These reviews often consider whether the commercial agent continues to cultivate goodwill at a rate which justifies the level of commission being paid to the agent (as this is often at a higher rate than any commission based internal resourcing structure a business may have) and also whether the commercial agent's output has become stagnant, or whether the market or geographical priorities for the business have changed in a way which means the agent is no longer the best route to adopt.
Where this review leads to a conclusion that the agent is surplus to requirements, care must be taken to ensure that any termination complies with the Commercial Agents Regulations 1993 ("the Regulations"). This is because agents have statutory protections around termination, and the cost to a business of getting the termination process wrong can be significant.
Generally, the Regulations can only be excluded or varied if this benefits the commercial agent, so the terms of the contract and the Regulations must be read together.
This article provides a summary of the three key pre-termination considerations for a business when considering terminating an agent, with a view to minimising the Principal's risk by identifying common pitfalls.
The Regulations stipulate a minimum notice period which must be adhered to by a Principal. The statutory notice period reflects the length of the commercial agency relationship and must expire at the end of a calendar month (unless agreed otherwise). The minimum notice period is between one and three months, depending on the duration of the contract. However, a written contract might impose a longer notice period than that stipulated in the Regulations, and so both the contract and the Regulations must be considered in terms of the period of notice required.
In most circumstances, a commercial agent is entitled to either an indemnity or a compensation payment where the contract is terminated by the Principal. This payment is based on rewarding the agent for the goodwill which they have developed for the Principal, and cannot be excluded. This right arises from the date of appointment onwards, and no minimum service period is required, although the duration of the agency is a relevant factor for calculating the amount payable.
Compensation is the default entitlement position, whereas the parties must expressly provide for the indemnity option in the contract if they want this to apply. Both payments relate to this reward for development of goodwill, but are calculated in a slightly different way.
This is calculated on the basis of the loss of the value of the agency i.e. what would the hypothetical purchaser be willing to pay for the commercial agency at the time of termination? Consideration is given to the future income stream as determined by factors such as; predicated market growth, number of agency relationships the commercial agent has and how likely the agent is to entice custom away from competitors. The duration of the agency relationship will impact the level of compensation due.
The Regulations stipulate this entitlement is conditional upon the agent having brought in new customers or increasing the Principal's business with existing customers, the substantial benefits of which continue to be derived by the Principal. This entitlement is calculated on the basis of whether such payment would be equitable i.e. fair and reasonable, under the circumstances.
Under the indemnity principal, the entitlement is capped at an average of one year's commission, taking into account the agent's average annual remuneration over the five years prior to termination.
In practice, it is important for a Principal to consider the potential payment it might have to make before terminating an agent. Where looking at a potential payment of a year's worth of commissions, this can be a significant sum to factor in to any decision.
There are some exceptions whereby the indemnity/compensation entitlement does not arise under the Regulations based upon the reasons for terminating the contract, which should be considered.
Even if a payment is likely to be required, the way in which termination is approached can be fundamental, particularly where the communications and rationale given might impact upon arguments as to the value of the agency (for example if the Principal admits in open correspondence that the agent has done a fantastic job of growing its client base).
In addition, when considering the costs of terminating an agent, a Principal must be mindful of the agent's commission entitlement, which, under the Regulations extends not only to commission due on orders placed during the term of the contract (and the notice period), but also on pipeline commission on orders which come to fruition after termination, provided such orders are "mainly attributable" to an agent's actions and are placed within a "reasonable time period" of the agency relationship terminating.
Consideration will be given to the facts of each individual commercial agency relationship and the terms of the contract, when deciding the parameters for what constitutes "mainly attributable" and a "reasonable time frame".
The disentanglement of a commercial agent from a Principal is a complicated process and must be navigated with careful consideration in order to prevent or minimise the impact of the Regulations.
In addition, a number of the risks can be reduced or mitigated by putting in place a carefully drafted contract at the outset when appointing the agent.
Through our strategic partnership with Ward Hadaway law firm, Ward Hadaway have a team of legal experts in the Commercial Department who have in-depth knowledge and experience of advising on commercial agency agreements. They can help you understand your current contractual position, advise on options and strategy for termination and help to put in place agency contracts to minimise the risks in so far as possible.
This article has been drafted on esphr’s behalf by Ward Hadaway Law Firm. Ward Hadaway Law Firm are one of esphr’s strategic legal advisory partners and provide certain services to our customers through a range of different Legal and HR support services offered by ourselves to the Corporate market. The content of this article does not constitute legal advice and it should not be relied upon. Specific legal advice may be required to address your specific circumstance.