Allowances and Bars to Relief
7
Allowances and Bars to Relief
I Introduction
Once liability for disgorgement damages is established, it becomes necessary to establish how the quantum of the profit should be calculated, as well as whether any allowances for skill and effort should be made in the defendant’s favour and whether there are any bars to relief. It is suggested that allowances for skill and effort should be allowed in some circumstances on the basis that the defendant deserves recognition of the skill and effort that contributed to the profits derived from the breach. This position is consistent with the principles applied to the account of profits remedy for breach of fiduciary duty. In addition, it is also suggested that some of the equitable bars to relief should be applicable to awards of disgorgement damages for breach of contract. This would ensure that disgorgement damages for breach of contract are not too ‘claimant-focused’, and that the interests of both parties are adequately recognised. The bars to relief are similar to those already developed for other equitable remedies such as specific performance, and thus disgorgement damages are consistent with existing law. The availability of allowances and bars to relief ensure that disgorgement damages are not over-deterrent. Further, they allow for recognition of circumstances where the claimant does not deserve relief, where the defendant’s efforts deserve recognition, or where the defendant either should not be punished at all or should be punished to a lesser degree (whether because he does not deserve it, or for reasons of mercy). In this way, disgorgement damages are nuanced according to the circumstances.
This chapter will first consider how profit is to be calculated, including issues of causation and apportionment. The method by which the court chooses to calculate the net profit also raises the issue of allowances for skill and effort. Attorney-General v Blake1 was not an appropriate case for an allowance for skill and effort given the nature of Blake’s breach, but in other cases lack of good faith will not be a sufficient reason for denying a defendant an allowance.2 Allowances can also saccommodate different shades of advertence in the conduct of the defendant. A defendant who breached his contract advertently, but genuinely thought he was entitled to break his contract, is more likely to obtain a generous allowance than a defendant whose breach is cynical and wilful.
Once the net profit has been quantified, the court must assess whether there are any bars to relief. The appropriate bars to relief are the recognised equitable discretionary factors: delay and acquiescence, hardship and lack of clean hands.
The availability of equitable allowances and the operation of the bars to relief are premised on the concept of desert. There may be reasons why the defendant does not deserve to be punished (to a greater or lesser degree). Or there may be reasons why the claimant does not deserve to have the benefit of disgorgement damages. In addition, principles of mercy may be relevant to ascertaining whether or not hardship can be established. Hardship, like mercy, implies that even when a defendant deserves to be punished, extenuating circumstances exist which mean that the court should be lenient.
As discussed in chapter two, the primary aim of disgorgement damages is deterrence. Perfect disgorgement strips the defendant of his profit and puts him in the position he would have been in if the breach had not been committed.3 Because the defendant receives no gain from breach, disgorgement damages effectively remove any incentive for potential contract breakers to breach and make a profit thereby. Considerations of desert and punishment do not necessarily conflict with deterrence. For example, in Blake the two aims of deterrence and punishment were working in tandem. George Blake deserved to be punished by being stripped of his profit because of the advertent nature of the breach of negative covenant. For the same reason, it was important that Blake and other potential defendants be deterred from committing a similar wrong in the future. However, in other cases considerations of desert may conflict with considerations of deterrence to such an extent that total disgorgement is not appropriate.
It follows that if the law allows bars to relief or makes allowances which reduce the amount of disgorgement damages awarded to the claimant, the corollary is that the deterrent effect of disgorgement damages is reduced. As Associate Professor Harding has argued in the context of equitable allowances for breach of fiduciary duty, the deterrent effect of disgorgement damages is lessened to the extent that the quantum of damages is reduced.4 If disgorgement damages are not awarded at all for some discretionary reason the deterrent effect of disgorgement damages is non-existent. It must be noted, however, that in circumstances where the bars to relief operate to prevent an award of disgorgement damages, an award of common law damages remains possible.
II Calculating the Account – Causation, Remoteness and Apportionment
A The Nature of the Account
The account has its origins in the common law writ of praecipe quod reddat, but the common law account was ultimately overtaken by the more efficient equitable account.5 The account of profits was particularly well suited to ensuring compliance with equitable obligations as it ensured that breach was less likely by deterring potential defendants.6 Thus, over time, the account of profits became synonymous with breach of equitable obligations.
The immediate function of an account is merely to provide an account to the claimant of the defendant’s financial affairs insofar as they relate to the claimant’s claim.7 However, once a profit has been identified, it can then be disgorged. The purpose of the account of profits is ‘neither compensatory nor restitutionary: rather it is designed to strip the [defendant] of the unauthorised profits he has made’.8 Importantly, the profits are the defendant’s net profits, rather than the defendant’s gross receipts.9
In assessing net profit, courts have traditionally made allowance for certain expenses incurred by the defendant in two ways.10 First, they have sometimes allowed specific disbursements, such as expenditures of money and other capital, as well as skilled labour by the defendant (perhaps a form of quantum meruit calculated according to an hourly rate of pay).11 Secondly, courts have credited the defendant with an allowance which is not specifically itemised, but more of an ‘all things considered’ allowance.12
B Causation and Remoteness
Commentary suggests that the test of causation for an award of an account of profits for breach of contract is whether the claimant can show that the defendant would not have made the profit ‘but for’ the breach in question.13 Similarly, the Court of Appeal in Blake required that recovery should be limited to profits ‘occasioned directly by the breach.’14 As will be discussed when considering apportionment below, the courts should distinguish between profits which arise directly as a result of the breach and profits which do not.15 This should not be confused with allowances, which involve making some recognition of the defendant’s skill and effort despite the fact that his acts were legally responsible for causing the gain.
The ‘but for’ causation rule for accounting for profits for breach of contract is less harsh on defendants than the more ‘claimant-friendly’ rule which is applied to fiduciaries. In breach of fiduciary duty cases, the breach need only be ‘a cause’ of the gain, and need not be a predominant cause.16 This reflects the greater need for deterrence in such cases. By contrast, the rule in disgorgement for breach of contract cases should be less stringent than that for fiduciaries.17
Disgorgement damages for breach of contract have also been limited by notions of remoteness.18 Edelman has argued that the Court of Appeal in Blake’s approval19 of Teacher v Calder20 imposes a remoteness requirement on disgorgement dam- ages.21 In Teacher v Calder the claimant advanced money to the defendant for the purpose of investing in the defendant’s timber business. The defendant did not use the money for this purpose, but instead invested the money in a distillery business and made significant profits. The House of Lords declined to award the claimant any interest in the profits.22 The Court of Appeal in Blake said of Teacher v Calder:
The mere fact that the defendant’s breach of his contract with the plaintiff has enabled him to enter into a more profitable contract with someone else should also not be sufficient. Teacher v. Calder . . . is sound law. Nor should it suffice that, by entering into the later and more profitable contract, the defendant has put it out of his power to perform his contract with the plaintiff: the distinction between the two cases is not one of substance. 23
As will be evident from the previous chapter, I disagree with the Court of Appeal’s conclusion that Teacher v Calder is sound law, but I agree that it is important to have a test of remoteness where disgorgement damages for breach of contract is concerned. A test of remoteness asks whether it would be fair to hold the defendant responsible for gain which has arisen as a result of his wrongful act, but which was a distant or unusual consequence of that act, or which was more immediately caused by the defendant’s non-wrongful acts, the acts of a third party or a natural event.24 It is appropriate to apply such a test in these cases.
Remoteness can be used by courts to moderate the severity of the effect of an award of disgorgement damages on a defendant.25 Remoteness could also be used to solve some of the difficulties which occur with the ‘reasonable fee’ cases, for example, when unanticipated events occur after the date upon which a ‘hypothetical negotiation’ would have taken place.26
C Apportionment
The principle of apportionment allows a defendant to argue that some portion of the profits should not be disgorged because these profits were not occasioned directly by the breach.27 In Warman International Ltd v Dwyer, the High Court left open the possibility that it may be appropriate to apportion profits where some profit resulted as a result of the breach and other profit did not, although the ‘general rule’ is that courts will not order apportionment in breach of fiduciary duty cases without a prior agreement for profit-sharing.28 Apportionment is frequently adopted in accounts of profits awarded for breach of copyright and patent cases, so that the profit is split between that resulting directly from the infringement and that resulting from other sources.29 Similarly, it is appropriate that in other cases, such as breach of contract, there should be apportionment between profits made as a direct result of the breach and profits which are attributable to other reasons.30 However, apportionment is less likely to be appropriate in breach of fiduciary duty cases where infringing and non-infringing acts cannot be separated because of the broad scope of the duties infringed.31 The only cases in which apportionment has been made have involved antecedent profit sharing arrangements, in regards to which courts have taken a ‘but for’ approach to causation.32 Nonetheless, it is argued that apportionment may provide a solution to those cases where an allowance for skill and effort is difficult to justify according to principles of desert.33
An interesting alternative to apportionment has been proposed by Professor Dagan where commercial contracts are concerned. He argues the parties should divide the profit between themselves.34 He rejects the idea that the defendant should be allowed to retain the entire profit because ‘it implicitly sanctions the promisor’s unilateral pursuit of [his] own interests, irrespective of the relationship [he] has already established with [his] contractual partner.’35 On the other hand, he also argues that the claimant should not be entitled to the net profits from the breach as a matter of course.36 Thus, he argues that the parties should divide the difference between the promisor’s gain from the breach and the promisee’s expectation between themselves.37 Still, this is not entirely straightforward. Dagan notes that there are arguments either way as to whether the parties should always divide the profit equally, or whether the court should have discretion to apportion the profit.38
An agreed apportionment occurred in Vercoe v Rutland Fund Management Limited.39 The claimants developed a management buy-in proposal for a chain of pawn broking stores and put it to the defendants, who were associated with a venture capital business. The defendants ultimately purchased the pawn broking business, developed it and sold it at a profit. However, they cut the claimants out of any involvement with the business prior to purchasing it, in breach of a contract between the parties which provided that the defendants would not use the confidential information provided in the claimant’s buy-in proposal without involving and consulting them. Roth J calculated damages according to a hypothetical ‘reasonable fee’ which the claimants would have accepted from the defendants to be released from their contractual obligations. The parties agreed that a reasonable fee award was an appropriate measure,40 although they disagreed as to precise quantum. It would not have been fair in the circumstances to strip the entire gain from the defendants when they had expended a good deal of risk, money and effort.
In some senses, the analysis described in the previous chapter, where the court declines to award specific relief even though it could do so, and instead awards a ‘reasonable fee’, represents a form of judicial apportionment, where the claimant takes only a proportion of the profit.
Thus, ‘but for’ causation, remoteness and apportionment are all principles which have been adopted in awards of disgorgement damages for breach of contract. In the next section, I will first consider the nature of desert and mercy before looking at how these concepts impact and inform allowances and bars to relief. These concepts provide the moral justification for courts to make such defences available.
III Desert and Mercy
A The Nature of ‘Desert’
Professor Feinberg has argued, ‘[t]o say that a person deserves something is to say that there is a certain sort of propriety in his having it’.41 Desert is based on ‘propriety’, not entitlement. Someone who deserves a thing cannot say that they have a right to it; rather they can only argue that it is proper that they be given an interest in the thing.42
The question is then when it will be proper for a person to be given an interest in a thing on the basis of desert. Desert looks to a person’s qualities, actions and status.43 As with the punitive rationale generally, desert is always backward-looking;44 it looks at what a person has done in the past. This can be contrasted with specific and general deterrence, which are always forward-looking.45 Further, desert is personal;46 it links to the specific conduct of the people involved, not to the conduct of third parties. In this way it is also different to general deterrence, which looks to prevent other people from committing the same conduct in the future.
Despite its personal nature, convention plays an important part in desert.47 Convention is important not because of any principle particular to desert itself, but because of the moral principles which shape the rule of law. That is, in order to be treated justly, a person deserves the same or similar treatment to that which is given to a person whose qualities and actions are the same as theirs. Someone can only be said to have received his ‘just deserts’ if there is parity between the treatment of that particular person and the treatment of other people who have done the same kind of thing. In other words, like cases should be treated alike.
Desert also links to the notion that when a person expends labour, he deserves remuneration in some way. This must be qualified according to circumstance. As Becker argues, ‘we must hold the principle of desert to be totally inapplicable to cases in which gains are gotten by violating moral prohibitions – e.g. by unjustifiably overriding the rights of others.’48 Thus, expending labour on a bank robbery is not deserving of remuneration. Nonetheless, our society has a general concept that labour should be rewarded when it benefits other people.49
Desert plays an important role in the operation of allowances for skill and effort, and in the availability of delay and acquiescence and lack of clean hands as bars to relief. However, before turning to this, I will first outline the nature of mercy.
B The Nature of ‘Mercy’
The nature of mercy is that, although the defendant deserves to be punished, he ought not to be punished because of his difficult personal circumstances. Rainbolt argues that mercy has three features. First, it is thought to be a virtue, secondly, it is thought to temper justice,50 and thirdly, no one has a right to mercy.51 Like desert, therefore, mercy is based on propriety, not entitlement. A person can only argue that it is proper in the circumstances that an exception ought to be made with regard to the imposition of a deserved punishment.
John Tasioulas says that in contrast to other manifestations of charity, mercy alleviates suffering which is in some sense deserved.52 Mercy highlights the potential inappropriateness of an otherwise just punishment once other considerations of the defendant’s life or circumstances are taken into account.53 Mercy has most often been linked with the imposition of punishment for wrongdoing. Most accounts of mercy focus on the imposition of criminal punishment.54 However, mercy has also been extended more broadly to the civil law, where a person has a right to enforce a certain remedy against another person, but does not do so.55 I argue that some private law remedies, such as disgorgement damages, have punitive aspects, and thus it is appropriate that mercy has a role to play, albeit in very limited circumstances. Even an award of compensatory damages can sometimes involve censure of wrongdoing.56 Nonetheless, when a claimant seeks fulfilment of an existing obligation, this does not ordinarily constitute punishment, and if mercy is shown by failing to impose an existing obligation, the claimant’s rights will not be vindicated fully. Therefore it is important that if courts do show mercy, they must do so after full consideration of any negative effects on the claimant.
This highlights a difficulty with the judicial exercise of mercy. It has been said that ‘judges have no right to be merciful because it is not to them that any obligation is due. And they have an obligation to impose the sentence the law prescribes.’57 Therefore, under this rubric the only person who has any right to extend mercy is the claimant herself; the judge has no standing to exercise mercy on her behalf. Like desert, there is a strongly personal aspect to mercy, and it must be queried why the court will deny the claimant full relief if the claimant does not benefit from the defendant’s conduct in any way or if the claimant does not choose to extend mercy. These criticisms have some force, and it is suggested that if judges exercise mercy in the stead of the claimant, they must be particularly careful to ensure that the claimant’s rights are not unduly prejudiced, and that there is still adequate vindication of the claimant’s rights.
In addition, judicial mercy has been criticised because it is said to violate the rule of law and the precept that like cases should be treated alike.58 However, other commentators have argued that mercy is an essential component of a just legal system and that it is an important facet of equity in particular.59 In Aristotelian terms, equity is ‘a rectification of law where the law falls short by reason of its universality.’60 Thus, it is necessary to have some method whereby the general harshness of the law is mitigated by consideration of individual circumstances, and in a sense, mercy is a sub-species of equity.
Where a judge has discretion to choose which level of liability to impose, or where there is discretion as to the appropriate penalty, it follows that there may be room for mercy. Some scholars have therefore argued that mercy is a species of ‘disjunctive desert’, where a judge is merciful if she chooses the lesser of the available ranges of liability or penalty.61 If desert does enter into mercy, then it is in a broader sense than discussed above. That is, the court takes into account more than just the facts of the dispute before them and considers desert in a global sense given the defendant’s specific circumstances.
Tasioulas argues that there are four paradigm cases of mercy:62
1. Where the offender’s history and upbringing may have presented obstacles to forming a decent and law-abiding character;
2. Where wrongdoing has occurred in a context which generates reasons for leniency because there were obstacles to law-abiding behaviour (eg where a woman kills her abusive spouse);
3. Where ‘the offender is already suffering some grave misfortune which will be cruelly exacerbated by the infliction in full measure of his just deserts’;63
4. Where the offender has sincerely repented of wrongdoing and made apologies and reparation to those he wronged.
The bar to relief based on hardship is informed by mercy rather than desert – although the defendant deserves to be punished, because of the exigencies of his circumstances, the court extends mercy to him. The extent of the mercy in this context is limited because a defendant will still be liable for common law damages.
I will now consider the operation of allowances for skill and effort in detail, and will then consider bars to relief.
IV Allowances and Disgorgement Damages
An allowance for skill and effort should be made for disgorgement damages in some circumstances.64 Indeed, allowances have been made in some cases to date. In Earthinfo Inc v Hydrosphere Resource Consultants Inc,65 Hydrosphere had made a series of contracts with EarthInfo’s predecessor, whereby Hydrosphere would develop hydrological and meteorological software and EarthInfo’s predecessor would package, market and sell the software. EarthInfo had an obligation to pay Hydrosphere royalties for the products it developed, but it ceased paying the royalties in breach of the contract. The court inter alia ordered EarthInfo to disgorge the profits it had made by selling Hydrosphere’s product since the breach of contract. 66 However, the court also found that the efforts of EarthInfo in packaging, marketing and promoting the products should be recognised.67
Similarly, in Experience Hendrix the English Court of Appeal was prepared to make an allowance for skill and effort when awarding a ‘reasonable fee’ award,68 although it could reasonably be asked what exactly PPX did to deserve such an allowance.
Allowances deal in some measure with the concern of law and economics scholars that ‘efficient’ breaches of contract would be prevented by an award of disgorgement damages.
Nonetheless, I suggest that desert provides the best justification for an allowance for skill and effort because allowances reflect the notion that people deserve remuneration for their labour, a desert-based concern.69 However, as will be explored below, the desert justification runs into difficulties in cases where the defendant’s labour has not benefited the claimant. The case law regarding allowances for breaching fiduciaries has been inconsistent. Sometimes allowances have been withheld where the defendant’s labour has not benefited the claimant,70 but in other circumstances allowances have been made regardless. There are also particular problems with justifying an allowance when a fiduciary is dishonest,71 and this may also prove a problem in breach of contact cases.
A Justifications for Allowances
Courts and commentators have sometimes suggested that allowances are made because the profit made by the defendant is not sufficiently causally connected to the breach.72 So, for example, the Australian High Court has said:
[I]t may be appropriate to allow the fiduciary a proportion of the profits, depending on the particular circumstances. That may well be the case when it appears that a significant proportion of an increase in profits has been generated by the skills, efforts, property and resources of the fiduciary, so long as they are not risks to which the principal’s property has been exposed. Then it may be said that the relevant proportion of the increased profits is not the product or consequence of the plaintiff’s property, but the product of the fiduciary’s skills, efforts, property and resources.73
However, this justification does not accord with the practice of courts in making allowances. The court does not divide up expenses in order to work out which ones were causally related to the breach and which ones were not.74 Nor does the justification accord with the law regarding breach of fiduciary obligations: the defendant’s conduct after the breach has never been taken into account in determining whether the defendant has breached; courts do not say that some conduct was ‘not a cause’ but other conduct ‘was a cause’.75 It is suggested that these courts and commentators are confusing apportionment with allowances.
Secondly, some courts and commentators have suggested that profit can be ‘too remote’ from the breach of fiduciary obligation and, therefore, need not be disgorged, and that this is a justification for awarding allowances.76 However, remoteness ‘tells us nothing meaningful about how allowances may be justified.’77
There needs therefore to be some other justification for the allowance for skill and effort.78 The most convincing justification is desert: namely, that the defendant expended time and skilled labour and deserves some recognition of this. Because desert gives rise to a claim of propriety, not to an entitlement, desert seems eminently suitable as an explanation for a discretionary allowance.
A defendant who wants to make a logically consistent claim for a reduction in the claimant’s award should point to some benefit he conferred upon the claimant by his skill and effort.79 Although the defendant’s labour may have benefited other people, this does not seem to be a justification for an allowance against the claimant specifically. Because of the personal and specific nature of desert it seems appropriate that the defendant must justify to the claimant why he properly deserves an allowance against her.
Nonetheless, a desert-based analysis does not sit well with the more utilitarian concerns of law and economics scholars. Easterbrook and Fischel exemplify this approach:
Recompense of some kind is necessary to spur the fiduciary to discover and exploit opportunities; the alternative is a structure of compensation such as a flat fee or a percentage of the managed assets that promotes idleness.80
Further, desert does not sit well with some of the fiduciary duty cases where the defendant’s profits have not benefited the claimant in any way, such as Warman.81
In Warman