The effect of the Commercial Agents Regulations on Termination of the Agency Agreement

Commercial Agents are entitled to statutory compensation on termination of their agency agreements. This compensation arises under the Commercial Agents (Council Directive) Regulations 1993 (“the Commercial Agents Regulations”). Compensation can be substantial and is in addition to any existing contractual rights.

As a result of the Commercial Agents Regulations, there are important questions for both principals and agents to consider before entering into or terminating agency agreements. These include:

  • Do the Commercial Agents Regulations apply to the contract?
  • How much compensation is payable and what is the basis of the assessment?
  • In what circumstances is compensation payable?
  • What steps can be taken (both on negotiating the contract and on terminating it) to: - limit any compensation (if principal); or
  • ensure appropriate compensation is paid (if agent)

There have been a number of changes in the law over the last two years. The most recent (17 July 2007), was when judgment was given in the House of Lords case of Lonsdale v Howard & Hallam Ltd.

It is important that the changes in the law are considered when addressing these issues. We are continuing to receive instructions from businesses which have made decisions on agency agreements, without obtaining up to date advice and have incurred large and potentially avoidable liabilities.

Do the Regulations apply to your contract?

Some principals are still unaware that the regulations apply to their contract. As a consequence, too many businesses are contacting us after they have terminated an agent’s contract and an agent is claiming compensation from them. By this stage some of them have incurred substantial liabilities (running to hundreds of thousands of pounds) as a result of the compensation provisions under the Commercial Agents Regulations. By the same token, there are a number of Agents that have failed to obtain compensation because they were unaware of their entitlement.

Some Principals have historically been advised that the Commercial Agents Regulations do not apply to their contracts and, whilst this advice may have been correct at the time, the way that the courts interpret the regulations has changed as a result of the case of P J Pipe & Valve Co. Ltd v Audco India Limited [2005].

The Commercial Agents Regulations only apply to contracts involving Commercial Agents. Article 2 of the regulations defines a Commercial Agent as a self-employed intermediary (which includes limited companies) who has continuing authority to negotiate the sale or purchase of goods.

Historically it was thought that it was possible to circumvent the provisions of the Commercial Agents Regulations by restricting the Agent’s ability to “negotiate” contracts. As a result, when contracts were drafted for Principals they were often drafted in such a way so that the Agent was prohibited from “negotiating” aspects of the contract so as to circumvent the Commercial Agents Regulations and the protection provided by them. In this way, it was thought that that Principals could avoid paying compensation provided for by the Commercial Agents Regulations.

This is no longer possible. In the PJ Pipe case, the Courts made it clear that they will not interpret the Commercial Agents Regulations in the manner previously envisaged. Thus, the regulations (and the provisions that apply to compensation) apply to all Agents that make introductions and play a significant role in persuading the purchaser to be interested in purchasing the Principals products, irrespective of whether they have continuing authority to negotiate.

As a result of the PJ Pipe decision, the Commercial Agents Regulations are far more wide-reaching than originally considered to be the case and now apply to a number of contracts, which were thought previously to be exempt. Importantly, it may well be that Principals have been previously advised that they were exempt and, whilst that advice may have been correct at the time, it may not be now.

How much compensation is payable and what is the basis of assessment?

The Case of Lonsdale v Howard & Hallam Ltd - the level of compensation

As you may be aware, the parties can agree in an Agency Agreement (covered by the Commercial Agent Regulations) whether compensation should be paid on termination or an indemnity provided. If the contract is silent on the point compensation is payable.

Both Principal and Agent need to be aware of the provisions of the regulations on termination and the liability of the Principal and make an informed choice at the stage the contract is entered into.

The case of Lonsdale v Howard & Hallam Ltd in July 2007 has a significant impact on the valuation on the basis of compensation. It set a clear precedent that an agent’s entitlement to compensation is based upon the value of goodwill in the Agent’s business at the date of termination. In the Lonsdale case, it was stated that goodwill should be valued as it would be in the sale of any business. What was important was the income stream that the agency business would have generated and the best evidence of this would be the price at which the agent could have sold his business on the open market.

The choice of indemnity or compensation should therefore be made on an informed basis and with care at the outset.

In what circumstances is compensation payable?

Compensation is payable on termination in a wide range of circumstances and can be payable whether or not the Principal is in breach of contract for terminating the agreement. The purpose of this aspect of the Regulations is to ensure that an Agent who spends a number of years building a client base for the Principal is adequately compensated for the value of that client base when the relationship between the Principal and the Agent comes to an end.

Compensation is payable in circumstances which the Principal may not necessarily expect. Some examples of this are:

  • Termination of a contract which is for an indefinite period by the Principal giving the appropriate notice (either under an express term of the contract or under Article 15 of the regulations);
  • The agent dies or retires;
  • The agent has breached the contract and the principal terminates but the agent’s breach is not so serious as to justify immediate termination under Article 18(a) of the regulations.

Level of compensation

The French law benchmark adopts the approach of two years average commissions and provides some certainty on the point. The initial approach of the English Courts was to follow French law (which adopts the approach of two years average commissions). It is now clear from the Lonsdale case that the English Courts have moved away from their previous adherence to the French approach and the compensation is assessed on the basis of the value of the business at the date of termination.

Indemnity

In what circumstances is an Indemnity payable?

As explained, as a pre-requisite, the contract must stipulate that an indemnity applies rather than compensation. An Agent is entitled to an indemnity if and to the extent that he fulfils two tests. Firstly, the Agent must have brought the Principal new customers or significant new business with existing customers and the Principal must continue to derive substantial benefits from this business. Secondly, the payment of an indemnity must be equitable having regard to all of the circumstances; including in particular the commission lost by the Agent on such business.

Level of indemnity

The upper limit of the Agent’s indemnity entitlement is given as one year’s average commission, calculated by reference to the preceding five years.

Compensation or indemnity?

In some ways, the Lonsdale case brings the method of calculation on the indemnity basis closer to the compensation approach. The difference subsists in the perspective from which the valuation is assessed. For indemnity damages, continued benefits to the principal are crucial. In contrast, the compensation method is based upon the desirability of the goodwill to a hypothetical purchaser.

The clearest outcome from the Lonsdale case is the need to think carefully about the facts of your own situation so that you are aware of the options available. As explained, in the absence of an election to the indemnity method, all contracts will be subject to Lonsdale-compensation.

How do the changes in the law affect my business ?

There are two main changes, namely:

  • many contracts previously considered outside the ambit of the Regulations now fall within it and therefore Principals and Agents must take this into account if they wish to protect their position appropriately; and
  • the basis of assessment of compensation has been clarified to some extent and in simple terms is value of the goodwill of the agent’s business. Notwithstanding this clarity, the indemnity basis is usually preferred by Principals as it limits the compensation to one years commissions. Both Principals and Agents should consider this issue when negotiating contractual agreements.

What steps should I take to protect my business

Before entering into or terminating a contract where goods are marketed and supplied through a third party you should take legal advice.