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• The Agency Minefield : How is Compensation calculated on Termination?

Introduction

It is reasonably well known that the 1994 Commercial Agents Regulations provide legal protection for self employed agents who sell products on behalf of someone else. Under these regulations, agents can claim compensation on termination of the agency relationship and pay outs can be substantial.

In the UK the parties have another choice. They can opt to pay an indemnity for unamortized costs by a more certain formulaic approach if they so agree. In the absence of agreement the agent is entitled to compensation. Which is the right choice needs to be assessed carefully but the uncertainty around what compensation is payable and the lack of an upper cap on the amount, has sometimes swayed the balance in favour of an indemnity.

Any business appointing an agent therefore has to be very careful when doing so and should seek legal advice. The same applies whenever an agency looks like it might be coming to an end.

What has not been clear before now is how our national courts should approach the calculation of compensation when an agency ends. The case of Londsale (t/a Lonsdale Agencies) –v- Howard & Hallam Limited heard in the House of Lords has provided much needed guidance.

Mr Lonsdale was a commercial agent in the shoe trade. His agency was terminated and he sought compensation under the regulations. He argued that his compensation should be calculated in accordance with the French method (the rule of thumb being to pay two years worth of gross commission). His argument was that a particular report issued by the European Commission had endorsed the French method and therefore this method should be applied by the Courts across the European Union, including in the UK.

The House of Lords did not agree. They said:

• The European Commission's report was not endorsing the French method of calculation as a true reflection of Community Law. Each member state has discretion to decide the basis upon which the agent's entitlement to compensation is calculated.

• The compensation represents the damage the agent suffers as a result of the termination of his relations with the principal. Thus in the UK the Courts will look at the loss of the value of the agency on the assumption that it continued. In Mr Lonsdale's case this would have been negligible given the decline of his principal's business.

How does this decision affect your business?

It is not possible to contract out of the regulations and some of the provisions are mandatory. It therefore makes sense for you to prepare your agreement in writing taking account of the regulations, but making them as favourable to your business as possible.

When it comes to calculating compensation you need expert legal and accounting help. Some of the key areas to look include how has the underlying business been doing, what goodwill is associated with the agent, and how transferable the goodwill might be. If it appears that all of the customers would be likely to defect to the former agent, or to another party, a replacement agent would be unlikely to pay much for the agency and the value of the agency and thus amount of the compensation would be low.

The Lonsdale case also shows the importance of having a written agreement in place so that you are able to specify which method of compensation is to apply upon termination. Generally speaking the indemnity payment is preferred by principals as it is based on 1 year's commission calculated as an average over the previous 5 years, unlike the compensation method which has no cap. If the agreement is silent the compensation model will apply and the value will be calculated by reference to the loss of the value of the agency.

Finally, where you are dealing in cross-border sales within Europe, this case demonstrates the need to think carefully about which law is to apply to the agreement. As each member state has implemented the EC Directive slightly differently it can have a real impact on your obligations and your legal and financial liabilities.