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Product derived indirectly from earlier misuse of confidential information – what damages are available?

26 July 2016

When considering damages for breach of confidence, there is a distinction between products which embody confidential information and those which merely derive from earlier misuse of information. The Court of Appeal in MVF 3 APS (formerly Vestergaard Frandsen A/S) & ors v Bestnet Europe Ltd & ors [2016] EWCA Civ 541 agreed with Rose J’s distinction between the measures of damages applicable in this case where the defendants had made different types of insecticidal mosquito nets using the claimant’s confidential information.

The dispute had a complex history involving hearings in the French and Danish courts, two hearings in the High Court and two in the Court of Appeal. This note is concerned with an appeal from Rose J on the question of damages.

The defendants (Bestnet) had produced particular types of mosquito nets using the claimant’s (Vestergaard) confidential information. The High Court distinguished between the ways in which Bestnet’s different products used Vestergaard’s confidential information and applied different measures of damages accordingly.

Products from direct misuse of confidential information

The High Court found that production of the first version of Bestnet’s products – the “First Formula” nets – involved direct misuse of Vestergaard’s confidential information. Rose J held that the correct measure for damages in such cases was that established in a patent-infringement case, General Tire & Rubber Company v Firestone [1975] 1 WLR 819, 16 April 1975. On this measure, damages were based on lost profits from the sales of nets which Vestergaard would have made, but for the sales of nets which Bestnet was able to make by its misuse of confidential data.

Derived products from earlier misuse

However, Rose J held that the second version of the nets that Bestnets produced (the “Later Formula” products) was merely “derived” from the original misuse of information. Rose J awarded damages in respect of Later Formula products based on losses Vestergaard incurred because of the accelerated entry into the market that Bestnet was able to make by selling these products sooner than it would have been able to without the earlier misuse (the “accelerated entry” basis). In this instance, Bestnet had been able to shorten the time needed to develop its Later Formula products by virtue of the earlier misuse.

Both parties appealed to the Court of Appeal, raising six issues. The Court of Appeal upheld Rose J’s original findings on all of them.

Derived products – which basis for damages?

The first issue was whether damages in respect of the Later Formula products should be calculated on the General Tire basis or on the accelerated basis. The Court of Appeal emphasised the difference between products which embody confidential information and products which merely derive from the earlier misuse of information. “The General Tire measure was to award lost profits on sales of Bestnet’s First Formula nets to the extent that those sales replaced sales that Vestergaard would otherwise have made.” However, the sale of the latter type of products would not in itself be wrongful. Instead, the issue was “what recoverable harm can be traced back to the initial wrongful use of the confidential information in order to develop the product”. Where a product is merely derived from the misuse, the consequences should be “more limited” and are likely to be “the acceleration or limitation of lawful competition.” The Court accordingly upheld Rose J’s decision not to apply the General Tire measure to the calculation of damages in respect of the Later Formula products. Instead, (the second issue), Rose J decided that damages in respect of the Later Formula products should be measured on an accelerated entry basis.

Accelerated entry – two heads of damages

Rose J held that there were two heads of damages:

  • a lump sum quasi-consultancy fee to reflect the extent to which use of the confidential information had contributed to sales of Bestnet’s Later Formula nets; and
  • payment for Bestnet sales made during any period when Bestnet would not yet have been able to sell their goods if they had not misused Vestergaard’s confidential information.

Development time saved

Rose J first concluded that Bestnet had saved six months in development of the Later Formula product by using the confidential information. Rose J then considered how much of that period had actually resulted in accelerated sales for Bestnet and concluded that there had in fact been no acceleration of Bestnet’s entry into the market.

Notional royalty rate

The Court of Appeal also upheld Rose J’s decision that damages should reflect a notional 4% royalty rate payable to Vestergaard in respective of a notional licensing agreement. In order to assess appropriate royalty rates, one had to consider what sum would have been arrived at in licence negotiations between the parties. This was on the assumption that each had made reasonable use of their respective bargaining positions, bearing in mind the information available and the commercial context in which this negotiation would have taken place.

These hypothetical negotiations assumed that “the nets which were to be licensed were those which did not cause sales to be diverted from Vestergaard.” The Court of Appeal rejected submissions that the judge had used hindsight and that it was wrong to assume that the parties would have known at the time of the hypothetical negotiation that sales of the product would not have deprived Vestergaard of any sales. Rather, damages had properly been assessed based on the “user principle”, reflecting the fact that royalties were not based on assumed sales which Vestergaard would have made but for licensing.

Rose J had awarded a quasi-consultancy fee on the basis that Vestergaard’s confidential information had given Bestnet substantial help in developing its own products. The Court held that “the proper approach was to award, as a first head of damage, a lump sum by way of a quasi consultancy fee to reflect the extent to which the sales of the Later Formula nets were brought about by use of the confidential information”. The second head of damage was compensation for sales made in any period when Bestnet would not have been in the market were it not for misuse of Vestergaard’s confidential information. Rose J had been right to take a retrospective approach taking account of what had actually happened – when assessing how much compensation Bestnet should pay Vestergaard in respect of the Later Formula products.

Court determines production levels

The High Court had asked Bestnet to provide production records for their First Formula and Later Formula nets in order to measure the quantities of each type of net that had been produced. The judge found that Bestnet’s response had been so unsatisfactory that the court made its own decision about how many nets were made to the First, and Later, Formula. Rose J found that a large order for nets had been for First Formula products. This was unfavourable to Bestnet, but the Court of Appeal upheld her finding: given Bestnet’s unsatisfactory disclosure, this was a finding open to the judge.

On the final issue, Bestnet appealed against the judge’s decision to award interest at 2% over Barclays Bank’s base lending rate. Vestergaard was a successful company, which, Bestnet argued, meant that the interest rate should be based on the interest paid by similarly profitable companies. However, the Court of Appeal upheld the judge’s award. The judge had not been given any evidence about the rates of interest available to companies similar to Vestergaard and the Court held that, by reference to the White Book, 2% above base rate was not sufficiently unusual to justify interference.

COMMENT

The Court of Appeal had to consider many different issues and many different possible bases for awarding damages. As Sales J put it in Vercoe v Rutland Fund Management Ltd [2010] EWHC 424:

“The law relating to breach of confidence covers a very wide range of different factual situations and it is unsurprising that the strength of the arguments in favour of any particular remedy or set of remedies … varies across that range.”

Sometimes the breach may be akin to a breach of fiduciary obligations, other times it may be akin to a breach of intellectual property rights, or of contractual rights, or the wrong may be similar to a tort. This particular judgment is a potentially useful guide to remedies and defences that might be available.

It is also a helpful reminder that it can be difficult to calculate, or even demonstrate, potential losses from breaches of confidentiality clauses. This is reflected in the fact that well-drafted confidentiality agreements will contain explicit recognition by the parties of the fact that other remedies, such as injunctions, may be appropriate.

Indeed, in an earlier hearing in this case before Arnold J, the court had agreed that Vestergaard was entitled to an injunction preventing Bestnet from using or disclosing certain data, but had refused an application for an injunction which would have prevented a Dr Skovmand from working for Bestnet on insecticides using a particular chemical that Vestergaard also used. Arnold J also declined to grant an injunction which would have prevented Bestnet from benefitting from past misuse of confidential information. Given the uncertainties around damages awards and the availability of injunctions, it may be worth considering whether to include a liquidated damages clause within confidentiality provisions if this is possible.

Finally, Bestnet’s failure to give proper disclosure meant it lost the benefit of the doubt when the court had to decide whether a large order for nets had been for First or Later Formula nets. This is a reminder that parties can expect no sympathy if they fail to obey disclosure orders.

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710.​