A recent High Court decision could mark a significant development in the courts' treatment of claims for compensation under the Commercial Agents (Council Directive) Regulations 1993 (the Regulations) - to the detriment of agents, and the benefit of principals.

What are the Regulations?

The Regulations were introduced to implement directive 86/953, the Directive on the Co-ordination of the Laws of the Member States Relating to Self-Employed Commercial Agents. The directive was widely seen as an attempt to offer protection to the "downtrodden race" of the commercial agent.

Why are they important?

The Regulations will apply to any agency contract (whether written or not). One particularly significant aspect of them is that they contain what may be a hidden pitfall for a commercial principal.

Regulation 17 entitles an agent, upon termination of the agency contract, to either an indemnity payment or a compensation payment. (In the absence of an express provision to the contrary, the agent is entitled to be compensated rather than indemnified.) The Regulations require such a payment even if the contract has been terminated lawfully and on proper notice.

The Regulations are therefore a rarity in English law: a commercial principal can be stung by an unexpected liability even where it has not done anything wrong.

How is the amount of the compensation payment calculated?

The Regulations themselves are, however, somewhat ambiguous as to precisely how a payment of compensation should be calculated. Some clarity was provided by the House of Lords' decision in Lonsdale (t/a Lonsdale Agencies) v Howard & Hallam Ltd [2007] UKHL 32. In that case, the House of Lords moved away from the approach of the French courts of awarding an agent compensation equivalent to twice the average annual gross commission over the three years prior to termination. Instead, the court held that compensation should be valued by reference to the notional value of that agency on the open market. In other words, the compensation properly payable to an agency upon termination is the value of the agency business on the assumption that it continued and was available for purchase.

Lord Hoffman, who delivered the leading judgment in Lonsdale, stressed however that all that was notional was "the assumption that the agency was available to be bought and sold at the relevant date. What [the agency] would fetch depends upon circumstances as they existed in the real world at the time: what the earnings prospects of the agency were and what people would have been willing to pay for similar businesses at the time."

The court recognised that valuing compensation on that basis would require evidence as to the value of the agency from an independent expert.

How might recent case law change things?

The case of Michael McQuillan, Lorna McQuillan v Darren McCormick, Wizzeweb Limited, Pandora Jewelry Limited [2010] EWHL 1112 (QB) has the potential to be significant. It may have been widely presumed following Lonsdale that a court would be likely, when assessing compensation, to follow the valuation of an independent expert. In McQuillan, not only did the Judge depart significantly from the experts' agreed valuation, but his reason for doing so could have substantial implications for other claims under the Regulations.

Mr and Mrs McQuillan were agents for Mr McCormick and/or his business from February 2006 until February 2008, when the agency was terminated by Mr McCormick. One of the elements of the McQuillans' claim was for compensation under Regulation 17. Each party had instructed its own expert, and after initial disagreements the experts ultimately reached agreement on the valuation of the agency (on alternative bases depending upon whether the agency was found to be exclusive). They agreed that if the agency was exclusive then the valuation of the business was £342,895; if not, then the value was £285,746.

The Judge declined to adopt either of these figures, despite finding that the agency was an exclusive one. The key factor in his decision was the notice period on which the agency could be terminated. This is not a factor that was identified either in the Lonsdale judgment or in the Regulations themselves. The Judge found that the agency was terminable on one year's notice on either side. Given this potential foreshortening in the period for which the agency could continue, the Judge held that it was unlikely that any potential purchaser would pay more than one year's income stream for it. The experts had determined that the annual income stream was £149,000, and so the Judge awarded Regulation 17 compensation of £150,000: less than half of the experts' agreed figure.

What are the implications of this decision?

Arguably, the decision in McQuillan represents a departure from the intention behind the directive which the Regulations implemented: namely, the provision of robust protection for commercial agents. But this decision is perhaps more in keeping with the general approach of the English courts to determine loss-based compensation. Indeed, in his speech in Lonsdale, Lord Hoffmann did appear to give relatively short shrift to the notion that the commercial agent is still, today, a "downtrodden race". In quoting those words of Staughton LJ, he suggested that they had been said "with more than a touch of irony."

McQuillan is a High Court decision. It is not binding authority but will be of persuasive value. If followed it could represent a significant shift in the balance of protection offered to agents upon termination. It would mean that the Regulation 17 compensation could be capped by the notice period on which the agency contract can be terminated.

This cap will be particularly tight if there is a short express notice period. The situation is even worse for an agent where there is no express provision for notice periods. In that situation, Regulation 15 provides that the notice period shall be one month for the first year of the contract, two months for the second year, and three months thereafter. An agent whose agency is terminated on three months' notice could find his Regulation 17 compensation capped at a sum equivalent to only three months' net profit. Had this been the notice period in McQuillan, for example, where the agency was a thriving and growing business, the compensation would nevertheless have been only around £37,500.

If followed, this decision will clearly be of great relevance to any commercial agents regulations litigation where a claim is made for compensation under Regulation 17. Agents who had a thriving agency business that happened to be subject to termination on a short notice period, may find themselves entitled to a rather lower sum in compensation than they had anticipated.

The decision will also impact on advice given to both parties at the time of entering into an agency contract. Previously, when advising a principal who was about to enter such an agreement, it was often assumed that providing for an indemnity on termination, rather than compensation, would produce a cheaper and more certain outcome for the principal. There is a real possibility that McQuillan will change that. A compensation payment, combined with as short a notice period as permissible under Regulation 15, might quickly become the more attractive option. It will be interesting to observe the extent to which this principle in McQuillan is now applied in future commercial agents' litigation.