UK: an interesting case law on goodwill indemnity in agency contracts.

Edward MILLER | UK | 2014-02-18

Edward MILLER

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The European Directive 86/653 on the coordination of the laws of Member Sates relating to self-employed commercial agents was implemented in Great Britain by the Commercial Agents (Council Directive) Regulations 1993. Article 17(1) of the European Directive obliges Member states to ensure that agents will be entitled to a termination payment at the end of their contracts, the amount of which should be assessed either on the French inspired compensation model or the German inspired indemnity model. The essential difference between the two methods of calculation is that indemnity is backward looking and aims to give the agent a sum representing the increased goodwill he has earned for the principal by developing the principal’s sales, and compensation looks forward and is based on the loss suffered by the agent as a result of termination of the agency. The indemnity is capped at one year’s commission averaged over the last five years or fewer if the relationship has been shorter. Compensation is not subject to a cap.

In implementing the Directive, France and Ireland adopted the compensation model, and all other states have adopted the indemnity model. The UK decided to go its own way and adopted both models. Accordingly, Regulation 17(2) of the UK Regulations provides that ‘Except where the agency contract otherwise provides, the commercial agent shall be entitled to be compensated rather than indemnified’. Accordingly, in the UK, the commercial agent will be entitled to compensation unless his contract provides that the indemnity method applies. If no choice is made, the default option is compensation.

Given that it is invariably the principal who drafts the agency agreement, principals appointing UK agents were faced with the challenge of deciding which option they preferred. Most principals decided that they preferred the indemnity method because, unlike compensation, which is uncapped, the indemnity is capped at one year’s commission. It had been thought that the UK courts would follow French case law on compensation, where an award of two years’ commission is not uncommon. However, in the Lonsdale case (previously reported on by IDI) the English Supreme Court adopted a different calculation method for compensation, which in many cases will be less favourable to the agent. The court held in Lonsdale that the agent was entitled to the value of the agency as if the agency was being purchased by a third party buyer. The agent needed to obtain an expert valuation which would allow in particular for the deduction of a notional salary where the agency is, as in many cases, run by a sole trader who is also the owner of the agency business. This change led some principals to start to doubt whether it was necessarily in their best interest still to opt for the indemnity.

Some principals then hit upon the solution which was adopted by Hunter in its contract with Charles Shearman Agencies. This was to provide in the contract that the agent would be entitled to either compensation or indemnity, whichever method resulted in the lower amount being due to the agent. It appeared that Shearman might have been entitled to no more than £204,000 under the indemnity (due to the cap), and possibly around £1.5 million if compensation applied. Given the difference, proceedings ensued regarding the validity of the clause, and the case has just been decided by the English High Court.

The court held that the clause was not valid. It therefore did not constitute a provision in favour of the indemnity under Regulation 17(2) of the UK Regulations, and was of no effect. The agent was thus entitled to the default option of compensation. The Court felt that the clause did not afford the agent a sense of entitlement to compensation or indemnity (as provided in the heading of Regulation 17 – ‘Entitlement of commercial agent to indemnity or compensation on termination of agency contract’).

The reasoning of the Court on this finely balanced question is not always easy to follow. It appears the case may now have been settled. If correct, this will clearly preclude clarification of the situation on appeal, with the likely result that principals will cease using clauses of this type.

 

 

Edward Miller, Agency & distribution Country Expert for UK

 

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