What does your agency agreement say about compensation?

Under the Commercial Agents (Council Directive) Regulations 1993 (the “Regulations”), an agent is usually entitled to a payment when his agency agreement is terminated by the principal (unless the agreement is being terminated as a result of the agent’s own breach). The Regulations provide for two different payment regimes: compensation and indemnity. It is not possible for the parties to contract out of these provisions of the Regulations.

If the agency agreement is silent as to whether the agent will receive compensation or an indemnity, Regulation 17(2) provides that he will receive compensation, which is calculated by reference to the open market value of the agency as if it were being sold as a business to a third party purchaser. Alternatively, the parties can agree that the agent will receive an indemnity instead of compensation. Regulation 17(4) provides that the amount of the indemnity will be capped at one year’s commission (averaged over the last five years of the agency). As a general rule, principals will favour the indemnity regime, as a year’s commission usually works out to be less than the open market value of the agency. However, there will occasionally be cases where the opposite is true. The recent case of Shearman v Hunter Boot Ltd considered an unusual clause in which the principal tried to limit its liability by providing that on termination the agent would receive an indemnity, unless compensation would result in a lower payment, in which case he would receive compensation instead.

Mr Shearman was an agent for the famous wellington boot company and his agency agreement was terminated. Calculating his entitlement on the compensation basis, Mr Shearman would have received approximately £1.45million. On the indemnity basis, he would have received only £204,000.  He therefore argued that the termination clause in his agency agreement was unenforceable and that he should receive compensation.

There were a number of issues between the parties, including whether Mr Shearman was entitled to any payment at all, but the High Court decided to consider the validity of the termination clause as a preliminary issue prior to trial. It found that the termination clause was not enforceable.

The court considered that it might be permissible for an agency agreement to provide for compensation and indemnity to be payable in different situations e.g. compensation if the agreement was terminated on notice, or indemnity if it was terminated by the death of the agent. What the court objected to about the clause in Mr Shearman’s agreement was that it operated to ensure that Mr Shearman would receive the least favourable outcome – whichever amount was cheaper for Hunter. This, it found, was inconsistent with the purpose of the Regulations, which is to protect agents who are generally the weaker party in the commercial agency relationship.

The clause would therefore be struck out of the agreement, with the result that if at trial it was found that Mr Hunter was entitled to a payment from Hunter, this would be calculated on the default compensation basis.

After judgment was handed down, the case was settled, so it is not known how much Mr Shearman ultimately ended up recovering from Hunter. However, the case nonetheless raises an interesting point about the parties’ ability to choose between compensation and indemnity. Principals should consider reviewing their standard agreements and amending any which contain a similar clause to the one in Mr Shearman’s agreement in light of the decision.