The House of Lords revises the way in which Commercial Agents’ compensation is calculated.

Commercial agents

When the Commercial Agents (Council Directive) Regulations 1993 (the Regulations) were first introduced, the legal profession and clients at large held their breaths as they waited to see how these regulations would be applied and interpreted. Over the years there have been a number of cases before the courts looking at terminology and interpretation of how to recompense an agent for the loss of their agency, through no fault of their own. Last week the House of Lords drew a line under the issue of how to calculate compensation payable to the agent. We look at the decision and its practical application.

A “commercial agent” is a self-employed intermediary who negotiates the sale or purchase of goods (but not services) on behalf of another party (the principal) within the European Union. Commercial agencies are common in the manufacturing industry, where agents rather than employees, sell the products in the market place. Under the Regulations, an agent is entitled to be compensated on the termination of the agency contract. Termination not only includes on notice, but also the end of a fixed term, on retirement, ill health or death.

The compensation takes one of two forms, either an indemnity, which will be agreed from the outset, or in default of any agreement, “compensation”.

An indemnity is subject to a cap of one year’s remuneration calculated as an average of the last five years remuneration. At the time the agency contract is entered into both sides can only estimate the amount of an indemnity based on sale forecasts, but once into the agency, the principal will have a much better idea as to how much this indemnity could equate.

Calculating compensation was no easier. There was no cap, no certainty and little guidance. Over the years, when calculating compensation, the courts have followed the French approach of a “two-year guideline” in relation to gross or net commission.

The House of Lords decision last week in Graham Lonsdale v Howard & Hallam Limited [2007] UKHL 32 (“the Lonsdale case”) has changed this.

The Lonsdale case

Mr Lonsdale was a commercial agent for Howard & Hallam Ltd (H&H), shoe manufacturers, which appointed him to sell its brand of shoes in southeast England. He was later appointed by another manufacturer to sell a different brand in a slightly larger territory, which sold well and by 2000 accounted for two-thirds of Mr Lonsdale’s business. However, his gross commission from H&H continued to fall and in 2003, H&H ceased trading and sold the goodwill of the brand to a competitor.

There were no express terms about the termination of his agency - there was no written agreement – and the agency was therefore terminable by reasonable notice, which was agreed at six months. He was paid the commission on the sales he had generated and was not entitled to any further contractual entitlement, but as a self-employed commercial agent, Mr Lonsdale was entitled to statutory compensation under the Regulations. Under Article 17(3) of the Regulations:

“[the]...commercial agent shall be entitled to compensation for the damage he suffers as a result of the termination of his relations with the principal... in circumstances where the commercial agent is deprived of the commission which proper performance of the agency contract would have procured him whilst providing the principal with substantial benefits linked to the commercial agent’s activities, and/or which have not enabled the commercial agent to amortize the costs and expenses that he had incurred for the performance of the agency contract on the principal’s advice.”

Mr Lonsdale argued that the French approach of twice the average annual gross commission should apply in his case, but the House of Lords disagreed for a number of reasons.

The House of Lords:

  •  recognised that commercial agencies in France and England operated in different market conditions and therefore the basis on which compensation, payable under Article 17(3) was calculated, should differ. It was to be calculated by reference to the value of the agency on the assumption that it continued: the amount which the agent could reasonably expect to receive for the right to stand in his shoes, continue to perform the duties of the agency and receive the commission which he would have received. 
  • considered that the value of the agency relationship lies in the prospect of earning commission. The agent’s expectation is that “proper performance of the agency contract” will provide him with a future income stream. What has to be valued is the income stream, which the agency would have generated. As a present value is being placed on future income, those future earnings must be discounted by an appropriate rate of interest. 
  • endorsed the county court judge’s original decision that the damage for which the agent is to be compensated consists of the loss of the value or goodwill he can be said to have possessed in the agency. As small businesses of all kinds are bought and sold on a daily basis, a major element in the composition of their price will be a valuation of goodwill. The House of Lords felt that valuation ought to be reasonably straightforward. The parties should be able to agree on an appropriate valuation (or benefit from advice from accountants) for the going rate for such businesses. The House of Lords predicts that fewer cases will now go to court, as there should be fewer disputes over the basis of this calculation. 
  • recognised that if valuation evidence is required it may be expensive and most claims too small to justify the cost of an expert witness. It may therefore be sufficient to place all the material before the court and invite the judge to act as valuer. In the Lonsdale case, neither side put evidence before the court about how commercial goodwill is conventionally valued, although it was ultimately for the agent to prove the value of what he has lost. In the county court, the judge assessed the commercial value of the business as the price that someone would pay for it. As Mr Lonsdale’s agency was producing a modest and falling income in a steadily deteriorating environment and there was no evidence that anyone would have paid anything to buy it, the judge said that he was strongly tempted to find that no damage had been established; however, he assessed a figure for compensation of £5,000. This was approved and endorsed by the Court of Appeal and the House of Lords.

The House of Lords refused a referral to the European Court of Justice.

Practical implications

The immediate consequences for commercial agents and principals are considerable as the established method of valuation of taking two years earnings is no longer a correct method for calculating compensation.

  • The correct method of calculating compensation is to value the agency as an asset at the time of termination having regard to the state of the principal’s business and the value of its goodwill.
  • The value of goodwill could be significant. For example, in the case of a principal in good financial health which chooses to restructure the business or change its focus to different market(s). Compare this with principals who close down their businesses, who may not have to pay an agent any compensation, as no one would pay for an agency business where there was no product to sell. 
  • Is it now more cost effective to appoint agents rather than have employees? The relative costs of terminating an employment relationship should be weighed against an agency in light of this decision. 
  • Principals may need to review their standard agency agreements to see if these should be changed, as compensation may now be the cheaper option compared to the indemnity route. Parties may consider in advance how that agency will be valued and seek to specify this in the agency agreement.

One final point

The Winemakers Federation of Australia was permitted to intervene in the Lonsdale case before the House of Lords in relation to factors to be considered in a valuation where an agent transferred from one principal to another. The House of Lords said that in such circumstances any valuation should be reduced if it was clear that the agent’s customers were likely to go with the agent to the new principal.