Most business sale agreements will include a provision prohibiting the seller from opening up a competing business nearby during a fixed period - this is known as a "restraint of trade provision".
The rationale for this is that the buyer will often pay a substantial premium for the goodwill of the business and will therefore generally require an assurance that the seller won't undermine the value of that goodwill by immediately setting up in competition and luring back the customers.
When a seller breaches a restraint of trade provision, the aggrieved buyer can apply to the courts for an injunction restraining the seller from competing with the buyer and/or seek damages from the seller for profits lost because of the unexpected competition.
The 2011 case of Denaro Ltd v Onyx Bar and Cafe (Cambridge) Ltd demonstrates that as an alternative remedy a buyer may be entitled to force a seller who breaches a restraint of trade provision to refund the value of the goodwill.
In November 2007, Denaro sold the Onyx Bar in Cambridge to Onyx Bar Ltd as purchaser.
The total purchase price was $685,000, of which $327,000 was paid for various intangible assets including the goodwill of the business. Denaro warranted that the annual turnover of the business was not less than $1,371,270.
The sale agreement contained a restraint of trade provision which prohibited Denaro and its director Mr Wilson from carrying on a restaurant, cafe and bar business either directly or indirectly within a 10km radius of the Cambridge CBD.
Within a few months of selling the Onyx Bar, Mr Wilson together with several others established a new business under the name "Stables Sports Bar" immediately next door to the Onyx Bar.
Surprisingly, the Onyx Bar was able to achieve the turnover warranted in the agreement despite the unexpected competition and therefore suffered no demonstrable loss of profit as a result of the breach. Onyx Bar subsequently took legal action to force Denaro to refund the sum which Onyx Bar had paid for the goodwill.
Onyx Bar initially claimed $247,500, which it estimated to be the value of the goodwill, but reduced its claim to $200,000 to bring the claim within the jurisdiction of the District Court.
The District Court found that Onyx Bar had paid for an asset (the right to trade without competition from Denaro and Mr Wilson) which proved to be worthless. The District Court held that Onyx Bar was entitled to damages to the amount of $200,000, that being the value of the goodwill which Onyx Bar had paid for but not received.
Denaro appealed the decision to the High Court.
In the High Court, Denaro's lawyer argued that restitutionary damages (damages which aim to strip from a wrongdoer gains made by committing a wrong) are not available for breach of a restraint of trade provision. If the court had accepted this argument, Denaro would not have been liable to pay any damages since Onyx Bar did not suffer any loss of expected profit requiring compensation.
The High Court concluded that Onyx Bar must have lost considerable turnover as a result of the former owner setting up in business next door and accepted that Denaro and Mr Wilson had made a "clear, unequivocal, callous and deliberate breach of the terms of the restraint of trade".
The High Court held that Onyx Bar had paid a substantial sum for something it did not get (a competitive environment without Denaro and Mr Wilson) and for this reason, with the support of precedent, Onyx Bar was entitled to recover the sum attributable to the restraint of trade provision despite the fact they had not suffered any loss of expected profit. Denaro and Mr Wilson were held to be jointly and severally liable for damages to the amount of $200,000 plus interest and costs.
• David Smillie is a partner in the legal firm Gallaway Cook Allan.
