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Why should a commercial agent get goodwill compensation for business he has not generated?

Under the UK Commercial Agents Regulations, a producer who has used a commercial agent must pay him goodwill compensation on termination of the agency contract. This is in addition to any claims the agent may have for damages for breach of contract or commission. The entitlement will be to either an “indemnity” or “compensation” as defined in the Regulations. The agent will only be entitled to an indemnity where the agency contract says so. Otherwise, he will be entitled to compensation.

What’s the difference between indemnity and compensation?

Entitlement to an indemnity depends on the agent having brought the producer new customers, or significantly increased the volume of business with existing customers, from whom the producer will continue to derive substantial benefits after termination.  The amount of an indemnity:

  • must be equitable in all the circumstances; and
  • is capped at 1 years’ average annual remuneration (commission, usually) over the last 5 years, or the whole life of the agency if shorter.

Aside from not being capped as above, or having to be “equitable”, an award of compensation under the Regulations does not depend on the agent having brought the producer new customers, or having increased business with existing customers. The agent is entitled to the full value of the agency business upon termination – the amount a hypothetical purchaser would have paid him for the right to take over the agency and receive the income stream the agent would have had but for the termination. ((This was decided by the UK Supreme Court in Lonsdale v Howard & Hallam (2007).))  This means:

  • that an award of compensation can substantially exceed the amount of an indemnity. In a recent case, an indemnity would have been worth c £200,000 whereas compensation was put at £1,454,000 ((Shearman v Hunter Boot Limited (2014, High Court).));
  • that the agent will be entitled to be paid the full value of the agency business, assessed as above, irrespective of how long he has had the agency, and how successful (or not) he has been in attracting new business or increasing existing business.

Is this fair?

The latter aspect strikes many producers as unfair. Sometimes the producer and agent will start from zero sales in the UK. But often a producer with some existing business in the UK decides to switch to another agent whom he thinks can help him get to a higher level. The new agent may or may not succeed. But even if he generates no new business whatsoever, the legal position is that on acquiring the agency he immediately becomes entitled to full compensation based on the whole of its value should the producer decide to terminate.

What is the rationale?

The concept of compensating an agent in this way is derived from the French legal system. In France, however, principals customarily require agents to pay a premium on granting an agency, particularly where there is already an established business. On termination the agent is entitled to compensation, the starting point for which in France is two years’ gross commission. If the agent paid a premium based on its value when he took the agency on, there is nothing unfair about compensating him for its full value when he exits, rather than just for the value he has added. And if the principal is switching to a new agent, the premium paid by the latter will help off-set the compensation payable to the outgoing agent.

In the UK wine trade, however, it has not been customary for a producer to require payment of a premium when granting an agency. The idea of having to compensate agents on termination in this way was completely alien to our legal system until the Regulations were introduced in 1993. And as already noted, it was only in 2007 that authoritative guidance was given on how awards of compensation should be assessed by our courts.

What can a producer do to minimise his liability?

  1. Insist on wording in the agency contract providing that the agent will get an indemnity rather than compensation. It is essential to get the wording right. ((In the Shearman case, the contract provided that the agent would be entitled to either an indemnity or compensation, whichever was the lesser in amount.  The court held that this was invalid.  The agent’s default entitlement to compensation therefore prevailed.  Potential cost to the producer of getting this wrong – £1.254m.)) Where the new agent is taking over an established agency, it is advisable to incorporate an agreed summary of that business within the contract.
  2. If an indemnity cannot be agreed, there are two other ways of making sure that any compensation payable is based only on value added. Both require very careful consideration and drafting.

Whichever option you go for, the necessary contract documentation must be put in place before the new agency commences. If your attitude is: “we’ll sort that out later, the priority is to get the new agency rolling”, you run the risk of it never being sorted out, and of ending up paying out substantially more on termination than you would otherwise have had to.

Please get in touch if you are interested in keeping your, or your client’s, liability for compensation to a minimum.

What if a producer has already transferred a valuable agency without doing any of the above?

Get in touch without delay!  We can advise on how to get the agent to come to a reasonable agreement, albeit belatedly.

Except where otherwise stated, all information given and any legal opinions expressed on this website assume that English law applies.  See Conditions of use.