Defendant's Gains From Breach of Non-Compete Not A Proper Measure of Damages (Phelps v. Wystrach)

The Court of Appeals of Arizona found recently that in the sale of business context, the purchaser could not rely upon the seller's gains from the breach of a non-compete agreement to establish damages.

The factual matrix in Phelps v. Wystrach is a common one. Wystrach sold her veterinary practice to Phelps and in turn gave Phelps a 5-year, 40-mile non-compete. That covenant, apparently, also included a separate covenant that Wystrach would not solicit the practice's former clients. It is not clear if this covenant contained any time or territory limit.

Following the closing of the practice's sale, Wystrach serviced the veterinary business of her former largest client, a breeder and trainer of show horses in Tucson. The owner of the horse farm testified she would not have worked with Phelps even if Wystrach had been unavailable. This is a classic third-party refusal to deal defense, which the court noted was irrelevant to the issue of whether Wystrach breached the non-compete agreement.

The issue of damages was a different matter, however.

The court found that evidence of Wystrach monetary gains from working with the horse farm was not a proper basis upon which to award Phelps damages arising out of the non-compete agreement. The holding is similar to TruGreen Cos., LLC v. Mower Bros, Inc., which I discussed a few years back that held under Utah law unjust enrichment is not a basis for awarding damages for a non-compete claim.

The concept of unjust enrichment damages in a sale of business context seems materially different than in a normal employee case. In a business sale, a purchaser is specifically paying the seller to avoid soliciting or working with customers of her former firm. Any breach would logically compromise the value of what was paid for the business. Employment cases, obviously, lack this key damages metric.

This highlights the need for sellers to include liquidated damages clauses in the purchase agreement. A predetermined damage formula can avoid the problems of proving lost profits and obtaining only chimerical relief at trial, like the buyer did in Phelps.

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Court: Court of Appeals of Arizona, Division Two
Opinion Date: 10/29/10
Cite: J.A. Phelps v. Wystrach, 2010 Ariz. App. LEXIS 201 (Ariz. Ct. App. Oct. 29, 2010)
Favors: N/A
Law: Arizona