Compensation claims & smaller value agencies

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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