Donald Cumming: Contracting with agents case for careful planning

A Brexit vote would have huge implications on vast swathes of laws affecting our business community. Picture: AFP/Getty Images

Later this week, we will know whether or not the UK will remain within the European Union. With so much of our current legal framework derived from EU legislation, a Brexit vote would have huge implications on vast swathes of laws affecting our business community. Among these are the existing laws governing the relations between commercial agents and their principals.

Many companies rely on the commercial agency structure to help drive business into new markets. By appointing a network of self-employed agents, an enterprise can bring products to new customers while saving on the costs of setting up its own presence in the market. However, terminating an agency can currently prove to be an expensive experience.

The EEC Directive on Commercial Agents provides protection to agents by giving them a right to payment on termination of the agency by the principal for any reason other than serious default by the agent.

This entitlement applies even where termination is permitted by the terms of the contract. It also applies at the expiry of fixed term contracts, on the death of an agent, or where the agent justifiably terminates on the basis of circumstances attributable to the principal or the agent’s age or infirmity.

It is payable in full even where the agent has replaced the reduction in earnings from loss of the agency.

Termination payments take the form of “compensation” or “indemnification”. The entitlement is to compensation unless the contract specifies entitlement to an indemnity instead.

Compensation focuses on an agent’s loss from being deprived of the benefit of their agency relationship. Following a decision of the House of Lords in 2007, English courts quantify this loss by looking at what a hypothetical willing buyer able to perform the contract would reasonably have paid, at the date of termination, for the rights the agent had been enjoying.

Scottish courts have adopted a more formulaic approach to determining a compensation figure, but the cases pre-date the House of Lords decision, and it’s not clear whether the courts would now follow the English approach and look at the open market value of the agency.

Indemnity payments focus on the goodwill the agent has built up in the principal’s business through their work, taking into account new customers generated and any increase to business with existing customers. The amount payable is capped at the average of the agent’s annual commission for the last five years.

In minimising a principal’s exposure to commercial agency pay-outs, it is often more advantageous to state in the contract that an indemnity payment (which is capped), rather than compensation, should apply on termination, especially in a more mature market where there’s less scope to bring in new customers or expand the business.

If there is an agreement for an indemnity pay-out, the principal should keep a careful note of the customers inherited by the agent at the start of the contract and those which the agent has brought in.

An agent’s entitlement to a payment on termination is rooted in a European tradition of identifying commercial agents as a down-trodden class who require a measure of legal protection from exploitation. This culture was not prevalent in the UK, and the right to receive a pay-out was a controversial issue when first introduced here in 1993.

In theory, a post-Brexit UK government could repeal the existing commercial agency regulations. It is likely that any replacement right under domestic Scots law would be the remit of the Scottish Parliament.

In the meantime, it’s important for companies to be aware of the existing obligations they assume when contracting with agents and ensure they are not overly exposed to excessive costs when the contract comes to an end.

• Donald Cumming is a partner at CMS