This briefing paper looks at recent cases concerning commercial agency agreements and explores how the legal concept of commercial agency works in the UK.
What is a commercial agency?
The appointment and use of commercial agents is employed as a well-established commercial practice. In general terms, an agent has the power to bind the party appointing it (the "principal") to contract with third parties. The agent will need appropriate authority to do so, normally by way of a contract.
The term "commercial agent" covers a wide range of arrangements, from a self-employed salesman in a given area of a single country operating on commission for a single principal, to a sales agent appointed for an overseas territory with local knowledge and a network of contacts, over whom the principal has little control.
EU Directive 86/653/EEC on the coordination of the laws of the Member States relating to self-employed commercial agents (the "Directive") sets out a legal framework for commercial agents in the EU with the aim of enhancing and protecting the position of commercial agents vis-à-vis their principals and harmonizing the different national laws governing commercial agency in the various EU member states to ensure certain minimum standards.
In the UK, the Directive was implemented by the Commercial Agents (Council Directive) Regulations 1993 (the "Regulations") which defines a commercial agent as:
"a self employed intermediary who has a continuing authority (a) to negotiate the sale or purchase of goods on behalf of another; or (b) to negotiate and/or conclude the sale and purchase of goods on behalf of and in the name of the principal" (Regulation 2(1)).
Whether a commercial agent falls under the remit of the Regulations will largely depend on the agent's ability to "negotiate" the sale or purchase of goods on behalf of the principal.
What is the impact of the Regulations?
Where the Regulations apply:
- each party has the right to a written statement of terms;
- any post-termination restrictive covenant is void unless in writing;
- commission has to be paid to the agent by a specific time; and
- (most importantly) compensation or an indemnity is payable to the agent on termination of the agency agreement.
Generally it is not possible for either the principal or the agent to contract out of the obligations imposed by the Regulations.
Recent Case Law
One Money Mail Ltd. v (1) Ria Financial Services (2) Sebastian Wasilewski
A recent case in the Court of Appeal examined whether a restriction on an agent's ability to work for another agency, both during the term of his contract, and for six months after termination constituted a restraint of trade rendering the restriction unlawful.
Mr Wasilewski ("Mr W") worked as an agent for One Money Mail Limited ("OMM"), a money remittance business that transfers money between the United Kingdom and Poland.
Mr W's Agency Agreement
Mr W's Agency Agreement stipulated that he must work exclusively with OMM and that he would not to operate as a principal or as an agent for any other money transfer organisation anywhere in the UK throughout the duration of the Agreement. There was no similar restriction on OMM – it was free to appoint other agents in Mr W's area as it thought fit.
During the term, Mr W joined a much larger organisation, Ria Financial Services Limited ("Ria"). OMM discovered this and complained claiming that he had breached the exclusivity provisions of his Agency Agreement. Mr W gave 6 months' notice to terminate his Agency Agreement with OMM and, as a result, OMM issued proceedings against both Ria and Mr W for damages.
The decision at first instance
The judge at first instance rejected OMM's claim and determined that the restriction on Mr W was, in fact, a restraint of trade and therefore unlawful. This decision was made despite the judge acknowledging that the restriction of Mr W might well be reasonable. She said that this was outweighed by the apparent unfairness that OMM was not itself restrained from appointing another agent in Mr W's area to compete with him, and the resulting potential effect of reducing the commission he could make.
The Court of Appeal decision
Lord Justice Longmore did not agree with the analysis at first instance. In allowing the appeal from OMM, he remarked that agencies with restrictions such as this are common in ordinary commerce and noted the requirement for there to be something especially restrictive before the restraint of trade principle will be effective.
He held that there was no question of Mr W being unable to earn his commission under his existing agreement with OMM. There was therefore no attempt by OMM to "sterilise" Mr W's activities. If there had have been then this may have changed the decision by the judge. As a result, the exclusivity provision in the contract was held to be a reasonable one and Mr W was held to be in breach of contract by signing up with Ria during his contract with OMM.
The decision underlines the need to carefully draft restrictions in commercial contracts so that they do not sterilise the business of the other party i.e. prevent them from doing any business at all. It also shows that courts generally are inclined to uphold reasonable restrictive covenants in commercial situations where they are intended, and go no further than is necessary, to protect legitimate business interests.
It is also a useful reminder that this principle applies to restrictions applicable during the contract, not just on or after termination.
Brand Studio Ltd. v St. John Knits, Inc.
In this case the judge at the High Court considered whether a clause in a commercial agency agreement that benefited the principal on termination could be severed. The clause stipulated that the agent was entitled to an indemnity payment on termination unless the compensation payment amounted to less, in which case the agent would be entitled to compensation.
Indemnity or Compensation – Why is this important?
Regulation 17 of the Regulations provides that on termination of a commercial agency agreement, except in excluded circumstances, a commercial agent will be entitled to either compensation or an indemnity payment to reflect the contribution the commercial agent will have made in developing the principal's goodwill.
The Regulations allow the parties to choose whether compensation or an indemnity is paid, with compensation being the statutory default option unless an indemnity payment is expressly agreed.
The differences are as follows:
An indemnity is a payment of goodwill to the agent i.e. the commercial agent is entitled to an indemnity if:
- he has brought the principal new customers or has significantly increased the volume of the principal’s business with existing customers and the principal continues to obtain substantial benefits from these efforts; and
- payment of the indemnity is fair in all of the circumstances and in particular, the commission lost by the commercial agent on business transacted with such customers.
The indemnity payment will not exceed one year of the commercial agent's commission (the average of the previous 5 years or, if shorter, then the average of the relevant period).
Compensation on the other hand is payable for damage suffered by the agent as a result of the termination, i.e. where the principal has deprived the agent of commission which would have been payable if proper performance of the contract had taken place or where the agent has not been able to recover the costs and expenses incurred in the performance of the contract.
The compensation payment will normally be assessed on the value at the date of termination of:
- the goodwill of the agency;
- the state of the principal’s business;
- the value of commissions and potential future commissions; and
- such other method of valuing a business as may be appropriate.
Case law suggests that compensation should be calculated based on what a hypothetical buyer could reasonably have been expected to pay for the rights the commercial agent had been enjoying. It is likely to be capped at the sum of two years' commission which is calculated over the average of the previous three years of the commercial agency agreement. However, it is generally acknowledged that compensation payments can be difficult to determine and can result in huge debate between parties as to how the projected future income stream of the agency is to be valued.
In the majority of cases compensation will produce a more generous result for the commercial agent and therefore most principals tend to opt for an indemnity payment on termination in their standard agency agreements.
The St. John Knits, Inc. agency agreement tried to combine the best of both worlds for the benefit of the principal and contained the following provision on the subject:
"6.3 (a) Upon expiry or termination of this Agreement for any reason:
(a) If and to the extent that the …Regulations apply, [the Agent] shall (if and to the extent so entitled in accordance with the provisions of the Regulations) have the right to be indemnified as provided for in regulation 17 of those Regulations. For the avoidance of doubt, [the Agent] shall have no right to any compensation under those Regulations upon termination or expiry of this Agreement provided that if the amount payable by way of indemnity under this Clause would be greater than the amount payable by way of compensation, [the Agent] shall …have the right to receive compensation instead of an indemnity under the regulations …"
There was also an express severance clause in the agreement.
Clause 6.3(a) of the agency agreement closely resembled provisions contained in an agency agreement which the High Court had considered previously in the case of Shearman v Hunter Boots Ltd.
In the Hunter Boots case the question of whether or not the principal could rely on the relevant clause was important as the compensation payment would have amounted to about £1.45 million whereas the indemnity payment would have been a (comparatively) mere £200,000.
In this earlier case, the judge found in that because it was not clear at the time that the contract was made whether the agent would be entitled to indemnity or compensation but rather provided a system for determining which option would be cheaper for the principal at the time of termination, it was incompatible with the Regulations. As a result, the entire clause was struck out which meant that the agent was entitled to compensation, being the statutory default option (whether the agent actually received £1.45 million is unclear as the case settled.)
In the Brand Studio case both parties agreed that the provision which the judge had to consider was in the same mould as the one that was in the Hunter Boots case. However crucially, this time counsel for the defendant argued that the unenforceable part of Clause 6.3(a) could be severed from the remaining part.
The High Court's decision
While considering whether the provision could be severed, the judge applied a three stage test, namely whether:
- the unenforceable provision was capable of being removed without having to add to or modify the wording that remained;
- there was adequate consideration to support the remaining terms; and
- with the unenforceable provision removed, the character of the contract changed to such a degree that it became a contract that the parties would not have entered into at all.
The last condition proved to be the most difficult to ascertain.
Whereas counsel for the claimant argued that the two parts of Clause 6.3(a) were interwoven to such an extent that they in fact constituted one covenant or two interdependent covenants, meaning that no severance was permissible, the judge held that although removing the unenforceable part of the provision meant changing its meaning as a whole, it did not change the character of the contract to such an extent that it became a contract that the parties would not have entered into: "Before severance of the proviso it was an agency contract in which the agent had purported to accept an indemnity but had in addition agreed to accept compensation if that was a lesser sum. After severance it is an agency contract in which the agency has agreed to accept an indemnity whether or not compensation would be a lesser sum."
He concluded that as a result the compensation provision could be severed from the indemnity provision.
Although it may be tempting to include a Hunter Boots style clause in an agency agreement, the two decisions in Hunter Boots and Brand Studios show that they are, in effect, unenforceable. What's more, they are likely to create tension during the negotiations as they are entirely one-sided and attempt to leave the agent with the worst of both worlds on termination. A better way of dealing with the prospect of having to pay a commercial agent on termination may be to set aside money during the term of the agreement.
Alan Ramsay Sales and Marketing Ltd v Typhoo Tea Limited
Lastly, in the case Alan Ramsay Sales and Marketing Ltd v Typhoo Tea Limited the High Court had to assess the amount of compensation payable to the commercial agent on termination.
It confirmed that any compensation payable to an agent on termination will be calculated based on what a hypothetical buyer of the agency business could reasonably have been expected to pay.
Take-away points from this judgment are as follows:
- when calculating the multiplier with which future net earnings need to be multiplied to get to the value of the agency business, it is important to take into account the type of goods that the agent sells for the principal. In the case both experts used the average price/earnings ratio ("P/E Ratio") from FTSE as a starting point, but whereas the agent's expert used the P/E Ratio for Consumer Goods and Consumer Services, the principal's expert looked at the P/E Ratio for Food Producers and Food & Drug. The latter did not convince the judge as he found that "Typhoo," being one of the major tea brands clearly, had a "beverage" element to it.
- with regards to the costs and expenses of the agency that the agent incurs and which will need to be reflected in the valuation of the agency business, the relevant figures are not what the agent actually pays, but what a hypothetical buyer would pay. In addition, where an agent acts for more than one principal and has multiple agencies, the costs incurred (both fixed and variable) should be fairly allocated.
Although this case does not contain any new law or findings, it provides a useful illustration of how the courts will calculate an agent's entitlement to compensation and which factors they will take into account in doing so.
The Brand Development Team at Fieldfisher advises its clients on franchising, agency, distribution, licensing, strategic alliances and hybrid structures across a range of sectors, including retail and fashion, food and beverage, hotel and leisure, education, healthcare and service based concepts.