How does a Court value a compensation claim?

When a commercial agency is terminated and compensation is payable, the amount is not fixed by a formula in the Regulations. Since the House of Lords decision in Lonsdale v Howard & Hallam in 2007, it is worked out by valuing the agency as if it were being sold: what a hypothetical purchaser would have paid for the income stream at the point of termination. In practice that means estimating the agency’s sustainable net earnings and applying a multiplier to reflect the risk.

The contributions below, from specialist commercial agency solicitors, set out that framework and show how the courts have applied it across a series of cases from 2008 to 2019, including where an agency was found to be worth little or nothing. Lonsdale remains the governing approach throughout. Each article is reproduced in full and attributed to its author.

How does a Court value a compensation claim?

A step-by-step worked example: how a court reached a compensation figure in the Typhoo Tea case.

Most principals and agents have heard of the House of Lords decision in the Lonsdale case in 2007 which set out the principles to be followed when valuing a compensation claim under Regulation 17 of the Commercial Agents (Council Directive) Regulations 1993. The recent case of Alan Ramsay Sales and Marketing Limited v Typhoo Tea Limited [2016] EWHC 486 (Comm) gives a good illustration of how those principles are applied in practice by the Courts to come up with a compensation figure.

Background

The Claimant company was a commercial agent for Typhoo (the well know producer of teas) from 2006 until May 2013 when its agency was terminated. There were issues in the case about which party terminated the agency, but the Court resolved those in favour of the Claimant and then assessed the value of the Claimant’s compensation claim following the Lonsdale principles. One of the key conclusions from Lonsdale is 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. To assess that notional price, each party in Ramsay instructed an expert forensic accountant who was a specialist in valuing companies. The experts agreed that the compensation value should be assessed in the following way:

• Identify the annual net earnings (ie revenue minus costs) likely to be made under the agency in the future;
• Apply the appropriate multiplier to that net earnings figure to measure the risk of investing in an agency business.

Net earnings

The Claimant’s annual revenue was actually quite straightforward to calculate because it was paid a fixed retainer of £260,000 per year by Typhoo. Revenue calculations are often more difficult to make where the agent receives commission payments as these can fluctuate quite a lot from year to year depending on the level of sales made. The costs of the Claimant to be deducted from this revenue figure included:

• Wage costs of staff employed by the Claimant who worked on the Typhoo agency. The Claimant also acted for a number of principals who had products which did not compete with Typhoo and the Court therefore had to assess what portion of wage costs should be allocated to the Typhoo agency. The experts disagreed on the approach to be taken, but the Court decided to adopt the approach taken by the Claimant’s expert in comparing the wage costs for the last year before termination of the Typhoo agency with the wage costs for the following year after the agency had ended.
• The cost of employing an equivalent replacement for Mr Ramsay, the owner of the Claimant company who ran the business on a day to day basis;
• Motor, travel and accommodation costs (which were borne by the Claimant rather than Typhoo). If those costs had been reimbursed by Typhoo they would not have been included in the costs calculation; and
• Fixed costs and overheads (eg cost of premises, telephone, electricity, insurance, computer expenses etc), which were apportioned between the various principals that the Claimant acted for. In this case, the Judge decided that a figure of £10,000 was appropriate.

The categories of costs incurred by a commercial agent will vary from case to case, depending on the nature of the particular agency and in particular what staff (if any) are employed by the agent. The categories outlined above are likely to apply where the commercial agent employs staff to assist them. Based on the above, the Judge determined that the future annual costs that would be incurred by the notional purchaser would be £217,375, which resulted in an annual figure for net earnings of £42,625. The Judge noted that this was a pre-tax figure and stated that the parties would need to calculate the post-tax figure for the purposes of the calculation of compensation under Regulation 17.

Multiplier

Neither of the experts could identify a business which could be used as a direct comparator to assess how the agency would have performed in the period following termination. This meant that the starting point for the experts in assessing the appropriate multiplier to be applied to the net earnings figure was to take the appropriate price / earnings ratio from the FTSE as at the date of termination of the agency. There was some disagreement between the experts as to which ratio should be used, but the Judge decided that the ratio for “Consumer Goods and Consumer Services” was the correct one. This gave a starting figure for the multiplier of 16.93. Both experts agreed that this figure should be discounted by 70% (40% for lack of marketability and 30% because the size of the Claimant’s business was small in comparison to the companies reflected in the FTSE price / earnings ratio). That gave a multiplier figure of 5.09, which the Judge reduced further to 4 to reflect uncertainty about Typhoo’s business and its falling share of the market and also to reflect the likelihood that any theoretical purchaser of the Claimant’s agency would be conservative and cautious in their approach to buying the agency.

The final compensation figure

The final calculation would be to apply the multiplier of 4 to the post-tax net earnings figure (ie £42,265 minus the tax payable on that figure). The Judge did not calculate the final compensation figure but noted it would be in the region of £130,000. This case highlights that the process of calculating the compensation figure can be quite complex. It can be expensive and time consuming to resolve areas of dispute, particularly if extensive expert evidence is needed. It is in the best interests of principals and agents to explore early on whether they can agree a compensation figure which is acceptable to both of them and go their separate ways.

Blake Morgan Solicitors
One Central Square, Cardiff CF10 1FS
Tel: 029 2068 6126 www.blakemorgan.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, Blake Morgan Solicitors and the writer accept no liability in connection with the general guidance given in this column. Please ensure that you obtain legal advice before acting in reliance upon anything in this article. For example, please be clear that the answers given in this column may not cover all possible angles, aspects, relevant considerations and/or points of law and so that all or any information which is given above needs in every instance to be referred for legal advice for clarification and amplification, before being relied upon.

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Regulation 17 Compensation: a Practical Overview and How You Can Negotiate the Correct Amount

The origin of the current approach in Lonsdale, plus the practical factors that drive an agency’s value.

When Mr Graham Lonsdale took exception to the Oxford County Court’s decision to award him a mere £5,000 for the loss of his agency business his further legal action triggered a radical overhaul of the approach to Regulation 17 compensation that we are still coming to terms with.

As any bookish principal or agent will know the House of Lords, the highest court in the land, determined that the so called “French rule”, which provided for compensation payments of around 2 year’s commission income, was not applicable on these shores and the correct approach was to assess the open market value of the agency at the date of termination taking account of all relevant factors. Many welcomed this clarification and it was originally thought that victory had gone to the principals because they could no longer be beaten with the “two year rule” stick by agents with weak agencies looking for generous pay offs. However, the outcome is more nuanced than this as is explained below and each case must be approached squarely on its merits.

Lonsdale was a curious case to travel all the way to the House of Lords because his agency was in such an evidently bad way. It is worth recalling that in 1997- 1998 Mr Lonsdale’s gross commission income was almost £17,000 but by 2002-2003 it had fallen to £9,621. The backdrop to all of this was that his principal’s shoe business was in terminal decline because like many UK shoe manufacturers at the time they were unable to compete on style and price. On this basis the Judge noted that he had been provided with no evidence as to the value of the agency and doing the best that he could arrived at a figure of £5,000. Mr Lonsdale wanted more.

In fact, he claimed for £19,670, an amount that was roughly equal to two years’ gross commission calculated by reference to the average of the last five years of his agency. He appealed unsuccessfully to the Court of Appeal and then finally to the House of Lords who gave him very short shrift. It was found that Mr Lonsdale enjoyed net commission income of around £8,000 only and yet he claimed that his loss was comfortably more than twice this amount, even in circumstances where sales were falling off a cliff. It is hardly surprising that the law Lords were not with him on this and instead they determined that compensation should be equal to the open market value of the agency at the time of termination.

This is the mindset that agents and principals must now adopt in seeking to come to a final figure where the right to compensation arises. Applying this analysis to Mr Lonsdale’s agency business the £5,000 awarded appears to be a reasonable assessment of its value at termination; after all, who would pay much more for a business vehicle generating just £8,000 net p.a. on a reducing basis with no sign of recovery and where work had to be undertaken? Would you? Conversely, there are other agencies generating net yearly income of, say, £10,000 and above, which, if there merits are properly presented and analysed will be seen to have a buoyant open market value. Further, it is possible to say that great agency businesses will have a better outcome than pre-Lonsdale, in some cases far better.

The main factors to consider when analysing an agency are as follows:

1. What is the gross commission income received?
2. Is this level of commission sustainable?
3. What are the business overheads attributable to the agency, i.e. the costs of running the agency such as petrol, hotel stays?
4. How many other agencies are carried and what expenses are attributable to each?
5. Is the agency time intensive and how many hours are worked?
6. Is the agency business on an upward curve and are there positive business trends identifiable?
7. Conversely, is business bad and are, for instance, cheap imports forcing the industry into “remorseless decline”?
8. Is a positive or negative business trend a mere blip or an indication of long term prospects?
9. Is the agency stable and in a good industry?

These considerations should be the first step in getting a rough feel for the value of the agency and thereafter the parties can choose to appoint a valuation expert to value the business. You should be aware that appointing a valuer will cost money and for lower value agencies the agent and principal should make real attempts to settle the matter between them rather than wasting disproportionate costs.

Once a valuer is instructed he will most often prepare a written report for the benefit of both parties and which may be used at court if necessary. He will generally establish the net income figure, the level of work required and the state of the business and then apply a multiplier of anywhere from 0 to 8 to arrive at the value. Clearly a higher multiplier is given where there is evidence of buoyancy and good things to come.

It is evident that there can be a great degree of variance in the approach to be taken and some valuers refer to “gut instinct” in choosing a multiplier, which is obviously not the most scientific approach. It is no wonder that agents, principals and even lawyers struggle at times to sensibly conclude how much an agency is worth.

This degree of variance also causes real practical difficulties and the writer recalls receiving two reports from separate experts in respect of the same agency and based on very similar facts and figures where the first valuation was under £100,000 and the second was over £1,000,000. This is, of course, very unsatisfactory and not what the House of Lords anticipated when it said that after a period of experience in such valuations the court could take judicial notice of what would be the going rate in the standard case, namely an agency which has continued for some time and in which the net commission figures are fairly stable.

It is not clear that this position has been reached and there is no indication that it will. For instance, the simplicity of the two year rule, which resulted in some haggling but eventual agreement in most cases, is a thing of the past. The uncertainty as to the correct approach to valuation can be seen in the reported cases post Lonsdale where expert valuation evidence has been rubbished and totally disregarded by Judges. The lesson from this is that even if you obtain a written report from an expert the judge in any given case retains discretion to disregard it and use it for guidance only.

In this sea of uncertainty it is suggested that agents and principals should cooperate together fully by objectively analysing an agency’s value at an early stage after termination and exchanging their sensible views in order that progress can be made, settlement achieved and both parties can carry on with what they do best, albeit not together.

Thom Vaughan is a solicitor with E.A.D Solicitors LLP and advises on all aspects of commercial agency dispute resolution.
Head Office: Prospect House, Columbus Quay, Liverpool L3 4DB
Tel: 0151 735 1000 www.eadsolicitors.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, E.A.D. Solicitors and the writer accept no liability in connection with the general guidance given in this column.

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Guidance on how to calculate compensation

The hypothetical purchaser concept explained, and what the court assumes about that buyer.

For many years after the Commercial Agents Regulations came into force in 1994, there was uncertainty over how a commercial agent should calculate the value of the “compensation” they were owed under Regulation 17 following the termination of their agency agreement.

Some argued for the French model of awarding agents compensation equivalent to two years gross commission and others applied a complicated checklist of points to take into account when valuing compensation.

That all changed in 2007 following the House of Lords decision in Graham Lonsdale v Howard Hallam Limited. The Court clarified that compensation is calculated by valuing the future income stream of the agency business.

In other words, you need to value what someone would have been prepared to pay to buy the commercial agency on the date the agency agreement was terminated. In practice, when a commercial agency agreement is terminated, there is usually no one who actually purchases the business.

Instead, the customers of the commercial agent often go on to deal directly with the principal or the principal appoints a new agent to take over the former agent’s customers.

To value compensation, therefore, a legal assumption is made that there is a “hypothetical purchaser” who is able to purchase the agency business, irrespective of whether the agency agreement would allow it, for example because there is a clause prohibiting assignment of the agreement.

In the recent Court of Appeal decision in Warren (T/A On-Line Cartons and Print) v Drukkerij Flach B.V. 2014, the Court provided further guidance on what the valuer should assume about the hypothetical purchaser when valuing the agency business. The case involved a commercial agent who sold cardboard packaging in the UK.

The principal terminated the agency agreement and a dispute arose about how much compensation the commercial agent was owed under Regulation 17.

When the matter was first heard by the Court, the Judge made two assumptions about the “hypothetical purchaser”. First, that there was a hypothetical purchaser who was able to purchase the agency business. This assumption is correct and follows the rule in Lonsdale.

The Judge also assumed that the hypothetical purchaser would have been prepared to pay an actual price for the business and noted that his function was to determine that price. That part of the judgment was incorrect.

It was quite possible that a hypothetical purchaser would not have been prepared to pay any price for the agency business.

This may happen where the business of the principal is in terminal decline and no sensible purchaser would pay anything for the privilege of taking on the agency business. Although the judge did get this point wrong, it made no difference to the overall result as the Court of Appeal held that, on the valuation evidence, there was every reason to believe that a hypothetical purchaser would have been prepared to pay a price for this business.

Although this case does not mark any change to the law, it is a useful practical reminder that actual evidence of what someone might have been prepared to pay for the agency business is relevant material the Court can take into account when determining compensation under Regulation 17.

If, for example, there is evidence that the commercial agent had tried unsuccessfully to sell their agency business in the period leading up to termination of the agency agreement, this will be relevant evidence for working out what a hypothetical purchaser would have been prepared to pay.

Christopher Tayton, Clarkslegal LLP.
One Forbury Square, The Forbury, Reading RG1 3EB
Tel: 0118 958 5321 www.clarkslegal.com

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, Clarkslegal LLP and the writer accept no liability in connection with the general guidance given in this column. Please ensure that you obtain legal advice before acting in reliance upon anything in this article. For example, please be clear that the answers given in this column may not cover all possible angles, aspects, relevant considerations and/or points of law and so that all or any information which is given above needs in every instance to be referred for legal advice for clarification and amplification, before being relied upon.

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What is the value of an agent’s compensation on termination?

The limit of that concept: the buyer is assumed to exist, but may be willing to pay nothing.

Ref: Warren (t/a On-Line Cartons and Print) v Drukkerij Flach BV

When an agent’s relationship with his principal ends, the agent is entitled to be compensated for damages caused by this termination. Lonsdale (t/a Lonsdale Agencies) v Howard Hallam Ltd introduced the concept of a “hypothetical purchaser” for the purpose of deciding the value of an agency and in turn the value of the compensation.

Following this decision, must it be assumed when assessing the value of an agency that a hypothetical purchaser who would pay something for the agency always exists? The recent Court of Appeal case of Warren (t/a On-Line Cartons and Print) v Drukkerij Flach BV provides useful guidance on this point.

The Facts

Mr Warren was working as a commercial agent in the UK, in September 2009 at the age of 69 Mr Warren decided to retire and provided three months’ notice to terminate his agency. The agency ended in December 2009 on good terms. In the six months following this termination, around £230,000 worth of orders were placed with the principal by two of the key customers Mr Warren had previously been maintaining. When Mr Warren discovered these orders had been placed, and that he had missed out on a large amount of commission, he brought claims under regulations 8 and 17 of the Commercial Agents (Council Directive) Regulations 1993.

Mr Warren was successful. In his claim for “pipeline commission” on the £230,000 orders placed after his retirement, he was awarded £5,771 under regulation 8. In addition, Mr Warren was awarded £18,800 under regulation 17 of the Regulations as compensation for the damage suffered by the termination of his agency. In deciding on the sum of £18,800 as compensation for termination the Judge considered what a reasonable hypothetical purchaser would have paid for the agency.

Appeal

The principal appealed the decision on the grounds that the Judge had made an error of law. The principal claimed that the Judge was wrong to state that he had to assume that there was a hypothetical buyer for the agency and that the agency should therefore be valued on the basis that a buyer existed who would pay something for the agency. The principal believed that there was in fact no buyer who would pay any sum for the agency.

The decision

The principal’s appeal was dismissed and the decision to award the agent compensation for the end of the agency stood. However, Longmore LJ in the Court of Appeal did agree that by not addressing the argument that the agency was in fact valueless, the trial Judge’s references to the term “hypothetical purchaser” made it look like the Judge assumed there was a value for the agency and his task was to assess what that value was, which was wrong. When making a valuation, one does always assume a hypothetical purchaser exists, but this does not necessarily mean that there is a price the hypothetical purchaser would pay.

Commentary

Although the principal’s appeal was unsuccessful, this case provides a useful interpretation of the “hypothetical purchaser”. In particular it demonstrates that the court will assume a hypothetical purchaser exists but the agent will have the burden of proving that the agency has a value of some kind. Equally the principal should put in clear evidence, where available, to demonstrate that the agency is worth less or indeed nothing. If the agent cannot show that the agency has some kind of value, then the agent’s compensation will also have no value. If you find yourself in a similar situation as Mr Warren or the principal in this case, Blake Morgan can assist you through our extensive experience of advising both principals and agents on termination disputes and the valuation of agencies.

By Nicola Rochon of Blake Morgan LLP. Nicola Rochan is a Paralegal with Blake Morgan Solicitors and specialises in commercial litigation and dispute resolution.
New Kings Court, Tollgate, Chandler’s Ford, Eastleigh, SO53 3LG
Tel: 023 8085 7026 www.blakemorgan.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, Blake Morgan Solicitors and the writer accept no liability in connection with the general guidance given in this column. Please ensure that you obtain legal advice before acting in reliance upon anything in this article. For example, please be clear that the answers given in this column may not cover all possible angles, aspects, relevant considerations and/or points of law and so that all or any information which is given above needs in every instance to be referred for legal advice for clarification and amplification, before being relied upon.

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Agency compensation: do £20k agencies have any value?

Why smaller agencies often struggle to show value, once a notional salary for the agent is deducted.

In the 2007 case of Lonsdale the House of Lords confirmed that in calculating the compensation payable to a commercial agent on termination or expiry of its agency under the Commercial Agents (Council Directive) Regulations 1993, the court should award the value of the agency business at the date of termination.

In some quarters this was seen as a bitter blow for commercial agents who had previously enjoyed sending written demands for the equivalent of 2 years commission following termination of their agencies.

Lonsdale changed all of that and in the intervening period a trend is beginning to emerge, which broadly suggests that high value agencies with, say, gross commission income of £50,000 and above continue to result in lucrative payments (in some cases more than pre-Lonsdale) whereas the run of the mill £20,000 agencies are facing real difficulties when it comes to demonstrating they have a value which results in any compensation.

One reason for this can be attributed to a line in Lonsdale, which reads, “If the agent would have had to incur expense or do work in earning his commission, it cannot be assumed that the hypothetical purchaser would have earned it gross or without having to do anything.” Effectively the court appears to indicate that a notional employment cost should be taken into account.

In practice what has followed is that when valuing agencies some experts have indeed deducted a notional employment cost of the agent and this is further supported by the later High Court case of Fryer v Firth (2008), which states,

“£14,100 per annum for an average 40 hour week is on any view a modest salary and is very much less than the 2005 New Earnings Survey figure for sales representatives which produced average earnings of £521.70 per week gross, £27,128 per annum. Almost anyone could obtain an income at that level in an unskilled job without paying a premium for it. No hypothetical purchaser would in my opinion be willing to pay a substantial sum for the opportunity of earning that amount through his own labour unless the prospects of increasing the return for approximately the same amount of effort were considerable.”

The deduction of a notional employment cost in cases involving the smaller agency may result in only a small profit or even no remaining profit, as in the case of Fryer.

Experts will value a commercial agency on the basis of a multiple of annual profits after the notional employment cost of the agent, an approach common to the valuation of any business. The assessment of the multiple is very subjective. In the case of non-agency businesses the multiple is normally based on those achieved in sales of similar businesses. In the case of commercial agencies there is no real market for the sale or purchase of agencies so the expert is faced with a lack of comparables.

The multiple is a measure of the risk of investing in a business. As a general rule a strong business with good prospects for growth or continued strong profits will attract a higher multiple as the risk to the hypothetical purchaser is lower. A weaker agency with declining profits will be perceived as a greater investment risk and therefore carry a lower multiple. This was recognised in Lonsdale which stated “if the market for the products in which the agent dealt was rising or declining, this would have affected what a hypothetical purchaser would have been willing to give. He would have paid fewer years’ purchase for a declining agency than for one in an expanding market.”

Therefore unless an agent is able to show that his £20k agency requires only a small amount of work (perhaps it is one of many agencies he carries) or he can show that he expected it to grow rapidly (with evidence in support) then he faces an uphill struggle to demonstrate that it has any value to a hypothetical purchaser, and therefore recover a worthwhile amount of compensation.

As an Agent, one really has to ask if this fits in with the intention of the European Council’s Directive and the grand aim of protecting the “downtrodden race” of agents. However, it appears that this is where we are post Lonsdale: social and equitable principles have given way to strictly commercial principles.

As a Principal, perhaps you would like agents to ask themselves what they would pay for a £20k agency taking into account their expense overheads and hours worked and then compare this to what they are seeking as compensation. This is an eminently sensible starting point and will force the parties to get to grips with the valuation process both practically and conceptually.

Adrian Pym is Director of Forensic Accounting for business valuation experts RSM Tenon.
Head Office: Charterhouse, Legge Street, Birmingham B4 7EU
Tel: 0121 333 3100 www.rsmtenon.com

Thom Vaughan is a solicitor with E.A.D Solicitors LLP and specialises in commercial agency matters.
Head Office: Prospect House, Columbus Quay, Liverpool L3 4DB
Tel: 0151 735 1000 www.eadsolicitors.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, E.A.D. Solicitors, RSM Tenon and the writer accept no liability in connection with the general guidance given in this column.

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Calculating claims for compensation: the potential significance of time spent in operating the relevant agency

A closer look at one part of the net earnings figure: the deemed salary deducted for the agent’s own work, and why keeping time records can matter.

Following the decision of the House of Lords in the landmark case of Lonsdale vs Howard & Hallam in 2007, the way in which compensation claims under Regulation 17(6) and (7) of the Commercial Agents Regulations are calculated is based on the hypothetical sales value of the relevant agency, as at the date when it was terminated.

In other words, the value of a claim for compensation (as opposed to any claim for an indemnity) is, broadly speaking, aligned with the amount of money that a third-party purchaser would hypothetically otherwise have paid for the agency in question (and, for the purposes of the relevant calculation exercise, making the obvious assumption that it [the agency] would actually have continued, instead of having been terminated).

Clearly, therefore, the more profitable an agency, the greater might then be its value from the perspective of calculating compensation, and this evaluation process is clearly something very different to what sales agents might otherwise imagine as being the appropriate process and criteria.

Following on from the above, the way in which businesses are valued has therefore become very important to understand, with one of the key fundamental aspects in this process being the calculation of net (as opposed to gross) earnings, including the deduction of a deemed salary for the sales agent in operating the relevant agency (and then applying an appropriate ‘multiplier’ to the resultant ‘multiplicand’).

As far as the deemed salary aspect is concerned (i.e.:- together with other expenses, to be deducted from gross income to then produce the required net earnings figure), this can often be quite difficult to be precise about in practice, but is generally based on (as a starting point) the appropriate basic salary (according to statistical data) for an employed sales person operating in the same territory area, and then making an apportioned deduction of that theoretical salary from gross earnings, based on one of several possible ways, including (as just one example) based on an assessment of what percentage the income from the agency was of the sales agent’s overall turnover. Another way, and possibly the most accurate basis of assessment, is to calculate the actual time spent by the sales agent in respect to the terminated agency.

Calculating actual time spent may however be particularly difficult to gauge where, obviously, the sales agent is not in a position to establish precisely how much time they spent in respect to any individual sales agency over any relevant period because they don’t have relevant records, and taking account of the fact that they may have a number of different agencies with any significant degree of overlap. That stated, it is obvious that it may be very valuable information to have. For example, if a sales agent had an agency earning them (say) £250,000 per annum, but which they could evidentially prove took them merely one day a week to operate as part of their business (i.e.:- and so that, as an expense, potentially only one fifth of a deemed salary needed be accounted for), then, and clearly, and assuming that other expenses were not excessive, the sales agency might in those circumstances (and for the purposes of calculating compensation) be regarded as extremely profitable. There are many examples I could indeed provide, however, and any terminated sales agency needs to be individually analysed as to its profitability from more of course than just this one perspective of deemed salary, before fact specific conclusions may be drawn.

It may also very well be that an agency which is relatively small in terms of its earnings pro rata to the aggregate amount earned by the sales agent from all of their agencies taken together nevertheless takes up a disproportionately large amount of time, precisely because the sales agent is trying to grow the level of business from that (currently low earnings level) sales agency.

Clearly, the precise method of calculation will vary from case to case, and as to which is the most appropriate will likely be fact dependent. It is also difficult to predict which methodology may produce the best outcome (for the sales agent). However, the message is intended to be clear that sales agents should try to as far as possible maintain accurate written records as to how they allocate and spend their time for individual principals, with the understanding that, potentially, the more time efficient that they can prove that they are in running specific agencies the more profitable they may then be valued at, thereby translating into greater compensation claims.

© David Bentley, Bentley Agency Law Limited, Bentley & Co Solicitors, 7 Littlemoor Road, Pudsey, Leeds, LS28 8AF
T: 0113 236 0550 e-mail: db@bentleyandco-solicitors.com
The ONLY law which we practice is the law as it relates to commercial sales agents.

Please ensure that you obtain specific legal advice before acting in reliance upon anything in this article, particularly since each individual’s circumstances may necessitate a unique approach, and also on account of the fact that the law may of course at any time change. Furthermore, please be very clear that information given in this column may not cover or otherwise refer to all possible angles, aspects, relevant information and/or points of law and so that all or any information which is given above needs in every instance to be referred for specific legal advice for clarification and amplification, before being relied upon.

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Commercial Agency Valuation: don’t ignore the positive factors

The counterweight to the sections above, and the companion piece to the smaller agencies article: the external factors that can push an agency’s value up.

The valuation of an agency relies on more than the commission figures or the accounts of the agent. In our previous article we discussed the costs of running an agency and how taking these into account in the smaller agencies often led to a very low or negligible value. In this article we look at some of the positive factors that impact upon the value of agencies. These factors are usually external to the agency but nonetheless are important in determining what a willing buyer might pay to acquire the agency.

In Lonsdale the court stated “if the market for the products in which the agent dealt was rising or declining, this would have affected what a hypothetical purchaser would have been willing to give. He would have paid fewer years’ purchase for a declining agency than for one in an expanding market.” So an assessment of the market is critical in assessing value.

AN EXPANDING MARKET

In the recent case of McQuillan v McCormick [2010] EWHC 1112 (QB) the Judge accepted our opinion that, in assessing the agency’s maintainable earnings, it was reasonable to reflect the rising market for the product sold by applying a ‘growth’ multiple of 1.5 to the commission income prior to deduction of the attributable overheads and directors’ salary. The agent sold jewellery products manufactured in Denmark. The principal was the UK importer and distributor of the product. The sales were rising exponentially for the manufacturer and the agent was benefitting from the rising market for the product. It is perhaps useful to add a layer of detail and note that the Defendant acted as UK distributor for Pandora Jewelry, which retails popular charm bracelets as its core product. Around 5 years ago the range could only be found in a small number of designer boutiques but is now a recognised name on the high street. It has enjoyed a stratospheric rise.

A willing buyer would recognise this positive factor and be willing to pay more for the agency. By applying a growth multiple to the commission income the rising trend was recognised in full rather then by applying a multiple to the profit of the agency. This was appropriate because the costs of operating the agency were not directly proportional to the commission income.

However, the court also recognised the risk that the principal’s contract with the product manufacturer could be terminated within two years. If it was the agent would be out on his ear. The Judge concluded that “For my part I doubt if anyone would pay more than 1 years purchase…” Therefore in assessing value the parties must look at the stability of the agency, was it longstanding, durable and likely to continue for a number of years? The case also considered other relevant factors, such as exclusivity and its impact on value; as well as overheads and directors’ salary.

EXPANDING MARKET, BUT FALLING COMMISSION?

In another unreported case the existence of a rising market did not result in an enhanced value for the agency. The factors specific to the case were that the principal was showing increasing turnover and profit year on year. Press releases and trade news were all positive about the future prospects of the business. In isolation these factors suggested an increasing value for the agency. However, the agent’s commission was falling year on year; the direct opposite of the principal’s rising fortunes.

Detailed investigation highlighted a change in the way the principal conducted business. It had historically relied on a number of regional agents to source and manage customers, and to sell its product, thus giving national coverage. However, in the last two years it had secured national deals with two new key customers independently of its sales agents. The agents were still required to manage the national accounts but were only paid a small commission on these “house accounts”. The impact over time was to dilute the influence of the agents and their commission income fell as a greater proportion of sales were made at the lower commission rates.

HIDDEN POSITIVES IN CYCLICAL INDUSTRIES

Certain industries have defined cycles of activity which need to be understood to explain the changes in fortune of the principal and agent. For example, large capital intensive projects can last many years.

The water treatment industry operates a five year cycle of asset management projects (“AMP”). This involves significant investment in new infrastructure projects to improve, replace and maintain water treatment facilities. Sales of water treatment equipment will therefore follow closely the current AMP, typically starting low, rising to year 3 and then declining.

This allows for planning, procurement and then installation of equipment. Advising an agent in this industry would require detailed knowledge of the current AMP, which phase it had reached and what level of capital expenditure was planned for the next AMP. Reliance on the normal three to five years accounts of the agent and principal would not necessarily result in the correct assessment of value in this particular industry.

Agents in, say, the fashion or furniture industries will be acutely aware of the often cyclical nature of business performance and the rapidly fluctuating fortunes of certain wares. One minute oak furniture is the rage and the next it cannot be shifted and sits on the shop floor gathering dust. Rimless sunglasses were cool when a certain Swede was managing the national football team and now they’re yesterday’s news.

SUMMARY

Understanding the agent’s business and the wider industry in which the principal operates is therefore critical to the valuation of any agency. It may be that positive factors exist within the market that enhances the value of an agency beyond that suggested by the accounts of the agent alone.

If these factors would arise as part of a notional purchaser’s theoretical “due diligence” then they should be fed into the valuation process when compensation comes to be discussed.

Adrian Pym is Director of Forensic Accounting business valuation experts RSM Tenon.
Head Office: Charterhouse, Legge Street, Birmingham B4 7EU
Tel: 0121 333 3100
www.rsmtenon.com

Thom Vaughan is a solicitor with E.A.D Solicitors LLP and specialises in commercial agency matters.
Head Office: Prospect House, Columbus Quay, Liverpool L3 4DB
Tel: 0151 735 1000
www.eadsolicitors.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, E.A.D. Solicitors, RSM Tenon and the writer accept no liability in connection with the general guidance given in this column.

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Commercial Agency Compensation & Termination Risk

How external risks, such as a shaky distribution agreement behind the principal, can reduce the valuation (the Pandora case).

Last year the case of McQuillan v McCormick was the talk of the town in agency circles. This was, of course, the case of the agents who sold Pandora jewellery and acted during the brand’s meteoric rise from obscurity to high street name.

Commentators read this case to be a departure from the leading case of Lonsdale and predicted a fall in the level of compensation payable to agents. In our view such comments are incorrect and need clarification.

Lonsdale sets out the basis of compensation payments and what should and should not be taken into account. Paragraph 12 states that “it is obviously necessary to assume that the agency would have continued and the hypothetical purchaser would have been able to properly perform the agency contract. He must be assumed to have been able to take over the agency and stand in the shoes of the agent…..What has to be valued is the income stream which the agency would have generated.” Paragraph 21 goes on to state that the compensation payable should be calculated on the assumption that the agency continued. Lonsdale clearly makes the assumption of continuation of the agency and of the conditions existing immediately prior to termination. What then are the risks of termination that can be taken into account?

Following Lonsdale the contractual notice period within the agency contract should not limit the value of the future income stream.

The notice period of one month for each year of the agency, to a maximum of 3 years, referred to in Regulation 17 of the Directive is therefore not a limiting factor is assessing compensation under Regulation 17(3). Equally, if the parties elected for a longer period of notice it is expected that this would not interfere with the principle.

However, external risks of termination, “real factors”, may also exist which could limit the amount a hypothetical purchaser would pay for the future income stream. If the financial health of the principal was in question at the date of termination, and there is a risk that the future income stream would cease if the principal were to cease trading, it would be logical for the valuation of the agency’s income stream to factor in the risk of such an event.

The external risks of termination is what brings us back to the decision in McQuillan. In this case the principal was not the manufacturer of the product sold by the agent under the agency agreement. McCormick was the UK distributor of the Pandora Jewellery products under its own contract with Pandora A/S.

At Paragraph 167 of the McQuillan judgement the Judge stated: “If the contract between Mr McCormick and Pandora A/S comes to an end then there will be no income stream. In that event it is clear from Lord Hoffmann’s speech that it is of no value. Thus the question to be asked is what is the value of an income stream of £149,000 which is increasing but which could be terminated within 2 years. When the question is asked in that way it becomes plain to my mind that the discount applied by the expert of 25% is far too small. For my part I doubt if anyone would pay more than 1 years purchase and I propose to value the compensation at £150,000…”

The risk of termination identified by the Judge was not the risk of the agency contract being terminated, as many commentators believe, but that of the distribution agreement between the manufacturer and McCormick; a separate contract over which the agent had no control or influence. A hypothetical purchaser would see this as a real commercial risk and would value the agency accordingly.

This is consistent with the comment at Paragraph 12 of Lonsdale that “What has to be valued is the income stream which the agency would have generated” and the comment at paragraph 13 that there is no reason to make assumptions contrary to the position in the real world. The real world in the McQuillan case was that at the date of termination, the principal’s distribution agreement hung very much in the balance and was at serious risk of termination, which did in fact take place.

The logical extension of this is that if a distributor had a secure contract with no contractual options for immediate termination and no commercial factors suggesting termination then it would not act as a limiting factor. What McQuillan shows us is simply the court’s readiness to take a global common sense view of all aspects of the trading basis in the real world and to feed this into the agency valuation.

It will be interesting to see if Defendant lawyers will now seek to obtain copies of distribution agreements in the hope of discovering details that show such agreements are precarious or likely to fail in the near future. If the principal is the manufacturer then this aspect falls away, unless it is in turn experiencing trading difficulties!

Therefore, whilst McQuillan is an interesting case, in our opinion it does not change the valuation of compensation payable under Lonsdale and simply allows an insight into the overall approach taken by the courts.

EAD Solicitors LLP successfully represented Mr and Mrs McQuillan in this case and RSM Tenon were instructed as joint expert to value the agency business.

Adrian Pym is Director of Forensic Accounting business valuation experts RSM Tenon.
Head Office: Charterhouse, Legge Street, Birmingham B4 7EU
Tel: 0121 333 3100 www.rsmtenon.com

Thom Vaughan is a solicitor with E.A.D Solicitors LLP and specialises in commercial agency matters.
Head Office: Prospect House, Columbus Quay, Liverpool L3 4DB
Tel: 0151 735 1000 www.eadsolicitors.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, E.A.D. Solicitors, RSM Tenon and the writer accept no liability in connection with the general guidance given in this column.

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Clarification from the courts on valuing agencies

A later refinement of the point above: how the right to terminate on notice feeds into the valuation, and whether damages can be claimed alongside compensation.

The case of Software Incubator Limited v Computer Associates UK Limited was big news in agency circles last year, providing long-awaited confirmation that the definition of goods for the purpose of the Commercial Agents (Council Directive) Regulations 1993 includes software. (Please refer to our article run in the November 2016 issue by Blake Morgan: ‘Commercial agents and software, goods rather than services?’) The judgment however also contained useful clarification on a number of other points relating to the sums payable to an agent whose agreement has been terminated.

First, the court considered the question of whether, when valuing an agency for the purpose of determining the compensation payable to an agent on termination under Regulation 17, the valuer should take into account the fact that the agency agreement may be terminated on notice. Computer Associates argued that the valuation should be reduced because the agency agreement continued on a rolling yearly basis and was terminable on three months’ notice.

No hypothetical purchaser, they said, would pay a large sum to purchase a business which would only last for a year. The court agreed that when valuing the business it could not be assumed that the agency agreement would last forever and the valuation should take into account any termination rights. However it should generally be assumed that the agency will be properly performed by the hypothetical purchaser going forward, and that the principal will not have any reason to take immediate steps to terminate it at the shortest possible notice.

Computer Associates went on to argue that where a compensation claim under Regulation 17 is successful, an agent should not also be able to claim damages for the principal’s breach of the agreement. In this case, Software Incubator had claimed damages for sums due for the three month notice period under the agreement. Notice pay is the most common form of damages claim we see in practice, but it is possible that an agent could have a damages claim for some other breach of the agreement by the principal if this breach has caused him loss.

The court rejected Computer Associates’ argument that an agent cannot claim damages as well as Regulation 17 compensation. The judge did however state that the valuation of the agency for the purpose of the compensation claim could be affected by a principal’s liability to pay a large damages claim. In this case the damages claim was not significant enough to make any impact on the value of the agency.

As the case shows, valuing an agent’s claim after termination of the agency agreement can be a complex exercise and almost always requires the involvement of expert accountants. We recommend that agents seek advice at the earliest opportunity to ensure that they do not under or overstate the value of their claims in any exit negotiations with the principal.

Emma Butcher is a Senior Solicitor at Clarkslegal
Clarkslegal LLP, One Forbury Square, The Forbury, Reading RG1 3EB
Tel: 0118 953 3932 Mobile: 07799 212 511
Email: EButcher@clarkslegal.com
www.clarkslegal.com

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, Clarkslegal Solicitors and the writer accept no liability in connection with the general guidance given in this column. Please ensure that you obtain legal advice before acting in reliance upon anything in the article. For example please be clear that the answers given in this column may not cover all possible angles, aspects, relevant considerations and/or points of law and so that all or any information which is given above needs in every instance to be referred for legal advice for clarification and amplification, before being relied upon.

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A typical compensation claim?

A recent, wide-ranging example touching whether the Regulations apply, valuation, and double recovery.

A recent High Court decision in Green Deal Marketing Southern Limited v Economy Energy Trading Limited and Others gives a really useful overview of the law on some of the key issues that commonly need to be decided when an agent puts forward a compensation claim following termination of their agency contract.

In this case, the Claimant (Green Deal) was engaged by the Defendant energy supplier (“EET”) to visit customers in their homes to try to persuade them to switch their gas and / or electricity supply to EET. Green Deal had a team of over 200 field sales agents who carried out these visits and Green Deal was paid an agreed amount by EET for each switch.

Did the Commercial Agents (Council Directive) Regulations 1993 (“the Regulations”) apply?

One of the first points the Judge had to decide was whether the Regulations applied to the agency contract. If the Regulations did not apply, Green Deal would not have been able to bring a compensation claim.

The Regulations only apply where the definition of “commercial agent” is fulfilled. This requires an agent to prove that they are “…a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of … the “principal”…, or to negotiate and conclude the sale or purchase of goods on behalf of and in the name of that principal”.

Is electricity “goods”?

It has been established in previous cases that gas is classified as “goods” but, strangely, there had been no equivalent decision in relation to electricity. The Judge was unequivocal in confirming that electricity is also classified as “goods”.

Did Green Deal have authority to negotiate?

EET argued that Green Deal did not have authority to negotiate, and did not negotiate, the sale of power to customers. It noted that Green Deal’s role was limited to soliciting customers to switch their energy supplier to EET, but Green Deal had no ability to alter the terms offered to the customer and played no role in the subsequent sale of gas and / or electricity to the customer. The Judge acknowledged that this was the extent of Green Deal’s role but pointed out that the meaning of “negotiate” in the context of the Regulations has been construed broadly to mean “to deal with, manage or conduct” and was satisfied that what Green Deal did fell within that meaning.

The Judge also dismissed an argument that Green Deal’s agency role was a secondary part of its activities for EET and concluded that the Regulations did apply.

How was compensation valued?

Green Deal and EET each instructed an expert forensic accountant in order to value Green Deal’s compensation claim, following the principles set out by the House of Lords in Lonsdale v Howard & Hallam Limited. The experts both agreed that the valuation should be based on the earnings of the agency, rather than the value of the assets held by the agency. They also agreed that the basic calculation to be used in the valuation was:

(Estimate of sustainable net annual earnings) x (appropriate multiplier for years of purchase) = value of compensation.

However, the experts adopted very different valuation methodologies and reached very different conclusions on the value of the compensation claims. Green Deal’s expert came up with a figure of £1,156,116 for net annual earnings and then applied a multiplier of 6.93 to arrive at a compensation figure of just over £8m. EET’s expert reached a figure of £656,000 for net annual earnings and applied a multiplier of 1.6 to arrive at a compensation figure of just over £1m.

The Judge agreed with EET’s expert and explained at length why he reached that conclusion. Some key points to note are:

• Both experts pointed out that GDM’s senior management team were paid by GDM via shareholder dividends rather than salaries and agreed that their calculations for net annual earnings needed to include “market rate” salaries to cover the functions undertaken by those directors. The inclusion of such “notional salaries” can be an important element of the calculation of net annual earnings.
• After some initial considerations, the Judge stated that a sensible starting point for the appropriate multiplier would be 4. However, there were two important considerations which reduced that multiplier down to the final figure of 1.6:
  • The starting point taken by EET’s expert was for a fully diversified business. A reduction by 50% was therefore needed to account for the risks associated with operating under an exclusive agency agreement for a single customer (ie GDM was solely reliant on the business it had from EET);
  • A further reduction of 20% to reflect the regulatory pressures and scrutiny facing the energy market.

Can an agent bring a damages claim for loss of profits in addition to a compensation claim?

The Judge noted that compensation is a different remedy to damages. While there have been cases where an agent has been successful in claiming both damages for loss of profit and compensation under Regulation 17, the Judge was keen to point out that the two claims could only be made where an award of damages over and above compensation would not result in a double recovery for the agent. He went on to express the view that an award for compensation and an award of damages for loss of profit would tend to result in two awards of compensation for the same loss. He therefore refused GDM’s claim for damages on the basis it would result in double recovery.

While the Green Deal judgment did not introduce new law into the sphere of commercial agency claims, it is a good example of the issues that Courts commonly have to decide when dealing with compensation claims.

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