Compensation magic

Whether you enjoy the judgment earlier this month of the House of Lords in Lonsdale v Howard & Hallam Limited more than the seventh installment in the Harry Potter series, Harry Potter and the Deathly Hallows, will depend on your choice of bedtime reading. But in the seventh major case to consider the issue of compensation under the Commercial Agents (Council Directive) Regulations 1993 (as amended), there is no doubting the significance of the unanimous judgment ([2007] UKHL 32 on appeal from [2006] EWCA Civ 63).

For those unfamiliar with the dramatis personae in the case so far, Graham Lonsdale was a commercial footwear agent. He started acting as an agent for the footwear company Howard & Hallam Limited in 1990. In particular, he obtained orders for its wide fitting Elmdale brand. While the brand and Mr Lonsdale were initially successful, in the five years up to 2003 the annual commission earned by the agent fell by over 40 per cent.

This reflected increasingly difficult trading conditions faced by the principal. It resulted in a cessation of trade and the sale of the goodwill in the Elmdale brand to a competitor. Mr Lonsdale was given six months' notice (which was agreed to be reasonable) and paid his outstanding commission.

Although it is somewhat difficult to remember, there was a time (before 1 January 1994) when the accounting of outstanding commission to a terminated agent would have been the end of the matter. But as a result of the regulations '“ and in particular regulation 17 '“ this is not so now. Those unfamiliar with the regulations will also find it surprising that the six earlier major cases had left the way in which this statutory entitlement is to be determined in a state of flux.

To unravel the knot, Lord Hoffmann went back to the issue of what a terminated agent should be compensated for. In this respect both the European Directive (and regulation 17(6) which reflects Article 17(3)) are clear '“ the agent is entitled to be compensated for 'the damage he suffers as a result of the termination of his relations with his principal.'

Or as Lord Hoffmann put it, 'the agent is treated as having lost something of value as a result of the termination and is entitled to be compensated for this loss.' In turn the value of the agency relationship lies in the prospect of earning commission which 'proper performance of the agency contract' would have provided to the agent.

From hypothetical to the real world

In this respect Lord Hoffmann fastened on to the language of regulation 17(7)(a) which is one of the two non-exhaustive examples of the damage an agent will suffer which is deemed by the regulations to occur particularly. As such Lord Hoffmann's starting point in determining how the agent's loss should be calculated was to make the assumption that the agency would have continued and that a purchaser would have been able properly to perform the agency contract. But thereafter consideration had to turn from the hypothetical to the real world.

As such future earnings are to be discounted by an appropriate rate of interest and the amount which a hypothetical purchaser would have paid is also to be determined by reference to market conditions '“ a declining market can be expected to result in the hypothetical purchaser paying less. In addition the expenses of the agent in earning the commission must be taken into account.

Cultural differences

It was at this point in his judgment, that counsel for Mr Lonsdale must have felt that he had been struck by a Harry Potteresque 'Avada Kedavra' as Lord Hoffmann rejected his submission that compensation should be calculated in the way in which it is by the French courts.

Lord Hoffmann rejected also the notion that the European Commission's report (COM (96) 364 final) on co-ordination of laws of self-employed commercial agents had endorsed any method of calculation as a true reflection of Community law. He correctly pointed out that the Commission had been required by the Directive only to submit to the Council a report on the implementation of Article 17 and, if necessary, proposals for its amendment.

Further both English and French law correctly reflect Article 17(3) in what the agent is entitled to be 'compensated for'. The fact that the respective national courts then differ as to the method of calculation is of no consequence (Honeyvem v De Zotti [2006] ECR I '“ 2879). Following on from this, Lord Hoffmann drew attention to the fact that market conditions for commercial agents in France and England are different. As he pointed out, in France commercial agencies are bought and sold and often this is for a price of twice the gross commission. In contrast no such market exists in England.

Anticipating this position of the House of Lords, the appellant's counsel had submitted that if English agents received less by way of compensation than agents under French law, the purpose of the Directive would not be achieved. Lord Hoffmann dismissed this submission as one based on generalities. Instead he considered that a useful cross-check could be obtained by considering what an agent might achieve by way of indemnity.

Different objectives

Unfortunately his justification for referring to indemnity was flawed. The French and German methods of 'compensating' terminated agents have different objectives. Crosschecking one against the other is not useful. Indeed Lord Hoffmann's reference to indemnity contradicts his statement (at paragraph 5 of his judgment) that, 'the two systems can plainly lead to different results'.

It would appear that it suited Lord Hoffmann to make his inconsistent remarks at the points at which he did. If therefore 'the courts of the UK' are to calculate the compensation payable to a terminated agent by reference to the value of the agency on the assumption that it continued, it followed that Lord Hoffmann should be dismissive of the judgment of Lord Caplan in King v Tunnock Limited (2000) SC 424. No longer can King be regarded as the philosophers'stone by solicitors acting for agents.

However, there are 'values' and there are 'values'. Lord Hoffmann agreed that: 'one is valuing the agency and its connections that have been established by the agent at the time at or immediately before termination (per Judge Bowers in Barrett McKenzie v Escada [2001] EuLR 567).

But he expressed caution that compensation should by reference to the notional value of the agency in the open market. All that was notional was the assumption that the agency was available to be bought and sold at a particular moment in time. But he added to the factors to be taken into account in determining the value so where an agent has more than one agency, the costs of the agent's business must be fairly attributed to each agency.

Before looking at and robustly approving, the judgments that were the subject of the appeal to the House of Lords, Lord Hoffmann took the opportunity to criticise the judgment given in Smith, Bailey Palmer v Howard & Hallam Limited [2006] EuLR 578 which concerned a claim made by three former agents against Howard & Hallam. In his judgment, the judge had attributed 42 per cent of the value of the brand to the agents on the basis that 42 per cent of the sales and distribution expenses had consisted of 'agent's (sic) commission'. Lord Hoffmann regarded this as flawed insofar as it treated the goodwill of the Elmdale brand as attributable to sales and marketing and therefore 'no allowance is made for the possibility psome of the goodwill may have been attributed to the fact that the company made good shoes'.

But Lord Hoffmann would appear to have mislaid his 'Marauder's Map' as the value which a purchaser may place upon an agency must reflect to some degree the value of the company or brand by which the products are known. Indeed, ironically, this is something certain Continental lawyers recognise when having regard to the so-called suction effect for the purpose of determining the indemnity payable to a terminated agent.

Lord Hoffmann expressed the view that 'once it is understood that the compensation is for the loss of the value of the agency, relatively few cases will go to court.' He considered that it would be relatively easy for the litigants to agree an appropriate valuation, not least because 'small comparable businesses' are regularly bought and sold.

While it must be better for judges to make decisions based on valuations (without the need to obtain a full-scale valuation) rather than 'choose figures at random', what is not bought and sold on a regular basis are commercial agencies in England as Lord Hoffmann accepted earlier in his judgment.

Establish the 'going rate'

Indeed at this point in his judgment it is likely that not even the exclamation of 'Petrificus Totalis' would have stopped Lord Hoffmann as he thought it possible that there could be established the 'going rate' for the 'standard case, namely an agency which has continued and in which the net commission figures are fairly stable. . . adjustments would be needed if . . . the market was in decline or had disappeared altogether.'

In making this obiter remark it is possible that Lord Hoffmann uttered 'accio' as he summoned a judicial notice barely distinguishable from the precedent sought by Mr Lonsdale's counsel.

In one particular respect Lonsdale v Howard & Hallam was unusual in that leave was granted to the Winemakers' Federation of Australia to intervene. The Federation was concerned with the situation where the terminated agent took with him customer connections but received compensation not reflecting the depreciation in the goodwill retained by the principal. It was Lord Hoffmann's opinion that this would be reflected in the value process.

Compensation or indemnity?

Perhaps it is good at this point that Lord Hoffmann did not need to crosscheck against the indemnity concept. This is because Article 17(2)(a) of the Directive gave member states the right to provide for the application of a restraint of trade on the terminated agent when determining the amount of the indemnity to be paid. But in the early 1990s the Department of Trade and Industry (as it then was) had failed to take up this opportunity.

At this point Lord Hoffmann curiously remarked in his judgment that what is to be taken into account (in valuing an agency) is what 'would have appeared likely at the date of termination and not what actually happened afterwards. But I do not see think (sic) that the court is required to shut its eyes to what actually happened.'

As such it would appear that:

• it is possible for the litigants to point to factors (for example, indicating a rising or declining market) which existed at or before termination; and
• what actually happened after termination may provide evidence of what the parties were likely to have expected to happen.

Agents are likely to welcome the House of Lords' decision if it results in a speedy determination of the value of the terminated agency and therefore compensation. They will hope, in this way, that battles with their principals resulting in substantial legal costs can be avoided. However, it remains to be seen whether this will be the case. It is possible that Lord Hoffmann's judgment will result in a repositioning of the goals not least as principals seek to avoid liability for compensation, let alone a fight as to its value.