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Rights of a commercial agent on termination of his agency under English law

Rights of a commercial agent on termination of his agency under English law

The purpose of this article is to set out the various claims a commercial agent can make on the termination of his agency agreement under English law.

The position is governed by the Commercial Agents (Council Directive) Regulations 1993 (as amended) (Regulations). The Regulations came into force on 1 January 1994 and apply to all agreements between commercial agents and their principals, even those entered into before 1994.

The Regulations are based on a European Union (EU) Directive whose aim is to protect commercial agents throughout the EU.

Before considering the claims a commercial agent can make on termination, it is necessary to understand who is a commercial agent for the purposes of the Regulations.

A commercial agent is defined under Regulation 2(1) as “a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of another person (the ‘principal’), or to negotiate and conclude the sale or purchase of goods on behalf of and in the name of that principal”. The important issues in relation to this definition are as follows:

  • Although the phrase “a self-employed intermediary” is used, this includes a limited company and indeed any other form of legal person.
  • In interpreting who is and who is not a commercial agent, the English courts have taken a very broad view of the Regulations, adopting a purposive approach to the interpretation of the Regulations; in other words, following the aims of the EU Directive by trying to protect the commercial agent so that as many agents as possible come within the ambit of the Regulations.
  • By way of example, even though the Regulations require a degree of “negotiation”, the courts have decided in many cases that the amount of negotiation necessary to fall within the definition is very small indeed and, in effect, if the input of the agent is simply to procure business for his principal, this will normally be sufficient to be classed as “commercial agent”. The only case thus far where an agent was deemed not to come within the Regulations was a garage selling petrol where it was impossible to conclude that the agent was in any way at all negotiating the sale of the petrol.
  • Under English law, the definition of “commercial agent” is limited to the sale or purchase of goods and does not include services, unlike the position in most of the continental European countries. There have been a number of cases where an agent has been negotiating the sale of computer software and, unless this includes the sale of computer hardware as well as software, such an agent will not fall within the Regulations.

When deciding whether or not the agent has the protection given to him under the Regulations, it is necessary to consider Regulation 1(2) which states: “These Regulations govern the relations between commercial agents and their principals and, subject to paragraph (3), apply in relation to the activities of commercial agents in Great Britain”.

Paragraph 3 extends the ambit of the Regulations to the rest of the EU and also to the three non-EU countries in the European Economic Area (EEA), namely, Iceland, Liechtenstein and Norway.

Accordingly, if you are engaging a commercial agent outside the EU and outside the three other non-EU countries in the EEA under a contract subject to English law and the agent carries out no activities within the EU and the EEA, then the agent would not fall within the Regulations. Thus, for example, if you engage a Swiss agent for the territory of Switzerland under English law, the Regulations would not apply to the contract.

If you are engaging an agent where the activities are partly carried out in Great Britain and partly outside Great Britain and the rest of the EU/EEA, then it would be appropriate to enter into two separate agreements.

Once you have established that the agreement is subject to the Regulations, what are the agent’s rights once the agreement is terminated?

Essentially, the agent has four separate rights:

  • Firstly he is entitled to any outstanding unpaid commission or other payment due under his contract. This would apply whether the agent is in fact protected by the Regulations or not as this is a normal contractual right.
  • Secondly there is a minimum notice period under Regulation 15. The minimum notice periods are:
  • one month during the first year of the contract;
  • two months during the second year; and
  • three months during the third year and subsequent years.

Unless otherwise agreed, the end of the notice period must coincide with the end of a calendar month.

  • Thirdly, the agent is entitled to what is known as “pipeline commission” under Regulation 8. In other words, if the agent can show in relation to a transaction concluded after termination that that transaction was mainly attributable to his efforts during the agency contract and if the transaction was entered into within a reasonable period after termination, then he will be entitled to contractual commission.
  • It is, however, possible to exclude this entitlement to pipeline commission in the contract.
  • There have been several cases regarding what is understood to be “a reasonable period after termination”. The standard period is normally three months, but this has been extended to as long as 21 months where complex projects are being negotiated which can take a long time to come to fruition, and the purpose of this Regulation 8 is to ensure, as far as possible, that the agent is protected by receiving at least some remuneration to reward him for his efforts.
  • The final and by far the most important right of the agent is that he has an entitlement to receive what is termed either an indemnity or compensation on termination under Regulation 17 and, unlike the pipeline commission under Regulation 8, this entitlement to indemnity or compensation cannot be excluded in the agency contract.

This final entitlement is a totally new entitlement under English law and is very often the major issue to be determined on termination. The purpose of the remainder of this article is to explain how this entitlement works in practice.

Firstly the indemnity or compensation (as the case may be) is payable in the event of termination of the agency contract for any reason except in the following circumstances:

  • under Regulation 18(a) where the principal has terminated the agency contract because of default attributable to the agent which would justify immediate termination of the agency contract; or
  • under Regulation 18(b) where the agent has himself terminated the agency contract unless such termination is justified (i) by circumstances attributable to the principal or (ii) on grounds of the age, infirmity or illness of the agent in consequence of which he cannot reasonably be required to continue his activities.

Accordingly even where the agent terminates the contract because he is too ill to continue or has reached retirement age, then indemnity or compensation will still be payable, even where the agent (being a natural person rather than a limited company) dies in which event his estate will inherit the agent’s claim.

In order to understand the two different concepts of indemnity and compensation, it is necessary to explain the background to the negotiations of the EU Directive.

The EU Directive was a compromise between the negotiating positions taken by Germany and France, the two major countries which had already provided legal protection for commercial agents for many years. Germany used the indemnity system under which agents received as a maximum the average annual gross commission over the period of five years prior to termination of the contract (or if shorter, the average for the contractual period), whereas in France the agents received compensation based on a payment of two years’ gross commissions, representing either the last two years of the contract or the average over the three years prior to termination multiplied by two.

By way of compromise, the EU Directive allowed member states to implement the Directive by adopting either the German indemnity system or the French compensation system. Other than France, most of the EU countries adopted the German indemnity system but the UK decided to give principals and agents a choice of either system.

Accordingly, under English law, the parties can agree to apply the German indemnity system but if such an agreement is not included in the agency agreement, then by default compensation will automatically apply.

We will now examine these two different systems in order to explain how each of them operates.

The indemnity system is set out in Regulations 17(3) and (4).

  • In order for an agent to be entitled to an indemnity, he must be able to show under Regulation 17(3) that “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 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”.
  • Under Regulation 17(4) “the amount of the indemnity shall not exceed a figure equivalent to an indemnity for one year calculated from the agent’s average annual remuneration over the preceding five years and if the contract goes back less than five years the indemnity shall be calculated on the average for the period in question”.

Although superficially, for the agent, it is attractive to be able to receive an indemnity on termination, the amount normally paid is likely to be fairly limited. Under German law, the calculation of the indemnity (known as an Ausgleichsanspruch in Germany) is extremely complicated and often results in relatively low awards with, in any event, a cap of one year’s gross commission.

The difficulty for English lawyers is that there has only been one reported decision on the calculation of an indemnity in Moore v Piretta [1999] 1 All ER 174 which was a decision by a High Court judge who decided to look to German law for help in ascertaining how the Regulations should be interpreted, but unfortunately he seems completely to have misapplied German law in making the relevant calculation, despite having had assistance from German legal expert evidence. This case was 14 years ago and we have still not had any further decisions on how the indemnity should properly be calculated under English law or whether or not in future decisions the English courts will again seek to follow the calculation methods adopted by German jurisprudence or alternatively build up their own English system which, as you will see below, has taken place with the alternative system of compensation.

One reason perhaps why there has only been one reported decision on indemnity is that it is still relatively unusual, as the adoption of the indemnity alternative requires prior agreement in the agency contract; this appears to be rarely the case and accordingly it is far more common that the compensation system applies. The basis of compensation is set out in Regulations 17(6) and (7).

Regulation 17(6) states that “the commercial agent shall be entitled to compensation for the damage he suffers as a result of the termination of his relations with his principal” and Regulation 17(7) continues by stating “such damage shall be deemed to occur particularly when the termination takes place in either or both of the following circumstances, namely circumstances which:

  • deprive the commercial agent of the commission which proper performance of the agency contract would have procured for him whilst providing his principal with substantial benefits linked to the activities of the commercial agent; or
  • have not enabled the commercial agent to amortise the costs and expenses that he had incurred in the performance of the agency contract on the advice of his principal”.

It is clear from the above that there are major differences between the two systems.

  • Firstly there is no cap i.e. no limit to the amount of compensation that the courts can award to an agent, which is a major disadvantage to principals.
  • Secondly the award of compensation is not specifically linked to the agent bringing in new customers or significantly increasing the volume of business.
  • Thirdly there is no requirement that the principal continues to derive substantial benefits from the business with such customers.
  • Finally there is no requirement that the payment of compensation is equitable.

As far as the agent is concerned, he would do better to ensure that the agency agreement is silent on the issue of which system should apply so that he receives compensation rather than indemnity, and this is a very common situation in practice.

Initially, the English courts did not fully understand how to approach the question of calculating the amount of compensation. The Regulations are drafted without too many specifics and as there was only one European country which awarded agents compensation on termination, the English courts naturally turned to France for guidance. In the first cases decided by them, the English courts took advantage of the French experience and agents more or less automatically received two years’ gross commission by way of compensation. This automatic adoption of the French system gradually started to change after about 10 years from the introduction of the Regulations and the English courts slowly started attempting to introduce new English principles to the method of calculating compensation.

However all previous case law was consigned to history as a result of the now leading case of Lonsdale v Howard & Hallam Limited [2007] UKHL 32 in 2007, the first ever decision made on commercial agency law by the then House of Lords.

Graham Lonsdale had been an agent for Howard & Hallam, a shoe manufacturer, for 13 years until the agency was terminated due to the closure of the shoe making business. It had been in decline as had Lonsdale’s commission income which fell year by year. For example, in 1997-98, Lonsdale earned gross commissions of almost £17,000, but five years later this had fallen to £9,621. As a result in 2003, Howard & Hallam ceased trading, the goodwill of the business was sold to a competitor and the agency relationship with Mr Lonsdale was terminated. Howard & Hallam offered £7,500 by way of compensation, but Mr Lonsdale claimed a sum of approximately £26,000 based on the French system of compensation, equivalent to two years’ gross commission. The law lords decided, based on the wording of Regulation 17(6), that the damage suffered by Mr Lonsdale was the loss of the agency business, including whatever goodwill attached to it, and so the compensation to which he was entitled should reflect the value of the agency business going forward. The court recognised that Howard & Hallam’s shoe making business was in serious decline and Mr Lonsdale’s income was, as a result, modest and falling at the date of termination. Consequently the court considered it unrealistic that a buyer would have paid as much as two years’ gross commission for Lonsdale’s agency business as at the termination date and instead he was awarded compensation of £5,000 as being a reasonable figure that he could have expected to receive for the agency. If the German indemnity system had been agreed in the agency contract, it is likely that Mr Lonsdale would have received nothing since he would not have been able to show that his principal continued to derive substantial benefits from the business with his customers, or indeed that the payment of the indemnity was equitable having regard to all the circumstances. However these conditions are not contained in Regulation 17(6) in relation to compensation.

Since the Lonsdale decision, the principles laid down in the case have been followed and amplified in subsequent decisions which have helped in formulating the method by which compensation is to be calculated.

This method is similar to the way in which businesses are valued and the following principles have been established.

  • Firstly one calculates the gross income of the agency business which is normally straightforward by calculating the gross annual commissions paid, probably taking the average income over the last three years (although whether three years is the appropriate period will depend on the circumstances of each case).
  • Then one deducts from this income the actual costs of running the agency business. This can become quite complex where one agent is running a multiple agency business, which is very common. Another area of difficulty is that the overhead expenses need to include a reasonable salary paid to a salesman.
  • Once the expenses have been calculated, one arrives at the net annual profit of the agency business.
  • The next step is to assess how many years’ net profit a hypothetical purchaser would pay to purchase the agency business; the current case law appears to be applying an average of 4.5 years. It goes without saying that the appropriate number of years to be assessed does depend on all the circumstances of the particular case and English law in this area is fast developing.

To give an example, if an average income over the last three years is £150,000, and average costs are £50,000, so that the average net annual profit is £100,000, one could anticipate compensation of around £450,000 being awarded.

  • Normally an expert accountant is appointed by each party and efforts are made prior to trial for the two experts to seek to reach an agreed report.

A final observation is that the agent must notify the principal (normally in writing) that he wishes to seek either indemnity or compensation within one year after termination of the agency agreement (Regulation 17(9)).

An agent’s rights on termination of the commercial agency agreement are extensive and complex and potentially very expensive for a principal. The principal, however, can potentially improve his position substantially if he takes legal advice before entering into the agency agreement and, in most circumstances, chooses the indemnity option since he can then at least limit his exposure.

Andrew Kaufman
Fladgate LLP