Compensation to agents upon termination of their agency agreement - the definitive answer

The House of Lords in Lonsdale (t/a Lonsdale Agencies) v Howard & Hallam Limited [2007] UKHL 32 has finally given a definitive answer on the issue of the compensation payable to agents upon the termination of their agency agreement.

Background

Designed as a means of protecting agents and harmonising the treatment of agents across Europe, the Commercial Agents (EC Directive) Regulations 1993 reinforce the existing common law of agency by imposing obligations on both agents and principals to act dutifully and in good faith.

They go further, however, by seeking to regulate how and when commissions are paid. In the most significant change to the UK regime, they give agents a right to receive a payment when their agency terminates other than as a result of the agent's breach.

This payment could be termed in two ways: compensation or indemnity. The European Commission gave member states the choice of which form to use. The UK, with no pre-existing regime to harmonise with, chose to give agents and principals the choice.

Compensation is the default position under the Regulations. Based on the French regime, it allows the agent to recover "the damage he suffers as a result of the termination of his relations with his principal".

Despite this, there is no guidance in the legislation as to how it should be calculated. The Regulations have been in force since 1994, and many agency agreements have since terminated, resulting in a fair amount of litigation regarding this controversial payment.

Thirteen years later, the House of Lords has been called on to settle the argument. And while they haven't set out a strict formula as to how to calculate compensation, by refocusing the arguments on the question of why compensation should be paid, they have made the settlement of compensation claims in the future much more certain.

What is compensation?

It is vital that agents and principals both remember that compensation is required to cover "the damage [the agent] suffers as a result of the termination of his relations with his principal" - Hoffman LJ was so confident that this would prove to be the crux of many disputes that he considered if agents and principals remembered this, "relatively few cases will go to court".

How should it be calculated?

The issue is one of the valuation of the agency business. As Hoffman LJ said, such valuations are carried out regularly for commercial reasons because in the UK there is a market where small businesses are bought and sold regularly. The House of Lords therefore felt that it should be relatively simple for agents and principals to come to a commercial valuation of the business, as they would do if the agency was being sold.

However, where such matters do go to court, it will remain the claimant's responsibility to prove the value of the agency in order to prove his claim for compensation. Expert accountancy evidence is therefore likely to be required to provide the judge with "some information about the standard methodology for the valuation of such businesses."

While Hoffman LJ recognised that this requirement for an expert may put additional cost onto the parties, he was confident that, as a result of this judgement, fewer cases should make it to trial, and that to allow judges to pick arbitrary figures would result in a lottery system and more litigation.

He also suggested that, with enough experience, the courts may be able "to take judicial notice of what would be the going rate in ... the standard case, namely an agency which has continued for some time and in which the net commission figures are fairly stable".

In the meantime, the following principles can be usefully drawn from his judgment:

1. Compensation should reflect what could reasonably have been obtained, at the date of termination, for the rights which the agent had been enjoying.
2. The value of the agency will reflect its net earnings and the income stream which the agency would have generated, making allowances for:
   • a rising or declining market;
   • the ability of the agent to transfer the goodwill he has created with customers to another principal, meaning that the former principal will not benefit from it, and any hypothetical purchaser will be entering into a competitive market with no guarantee that customers will move with the agency business,

and discounting future earnings by:

• an appropriate rate of interest;
• any expenses or work incurred by the agent in earning his commission (in the case of an agent who has more than one agency, the costs must be fairly attributed to each),

assuming:

• the agency would have continued; and
• the agency is capable of assignment to the purchaser, although not necessarily that the agency contract was capable of further assignment.

A quick note on indemnities

As an interesting aside, the House of Lords felt that had Mr Lonsdale agreed in his agency contract to receive an indemnity on termination rather than compensation, he would have received nothing.

An indemnity will be paid "if and to the extent that -

1. he has brought the principal new customers or has significantly increased the volume of business with existing customers and the principal continues to derive substantial benefits from the business with such customers; and
2. the payment of this indemnity is equitable having regard to all the circumstances and, in particular, the commission lost by the commercial agent on the business transacted with such customers"

and is capped at one year's average annual remuneration. Mr Lonsdale's agency however was in a declining market, and Howard & Hallam therefore would not continue to derive benefit from it.

But do you have a commercial agency?

It is important always to consider whether your agency is indeed a commercial agency for the purposes of the Regulations.

In general use, the terms 'agency' and 'agent' have a number of different meanings. Legally however, an agency relationship means that one person has authority to create legal relations between the person instructing them (the principal) and third parties. But a "commercial agent" is a specific legislative construct, applying only to agents whose primary function is as a self-employed intermediary:

• having continuing authority to negotiate, or negotiate and conclude in the name of their principal, a sale or purchase; and
• deal in goods, not services, on behalf of another person (the "principal").

Much has been made of what constitutes authority to negotiate and when a "marketing agent" is a commercial agent. For more information on this point, please see our briefing note on PJ Pipe and Valve Co. Limited v Audco India Limited [2005] EWHC 1904(QB)(High Court).

However, an additional point to consider is whether the activities that an agent carries out are secondary, which would bring them outside of the scope of the Regulations.

The Regulations give us some indicative guidelines to describe when activities will be primary or secondary.

The commercial agency activities will likely be primary if:

• the goods concerned are such that transactions are normally individually negotiated and concluded on a commercial basis
• procuring a transaction on one occasion is likely to lead to further transactions in those goods with that customer or others on future occasions
• the agent devotes substantially the whole of his time to representative activities (whether for one principal or for a number of principals whose interests are not conflicting)
• the goods are not normally available in the market in question other than by means of the agent

They will be secondary if these factors are not present, or if:

• promotional material is supplied direct to potential customers
• persons are granted agencies without reference to existing agents in a particular area or in relation to a particular group
• customers normally select the goods for themselves and merely place their orders through the agent
• the agent competes with the principal.

So do not simply assume that because your agreement is called an agency agreement that it is necessarily a commercial agency (or indeed an agency at all within the meaning of the Regulations).

Hints & tips

If you are considering terminating an existing agency arrangement:

• Analyse the arrangement to see it falls within the definition of "commercial agency".
• Check whether the agency contract provided for an indemnity to be paid on termination.
• Consider why the agency is being terminated - is it for breach of the agent's obligations?
• Consider the true market valuation of the agency business when calculating compensation, bearing in mind the factors set out above