You're worth it! Calculating compensation under the Commercial Agents Regulations 1993
The Commercial Agents Regulations 1993 (as amended) govern the relationship between commercial agents and their principals. A commercial agency will arise where one party gives authority for a self-employed intermediary to negotiate the sale or purchase of goods on its behalf.
When a commercial agency ends, the agent is treated as having suffered a ‘loss’ because the agent has a share in the goodwill of the principal’s business that the agent has helped to create. Therefore, the notion is that the agent should be compensated for the loss of the goodwill that the principal retains.
The often thorny questions however are whether the agent is entitled to receive ‘compensation’ or an ‘indemnity’ upon termination of that commercial agency and what either is worth.
Unless the agency agreement provides for it, the Regulations state that the agent is entitled to compensation. If there is an indemnity, it is capped at the value of one year’s commission, and only payable in any event it can be shown that the principal will continue to derive ‘substantial benefit’ from business introduced by the agent.
A common consequential issue is therefore calculating the value of the compensation. In this respect, the key cases are Lonsdale v Howard & Hallam Ltd (2007) (“Lonsdale”) and more recently, Green Deal Marketing Southern Limited (“GDM”) v Economy Energy Trading Limited (2019) (“Green Deal”)
In Lonsdale, the Court said there were a number of assumptions to be made when carrying out a valuation, such as whether the market in which the agent was carrying out its business was improving or declining when the agency was terminated, and whether the agent was likely to solicit customers away from the terminating principal to a competing principal, but in essence, under the Regulations,
- The damage suffered by an agent upon termination is the loss of the value of the agency relationship;
- The value is the future income the agency would have generated for the agent were it not for the event of termination; and
- The agency should be valued on a net basis.
Additionally, compensation payable should be based on the commission which the agent would have earned if the contract had continued to be performed in the normal manner in which the parties had intended, and not by reference to the commission which the agent could have earned if the principal had carried out its contractual obligations with a view to minimising its liability to the agent.
In Green Deal, the court shed further light on how compensation should be calculated.
- Calculation of the value of an agency should be based on a hypothetical situation that the agency would continue, but not forever, and be valued as if it were to be purchased on the date that the agency would have come to an end.
- Compensation can be reduced for a number of reasons; however, the risk of an exclusive agency agreement can cause the value of the company to be reduced up to 50%.
- The value of the agency can also be reduced if there have been repeated breaches of the contract that would have allowed the principal to terminate the contract without becoming liable for compensation.
Naturally, the exiting agent will wish to enhance the value of the agency. The terminating principal will of course seek to devalue it by for example, arguing that the agency was not exclusive (i.e. the principal is free to transact with other agents or sell products on its own behalf within the territory).
When dealing with a terminating principal acting as it should under the Regulations, in good faith, smaller claims will not usually require expert evidence because a sensible negotiation often quickly arrives at a figure without acrimony. Indeed, terminating principals will have often calculated the compensation payable before terminating because knowing what compensation will be payable to an exiting agent is invariably one of the commercial drivers behind the very decision to terminate the agency relationship rather than continue performing the contract.
However, where there is an entrenched dispute, it often difficult to break the deadlock in letters back and forth between lawyers without an independent valuation. Indeed, it is difficult to see how a judge can decide a case, if it is litigated, without independent valuations, usually from both sides. Where the value of the lost agency is high, the more obvious the need for independent expert help.
In Green Deal, GD’s valuer adopted a Price/Earnings ratio method, which is most commonly used for making valuations especially of smaller private companies. This method creates a price for the asset by comparing the asset to a range of benchmark companies and adjusting the price in accordance to a range of factors including the risks and prospects of the asset. In comparison, EE’s valuer adopted the EV/EBITDA method (similar to the cash flow method) which values an asset independently of the capital structure of the companies under consideration. It had the advantage of comparing companies with different debt to equity ratios from the asset and which had different tax rates to the asset. EE’s valuer then discounted the amount in relation to three elements:
- an amount for the risk associated with operating under an exclusive agreement for a single customer;
- an amount to reflect the regulatory pressures and scrutiny affecting the market; and
- an amount to reflect the assumption that the agency could not be assigned once sold to a hypothetical purchaser.
The Judge preferred EE’s valuer, stating that the value of the income stream at the date of termination of the agreement depended on the risks facing GD’s income stream at that time, the main risks being,
- the state of the doorstep market for sales – was it declining or improving?
- the relationship between Ofgem and EE – there was no communication between EE and the regulator Ofgem that the cessation of doorstep selling was required. This would have reduced the value of the agency.
- GD’s repeated breaches of its contract with EE. If the principal would have had the right to terminate the contract, the longevity of the agency would have been at risk and termination would not have led to an entitlement to compensation.
In our experience, it is a false economy to try and rely on the power of persuasion or fancy spreadsheets and statistics compiled by the respective parties’ own accountancy advisors and that parties often find that their initial reluctance to incur the relatively small expense of an independent report dissipates when it very often unlocks a settlement this way or thought at a cost fractional of the sums in dispute when weighed against the potential returns.