is the key to determining whether disgorgement damages will be available in these cases, and this produces the best fit with the few existing cases. Substitutability looks to what the claimant hoped to gain from the contract, and therefore what remedy the defendant must give the claimant as a substitute for the performance which was denied as a result of the breach. Ordinarily, damages or specific relief ensure that the claimant receives an adequate substitute for performance, but in a ‘second sale’ scenario, neither damages nor specific relief are available. Thus some other remedy is needed to vindicate the claimant’s performance interest, namely disgorgement damages. It is sometimes suggested that disgorgement damages for breach of contract is precluded by ‘efficient breach’ theory.15 This postulates that where a promisor breaches to make a more profitable contract with a third party, the breach should be encouraged because it is economically efficient. The promisee does not lose out because she gets compensatory damages, and the resource is allocated to the person who values it the most. However, while ‘efficient breach’ seems at first blush to fit better with the preference of contract law for compensatory damages, where the subject matter of the bargain is not substitutable, courts generally do not allow promisors to breach, and instead award specific relief. In addition, the theory of efficient breach does not fit with other areas of contract law.
Chapter five will consider the ‘agency problem’ cases, for which additional considerations must be taken into account besides substitutability. In particular, courts must consider whether the remedies for breach of negative covenants adequately protect the performance interest in certain sorts of contracts in which the claimants are particularly vulnerable. Typically such contracts seek to protect a non-financial interest.
Courts have indicated that an allowance for skill and effort may be awarded to a defendant in some cases of disgorgement damages for breach of contract.16 This is correct, and I seek to fit these cases into the law with regard to bars to relief and allowances (which basically deal with questions of desert in one form or another). This will be considered in greater detail in chapter seven.
B Coherence
I seek to establish that disgorgement damages are coherent17 and consistent with both contract law principles and other existing laws. I also seek to ensure that the development of disgorgement damages continues to be intelligible.
The criterion of ‘substitutability’ (discussed in detail in chapter three) assists in making the law of disgorgement damages coherent. Not every breach of contract gives rise to disgorgement damages. It is important to have regard to the aims of contract law and, specifically, the aims of remedies for breach of contract. The claimant has a ‘performance interest’, or an interest in gaining what was promised according to the contract.18 Remedies for breach of contract seek to provide either the means by which to procure a substitute performance, or the performance itself. The primary remedy for breach of contract in common law countries is expectation damages.19 Expectation damages do not merely compensate for loss, but also seek to recognise the claimant’s performance interest in a way which is least intrusive to the defendant.20 When expectation damages do not adequately recognise the performance interest, courts are likely to award specific relief and compel the defendant to give the claimant exactly what she bargained for. However, if compensatory damages are inadequate and specific relief is no longer available, and the defendant has made a profit, the ‘next best’ remedy to effectively vindicate the claimant’s performance interest is disgorgement damages. Courts have already given extensive thought to questions of substitutability when awarding specific relief and these cases provide guidelines as to when it will be appropriate to award disgorgement damages.