The latest figures released today show that inflation is running at 9% and will almost certainly increase in the short term.
In doing so, inflation will affect agency and distributorship agreements in different ways.
The use of inflation-linked clauses in agency agreements is very unusual. This is unsurprising as most agents are remunerated on a percentage commission basis. But the impact of inflation will have consequences in relation to both performance targets and compensation/indemnity entitlements.
Where the agency agreement contains minimum sales requirements or sales targets, it should be much easier for the agent to fulfil the requirements or targets provided that demand for the principal’s goods remains constant.
But as a result, inflation could end up disguising underperformance by the agent.
Given this scenario, principals should be looking at the performance provisions contained in their agency agreements and consider:
- Do such provisions provide the principal with sufficient flexibility to allow the principal to require an improvement in the agent’s performance?
- Alternatively, if such provisions were not included in the agreement, is it possible to vary the existing agreement or introduce a new agency agreement containing such provisions?
Compensation / indemnity
Compensation and indemnity are alternative statutory entitlements under the Commercial Agents Regulations. Compensation and indemnity recompense the agent for the loss of the agency when the agency ends unless this is as a result of a material breach by the agent or by the agent walking away from the agency.
Compensation represents the value of the agency to a notional third-party purchaser, see here. In contrast, indemnity is calculated by reference to the yearly average of the commission earned by the agent in the five years preceding termination or, if the agency terminates within five years, then a shorter period, see here.
In either case, inflation resulting in an increase in the commission earned by the agent can be expected to affect the amount of compensation or indemnity. Indeed, in its own way, this can be compared to how the effect of Covid has been taken into account in valuing some agencies over the last two years, see here.
The position in respect of indemnity is more nuanced. First, indemnity cannot exceed the annual average commission as determined above. Second, the Regulations refer to the payment of the indemnity being “equitable having regard to all the circumstances…”.
It is the case that a rising tide lifts all boats – so it would be unsurprising to also see in the coming months claims by agents that, as a result of inflation, they have lost commission as the business undertaken with the principal’s customers has flatlined.
Our research has shown that usually compensation is better than indemnity for agents (and vice versa for principals). Ironically, the impact of inflation could see the reverse.
The effect of inflation on distributorship agreements can arise in two ways:
1. Fixed prices – a distributorship agreement is an umbrella agreement setting out how the distributor will act for the supplier in developing and maintaining a market for the supplier’s products. Under the distributorship agreement, the distributor will place orders for the supply of goods which are to be sold by the distributor to its customers.
If the distributorship agreement sets out the prices for goods to be supplied by the supplier to the distributor, the supplier will face a difficult situation under English law.
As much as it might wish to increase prices, it will require the agreement of the distributor to do so. Indeed, this can be compared to the laws of some countries – such as, France – where (in broad terms) prices can be changed to take account of unforeseen events.
If the supplier seeks to increase prices unilaterally, it will result in a material breach of the contract for the goods in question and – subject to the language used in the agreement – as well as a material breach of the distributorship agreement itself.
In contrast, the absence of prices being specified in a price list will provide the supplier with flexibility to increase prices to take account of inflation.
However, even here there will need to be some care taken by the supplier as a distributorship agreement is a relational contract which means that an implied duty of good faith will be included – on both the supplier and the distributor.
Given the nature of a supplier/distributor relationship, minimum purchase obligations are often found in distributorship agreements. Such obligations are a way of measuring the performance of the distributor. However, if the distributorship agreement sets out minimum purchasing obligations for a number of years, these will be impacted by higher inflation – another example of a rising tide lifting all boats.
Nor is the answer to be found by including a provision in a distributorship agreement that supplier and distributor will agree on minimum purchase obligations after, for example, the first year of the agreement. Such a provision constitutes an unenforceable agreement to agree.
In any event, in reselling the goods which the supplier had supplied, the distributor will apply a mark-up or seek to resell on a multiple of the seller’s price. Subject to demand remaining stable, increases in prices applied by the seller will be magnified by the mark-up or multiplier applied by the distributor to its own prices. In turn this may affect the amount claimed by the distributor for loss (termination) of the distributorship.
2. Compensation for the loss of the distributorship – for distributors there is no equivalent to the statutory entitlement of an agent to compensation or indemnity on the termination of the agreement.
However, over the last thirteen years, there have been a number of judgments in the English courts concerning the termination of a distributorship agreement and claims for damages for failure to give proper notice of termination. In giving these judgements, judges appear to have been influenced by the principle underlying compensation under the Regulations.
Going further, it can be expected that if a supplier terminating a distributorship agreement should fail to give proper notice of termination, the distributor claiming damages for such failure will look to take advantage of the effect of inflation both on its own performance and how damages should be calculated.
Take home points
- Until such time as the current burst of inflation works its way through the economy, principals and suppliers should be giving thought to the impact of inflation on their agreements with their agents and distributors respectively as well as on other agreements which are key for their businesses.
- Where possible, principals and suppliers should seek to put in place variations to existing agreements which go some way to moderating the effects of inflation.