Compensation claims & smaller value agencies

For a high-earning agency, a compensation claim on termination can be substantial. For a smaller agency, the picture is harder: the way the law values these claims can leave little to recover, and the cost of fighting for it can outweigh the claim itself.

The articles below work through this in sequence: first how smaller-value claims are valued and why they often disappoint, then whether it is worth taking one to court, and finally the argument that the law here is due a challenge. Each is reproduced in full and attributed to its author.

Compensation claims & smaller value agencies

Part one: how smaller-value claims are valued, and why the notional salary deduction makes a fair recovery hard.

In the Lonsdale case in 2007 the House of Lords set out the principles to be followed when valuing a compensation claim under Regulation 17 of the Commercial Agents (Council Directive) Regulations 1993. Since then, the Courts have dealt with a number of cases where the value of a compensation claim has been a key factor.

One of the key conclusions of the House of Lords in Lonsdale was that the compensation payable to the commercial agent should be the notional price a hypothetical purchaser would be willing to pay for the agency, as at the date of termination of the agency.

While the methods for calculating compensation can vary depending on the circumstances of the specific agency, it seems to be generally accepted that the value of a compensation claim should be calculated in the following way:

1. Identify the net annual earnings (i.e. annual revenue minus annual costs) likely to be made under the agency in the future if it had continued instead of being terminated;
2. Apply an appropriate multiplier to that net annual earnings figure to give the figure that a hypothetical purchaser would be willing to pay for the agency to secure that income stream.

Where an agency generates high levels of income and costs, calculating the value of the compensation claim can be a significant task which requires the expert input of a specialist forensic accountant. Many of the cases since Lonsdale record disputes between the experts acting for each party about what future revenue might be (because sales and therefore commission can fluctuate from year to year) or how costs should be apportioned where the agent acted for a number of different principals and it was not possible to separate costs by principal.

Calculating revenue

When calculating the future revenue of an agency, many experts will look at the revenue actually earned by the agency in the period before termination of the agency contract as a guide or a starting point. The period of time considered by the expert will vary depending on how well or badly the agency performed before termination. For example, where an agency had revenue which fluctuated up and down over a number of years but generally resulted in a fairly steady income stream, an expert is likely to take an average of the annual revenue earned over a period of 3 or 5 years. In contrast, where an agency saw a continuous drop in revenue in the period leading up to termination, the expert may decide that only the revenue earned in the 12 month period immediately prior to termination is relevant.

The key here is that the actual revenue earned by the agent is used by the expert to project what the future revenue from the agency might have been.

Calculating costs

The costs incurred by an agent often include some or all of the following:

1. Motor, travel, accommodation and subsistence costs (i.e. the costs of the agent getting out and about to visit their customers);
2. Fixed costs and overheads (e.g. cost of premises, telephone, internet, electricity, insurance, computer expenses etc); and
3. Where appropriate, the wage costs of staff employed by the agent who worked on the agency for the principal.

Notional salary / labour cost

In many of the high value compensation claims the calculation of net annual earnings contains a third element, which is the notional cost of employing or engaging an equivalent replacement for the agent or agents. This could involve the cost of employing a Sales Director or Managing Director for a company or the cost of engaging a replacement sales agent to carry out the role of the agent. Those costs can vary quite significantly from case to case depending on the size, structure and role of the agent and it is not really surprising that no single methodology has emerged from the cases for calculating this notional salary or labour cost.

The multiplier

The net annual earnings figure is important because it is the base figure to which the multiplier is applied, which then results in the value of the compensation claim. Identifying the correct value for the multiplier can be a difficult and complex task and is often a point of dispute between experts. In the economic climate over the last few years, the currently applicable range of multipliers seems to be between 0 and 4 (with 4 being applicable for the best performing agencies).

The compensation calculation in smaller value agencies

The steps outlined above would seem to apply to all compensation claims under Regulation 17, irrespective of the value of the agency. In my experience, this makes it more difficult for agents with a smaller value agency (by which I mean £25,000 or less revenue a year) to recover what they would consider to be a fair sum by way of compensation. The main reason for this is the impact of the notional salary / labour cost of a replacement for the agent. In calculating the value of the compensation claim, it is assumed that the hypothetical purchaser will either engage a suitable replacement for the agent or a sum is attributed to the labour cost of the purchaser carrying out the role of the agent themselves.

I have discussed this with a number of agents who consider this approach to be illogical, it is not how they operate in practice so why should this form part of the calculation? The net income earned by the agent is their revenue minus their costs, isn’t that the true value of the agency? I have a great deal of sympathy for this view but the position from the cases seems to be that the notional salary / labour cost calculation is part of the compensation calculation, even in these lower value claims.

The reason for the difficulty is how the cost of the agent’s replacement is calculated. There is no accepted methodology for this calculation from the cases, particularly when dealing with a smaller value agency performed by a single agent as an individual. There are a number of different approaches that can be used, from identifying salaries of employees performing a similar role to the agent in the geographical area (if that is possible), to using the Annual Survey of Hours and Earnings to identify similar roles to the agent and apply the average salary for those roles across the UK as a whole or a particular region. These approaches are far from ideal because there are a number of variables between different agencies and there isn’t really a “one size fits all” methodology that can be used. Some of the obvious variables are:

1. The number of hours worked each week by the agent. These calculations are often based on a full time role (ie 37 hours per week) but, when apportioned across all of their agencies, the time spent by an agent for a particular principal could be significantly less than this.
2. The level of technical knowledge required by the agent can vary quite considerably depending on the products that they are selling. An agent selling greeting cards or clothing items would not be expected to have as much technical knowledge of their products as an agent selling bespoke concrete bunkers for sewage systems or high end technology products.
3. The extent of the agent’s role in the sales process. Some agents have authority to enter into sales contracts on behalf of their principals, while others simply pass on orders and the principal decides whether or not to accept them. Some agents have significant discretion as to prices and discounts that can be offered to customers while others are limited to list prices unless the principal specifically agrees a discount.

The uncertainty arising from the above means it can be difficult for agents and principals to reach agreement on an acceptable figure for the notional salary or labour cost. While the principal will want to keep the value of the compensation claim as low as possible, the agent will want to ensure that an additional lump sum is not deducted from their actual net earnings. If those issues cannot be resolved amicably then if the agent wishes to pursue the claim they have to go through the Court process. That can be expensive and the costs of pursuing a smaller value compensation claim can quite easily equal or exceed the value of the compensation claim, particularly if experts are unable to agree the compensation figure. In these situations, the losing party (and sometimes the winning party) are faced with significant costs liability and it is simply not cost effective to run these claims to trial. That is a situation that no agent or principal wants to face.

Kevin Manship, Legal Director
Blake Morgan Solicitors LLP, One Central Square, Cardiff, CF10 1FS
Email: kevin.manship@blakemorgan.co.uk
Direct Tel: 029 2068 6126
www.blakemorgan.co.uk

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Is it worth taking smaller value sales agent compensation claims to Court?

Part two: given those valuation difficulties, whether it is actually worth taking a small claim to court, and the costs risks on each side.

In the April 2020 edition of the AgentBase magazine I explained how compensation claims are valued under Regulation 17 and discussed some of the issues this can cause where the sales agency has an annual revenue of £25,000 or less.

The first step in calculating the value of the compensation claim is to determine the net annual earnings that the sales agency would have generated in the future if it had continued instead of being terminated. This exercise is usually carried out by an expert forensic accountant. Within that exercise, the deduction of a notional salary / the labour cost of a replacement for the sales agent can have a significant impact. There are several different ways to assess that cost, which can increase the uncertainty as to whether the deduction will be quite small or whether it could be quite large and reduce the value of the compensation claim significantly (potentially even to 0). The latter is often the view taken by principals, which leaves the sales agent with a difficult decision to make, to either pursue their claim through the Court process or to drop the claim.

Litigation is a risky process and there is no guarantee that the sales agent will win their case or that the expert will give a favourable valuation of the compensation claim. This is a problem because litigation involving compensation claims is also likely to be quite expensive, even where the value of the compensation claim is relatively low. It would still be necessary to disclose key documents, produce witness statements and obtain expert evidence from a forensic accountant.

If the parties are unable to agree a settlement of the compensation claim, the costs incurred by each party to get the claim to trial and get a judgment could quite easily equal or exceed the value of the compensation claim. The risks around costs apply to both the commercial sales agent and the principal. Unless the claim is allocated to the small claims track (see below), in the usual course of events the losing party at trial would have to pay the winning party’s legal costs in addition to their own. If the freelance agent loses, they would have to bear two sets of legal costs, their own and the principal’s. For the principal, the situation would be worse because they would have to pay the value of the compensation claim as well as bearing two sets of legal costs. The stakes are therefore very high for both parties.

The position is slightly different if the Court allocates the claim to what is called the small claims track (this happens where the value of the claim is £10,000 or less and the issues in the case are not particularly complex). The usual position on the small claims track is that the costs of the winning party are limited to any Court fees or expert fees paid by that party, plus a small amount of fixed costs attributable to starting the Court process if the Claimant agent is successful. The Court has discretion to make a different order on costs if it considers that one of the parties has behaved unreasonably during the course of the proceedings, but this is quite rare.

While the costs position on the small claims track reduces the overall costs exposure of both the sales agent and the principal it also means that, whatever the outcome of the case, both parties are going to have to incur legal costs which they cannot recover from the other party. This should push the parties to consider, at an early stage, whether a settlement of the compensation claim could be reached and if both parties act sensibly this is often what happens.

However, emotions sometimes run high and the positions of the parties become entrenched. In those situations, the losing party can be liable for hefty sums compared to the settlement they could have reached at an early stage. By way of example, I have previously dealt with a claim where the principal lost at trial and was faced with a total liability for compensation and legal costs of almost £30,000, for a claim that was found to be worth around £11,000 at trial and which my client had offered to settle several months earlier for £7,000! A painful lesson for the principal in that case.

My advice to both principal and sales agent in dealing with low value compensation claims would be to explore whether a settlement can be reached before Court proceedings are started. If the parties have wildly different views on the value of the compensation claim, it might be worth them jointly instructing a forensic accountant at that early stage to provide an informal view on the value of the compensation claim. This could save them both a great deal of time, cost and stress because, ultimately, if it can be avoided, neither party should want a smaller value compensation claim to go to Court.

Kevin Manship, Partner
Fletcher Day, 110 Cannon Street, London, EC4N 6EU
Email: kevin@fletcherday.co.uk
Direct Tel: 029 2130 3485

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Challenging the Small Agency Injustice

Part three, and a dissenting view: the argument that denying compensation to a low but steady earner is unjust, and that the case relied on for it is ripe for challenge. Written in 2018.

The law regarding the assessment of an agent’s entitlement to compensation has been long settled following the case of Londsdale v Howard & Hallam [2007] 1 WLR 2055. Agents and principals are now familiar with the concept that compensation falls to be calculated by reference to the price which a hypothetical purchaser would have been willing to pay for the agency business at the date of its termination. This is intended to compensate the agent for the loss of value of the agency business, including goodwill.

Whilst agents and principals alike have welcomed this clear guidance, there remains scope for clarification of the law in this area in the instance of an agent with a single, low earning agency.

There are many different methods of valuing a business, and there remains scope for arguing what methodology should be used.

It is common in our experience for accountancy experts to value commercial agency businesses using the capitalised earnings method. However, in the case of a low earning agency this method may produce what appears to be an absurd outcome.

In the case of Nigel Fryer Joinery Services Limited & Mr Nigel Fryer v Ian Firth Hardware Limited [2008] EWHC 767, the court was required to consider whether Mr Fryer, who was employed by the defendant as a sales representative, was a commercial agent for the purposes of the Commercial Agents Regulations 1993.

Mr Fryer was, on the facts, found to be a commercial agent for the purposes of the Regulations. However, it was determined that the principal had validly terminated the agency agreement because of a repudiatory breach of contract by Mr Fryer which meant that he was not entitled to compensation under Regulation 17. Despite finding that Mr Fryer was not entitled to compensation, the court did go on to address the question of whether he would have been due any compensation if he had not been in repudiatory breach.

Mr Fryer was earning a salary as a sales representative of £11,000 per annum plus commission of 1.5% of the net value of sales from all new accounts introduced by him. After taxes and expenses he was left with a net income of £14,100 per annum, which was well below the UK average earnings of £27,128 per annum. The Judge commented that he did not think that anyone would be willing to pay a premium for such a business, and would therefore have rejected a claim for compensation under Regulation 17. These comments are not binding because they did not concern the decision which was made in the case, but they are noteworthy and of much interest nonetheless.

They suggest that the idea that an agent is automatically entitled to compensation on termination may not be correct. In addition to what a hypothetical buyer might be willing to pay for the agency, there may be a further factor for the court to consider, that being whether there would be a buyer at all?

The comments made in the Nigel Fryer Joinery case as to the entitlement of Mr Fryer’s hypothetical claim for compensation are highly questionable in our view. Why should an agent with a low value but steady agency be penalised in this way? Should every agent not be entitled to be compensated to some extent for the value of the goodwill in the agency?

It is argued by some commentators that it is unlikely on commercial grounds that any purchaser or investor would be willing to pay for a business providing a return equal to the market wage for the proprietor’s efforts, when he or she could obtain that in the employment market without any capital outlay or investment risk. Whilst at first blush these comments have some force, the idea that an agent with a low earning agency will not be entitled to any compensation under Regulation 17 simply because a hypothetical purchaser would be unwilling to pay anything for the agency business, does not sit comfortably with the intention and spirit of the European Directive from which the Regulations are derived.

Of interest is the observation that the valuation methodology used in commercial agency claims is often the capitalised earnings method. In the case of low earning agencies where this methodology provides an unfavourable outcome for the agent on a Regulation 17 claim, a different methodology might be more appropriate.

The decision in the Nigel Fryer Joinery case is a County Court decision so has limited impact on future decisions of the court. Nevertheless, the court’s comments are regularly relied upon by principals facing claims for compensation in similar circumstances.

It therefore remains to be seen what stance the court will take when faced with a claim for compensation which under current caselaw appears unviable on the figures. The question is when, not if, the comments of the court in Nigel Fryer Joinery will be challenged?

Never one to dodge a challenge, Myerson Solicitors LLP, in conjunction with Old Square Chambers, are looking to overturn the current inequitable status quo and create a more nuanced interpretation of the Regulations that would produce a favourable result for lower-earning agencies. We are therefore interested in hearing from agents with sole low earning agencies which have been terminated and whose claims for compensation have been rejected. If you are an agent in this or a similar position, our specialist team would be delighted to hear from you to discuss how we may be able to assist on favourable terms.

Adam Maher, Partner, Dispute Resolution & Commercial Litigation, Myerson Solicitors LLP
Grosvenor House, 20 Barrington Road, Altrincham, Cheshire, WA14 1HB
Tel: 0161 941 4000
adam.maher@myerson.co.uk
www.myerson.co.uk