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To indemnity and beyond? Is compensation or a lump sum indemnity better on termination (Lonsdale)

13 May 2011

The European Self Employed Agents Directive allowed member states the opportunity to specify that a commercial agent may be entitled to either an indemnity or compensation payment in certain circumstances on termination. 

While the majority of member states opted for a lump sum indemnity, the UK’s approach was to leave the decision to the parties. Unless the contract provides for an indemnity, the agent will be entitled to compensation. As many agency relationships are never reduced to writing, generally compensation will be applicable in the UK.

However, particularly after the decision of the House of Lords in Lonsdale, many principals and agents have been attracted by the certainty of the indemnity system. While a claim for compensation is not limited by the Regulations, in the absence of guidelines to be used in a calculation, there is a huge scope for parties to debate and take positions at wildly different ends of the spectrum. 

In contrast, the Regulations provide that the maximum indemnity payable will be the average of the last five years. In the event that the agency has been running for less time, it will be the average of that period. Therefore, there will always be a clear ceiling for both parties. While an indemnity is intended to reward future benefits, its calculation is reached based on historic performance. In contrast, compensation will often be focussed more on the projected future performance of the agency.  

An indemnity will be payable to the extent that the agent has brought new customers to the principal or increased the business generated with existing customers and the principal will continue to derive substantial benefits from these customers even after the departure of the agent. 

In 1996 the European Commission provided further guidelines as to how an indemnity should be calculated. While there has only been one reported UK case on the assessment of an indemnity, the generally accepted approach is that the calculation in the Report is undertaken then compared to the maximum cap.

In addition to the calculation of the gross commission generated by new customers and increased with existing customers, the length of the retention of these customers must be assessed. While the Report referred to a usual period of 2-3 years, this will depend on the background of the agency. For example, if an agency has been running for 10 years, with continued increasing orders from the same customers then the future duration of benefit could justifiably be longer. These factors will also be relevant when undertaking the next stage, the percentage rate of migration.

Once these have been considered, in addition to a reduction for the early receipt of the income, it must be considered whether the amount should be discounted having regard to equitable factors. While not prescribed by the Regulations, the Commission identified several factors, including:

  • the extent of the advantage to the principal,
  • whether the agent was at fault,
  • the existence of any post-termination restrictions on the agent; and
  • whether the agent acts for other principals or this principal generated its full income.

In addition, while not specified, the German Courts have also applied reductions for trade mark suction. The basis of this concept is that the brand of the product sold by the agent “sells itself”. However, as yet this has not been approved by the UK Courts.

Therefore, an indemnity calculation is not a purely mathematical assessment. However, given the current uncertainty in respect of compensation, it can be expected that more principals will include this in their standard contracts or seek to agree it with agents. Conversely, while the initial reaction of an agent may be to consider that access to a potentially higher compensation payment is preferable, the bird in the hand of indemnity may overall be better for an agent than the bushes of compensation. This is due to the more limited scope for argument and there being no need for an accountants valuation, which necessarily will reduce legal and professional fees.

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