Commercial Agents Regulations - A Recent House of Lords Decision on Compensatory Awards

The Commercial Agents (Council) Regulations 1993 (the "Regulations"), which came into force on 1 January 2004, introduced increased protection for commercial agents which included, amongst other things, the right for an agent to be entitled to compensation or an indemnity from the principal on termination of the agency relationship in many situations. Therefore, if the Regulations say that compensation or an indemnity is payable, then it can be payable, even in circumstances where the agent has no right to damages at common law in respect of the termination.

Since the introduction of the Regulations there has been significant doubt as to precisely how much a principal may be liable to pay an agent by way of compensation and how best to minimise such liability. The recent House of Lords decision of Lonsdale v Hallam finally offers some clarification on this issue.

Background
It may be helpful to set out in brief the difference between the compensatory payment and indemnity payment regimes.

The agent and principal are able to specify whether an indemnity or compensation will be paid to the agent upon termination and, in the absence of agreement, the agent will be entitled to be compensated rather than indemnified.

Therefore, the indemnity will only apply if the parties expressly provide for the indemnity method when entering into the agreement and will be payable where the agent has (a) brought new customers or increased the volume of business with existing customers and the principal continues to derive substantial benefits from the business with such customers; and (b) the payment is equitable having regard to all the circumstances including the commission lost by the agent on the business transacted with such customers.

Compensation applies where the agreement is silent or does not provide for the indemnity to apply and is payable to compensate the agent for the damage he suffers as a result of the termination of business relations with principal.

One main difference between the two regimes is that an indemnity payment is capped at an indemnity equivalent to one year's commission based on average annual commission over the preceding 5 years (or the life of the contract, if less), whereas there is no cap on the payment due under the compensatory regime. The Regulations are silent as to how indemnity and compensation should be calculated and the lack of guidance and indicators in this respect have made it difficult to assess the potential value of such payments, particularly under the compensatory regime. Consequently, it has been left for the courts to define the principles as to the basis of assessment of such payments.

Lonsdale v Hallam
Until recently, there has been no definitive rule as to how much compensation an agent will be entitled to if an agent makes a claim under the Regulations. However, the House of Lords judgment in Lonsdale v Hallam in the Summer of 2007 has clarified the position somewhat by ruling that the compensation to which an agent is entitled under the Regulations must be based on the value of the agency at the time of termination. The House of Lords judgment provided further guidance by establishing the following principles on which such value should be assessed:

In order to calculate the value that could reasonably have been obtained at the date of termination for the rights which the agent had been enjoying there must be the assumption that the agency would have continued and that a hypothetical purchaser would have been able to perform the agency properly (even if contractually the agency is non-assignable and/or there is no market for such agency).
Consideration must also be had as to how the price that a hypothetical purchaser is willing to pay for the agency is affected by the prevailing circumstances in the real world at the date of termination. For example, if the market for the products which are subject to the agency is in decline or on the rise this would affect the price that a hypothetical purchaser would be willing to pay.
It should be assumed that if the agent would have incurred expense or have been required to do work in earning his commission, the value should be assessed by reference to net anticipated earnings as opposed to assuming that the hypothetical purchaser had earned it gross and without having to do anything.
Given that a present value is being placed upon future income, future earnings must be discounted by an appropriate rate of interest.

Valuation of an agency business
Since the Lonsdale v Hallam judgment, valuers are now likely to take into account a number of issues when valuing an agency business, namely:

Precedents in valuations of agency businesses – i.e. the principles laid out in Lonsdale v Hallam above. Some business valuers have taken these principles to mean the open market value of the agency business, that is the best price reasonably obtainable in an arm's length transaction in the open market between a willing knowledgeable purchaser and seller.
The single-customer nature of an agency business - For example, in the case of a typical purchaser of an agency business with a single customer the risk of the agency contract being terminated would need to be considered. Such risk would vary depending, inter alia, on the period for which the agency had been in place, the relationship between the principal and the agent, and the status of the business of the principal and of the agent (i.e. would the principal be able to take over the activities of the agent).
The relevance of the notice period of the agency agreement (and that of the Regulations) – Hypothetical future events, in particular the possibility of further future termination and/or future compensatory entitlements should not be taken into account when valuing the business in accordance with the principles of Lonsdale v Hallam.
The relevance of the contribution of the agency business to the success of the principal business - Despite the Court of Appeal's interpretation in Lonsdale v Hallam that compensation to the agent should not depend on the contribution made in the past by the agent and principal to the success of the agency business, it may be possible to argue that expected future contributions by the parties should affect the value of the agency business and consequently the compensation to the agent. The rationale for this is that the higher the contribution made by the principal, the lower the need that the principal may have for an agent, resulting in the increased risk to a potential purchaser that the current level of earning potential may not continue indefinitely.

Practical advice
With all this in mind, careful consideration needs to be given by both the principal and agent when drafting and negotiating the agency agreement. It is generally considered that there is significant benefit to be had for a principal in providing for the indemnity principle to apply, as it is capped in value and the agent has to show he has increased business. The inclusion of indemnity provisions by the principal in the agreement therefore helps avoid the uncertainty of unlimited claims. However, when deciding whether to adopt the indemnity route the principal needs to assess whether they wish to flag the potential entitlement by dealing with it expressly in the agreement or hope that the agent is unaware of its entitlement and leave the agreement silent. Principals might also wish to follow in the steps of some of their continental counterparts by charging their agents a premium upon entering into the agency agreement so as to off-set their exposure to potential liability upon termination.

From the agent's perspective, as indicated by Lonsdale v Hallam, the compensation route would currently appear to give rise to potentially higher claims therefore compensation should be specifically allowed for in the agreement or the agreement should remain silent with reliance on the default position set out in the Regulations. In any event, agents need to be aware of their rights under the Regulations and exercise them within the relevant timeframes. It is worth remembering that under both regimes, the agent loses the right to the payment if he does not notify the principal that he intends to pursue his entitlement within 1 year following termination of the agency contract, although such notification need not be in writing nor does the agent have to bring the claim within the year.