AGENCY UPDATE – ASSESSING COMPENSATION ON TERMINATION

Some 18 months have gone by since the Courts tried to clarify this thorny area of dispute once and for all. Now is a good time to take stock and see how the land lies for agents and principals.

Background
Except for some limited situations, the Regulations provide for an Indemnity or Compensation, where an agency is terminated.

Indemnity is pretty straightforward. It is capped at 1 year’s earnings. This is the exception however as agent and principal must expressly agree for it to apply. Otherwise the default position is Compensation.

And Compensation has been anything but straightforward. Litigation over how to assess Compensation has been continuing for over 10 years.

Until the case of Lonsdale, the general rule was tariff-based,  assessed on about 2 years’ earnings. In the summer of 2007 however the House of Lords firmly rejected that approach.

So what is the legacy of Lonsdale ?

Basic Assumptions
The Lonsdale decision said assessing Compensation is done by pretending there is a business sale – the principal buying the business of the agent. It also said this required certain assumptions. These include -

• an open market for sale of the agency
• no restrictions on assignment
• that the agent would in fact sell
• the imaginary ‘buyer’ is the principal

Reality is very different. Your Agency Agreement may prevent any assignment. There is probably no open market. The agent may be retiring without plans to sell at all.
None of this matters.  

An agent is entitled to what a buyer would pay for the business, if the assumptions did apply. This comes down to valuation of the future income stream. Historical earnings may be a poor guide. The key thing is true value of the agent’s business, warts and all, looking both backward and forward.

Valuation Issues
A number of questions arise from the Lonsdale approach:

 Q:       Are the principal’s business prospects relevant ?
A:        Yes. These must be reflected in the value. Good prospects may well increase the amount a buyer can be expected to pay. Declining trade will do the opposite. It is possible prospects are so poor there is no real value at all. This was more or less the case for Mr Lonsdale.

Q:        Are there strings attached to the agency ?
A:        Restrictive covenants may limit the agency. These should also limit value. Without ‘strings’ the principal could pay Compensation only to find the customers stay with the agent anyway.

Q:        Is income considered gross or net ?
A:        Any buyer would have expenses, as does the present agent. These should be taken into account.

Q:        What is the correct valuation date ?
A:        Actual termination.

Q:        Can a notional salary be deducted as an expense ?
A:        A post Lonsdale legal case suggest it can.  In other words a hypothetical buyer can expect a notional salary before calculating the profit on which he bases valuation of the business.

Health Warnings
Sometimes the decision to finish is not the principal’s. For example retirement.

Compensation will still be due and the same valuation issues arise. Retirement payments may be substantial. For many agents they may be an important feature of retirement planning.

Principals however should exercise caution. It is not unknown for agents to appear to ‘retire’, only to surface again a few months later with a new agency. Their right to Compensation is lost – as long as it has not already been paid !

Early assessment and advice is vital in any Compensation claim. This allows both principal and agent to –

• know what to expect
• minimise legal fees
• protect their position on costs with a suitable offer

Poor assessment means the time spent fighting will only push up the total bill – good for us lawyers but not so great for the client.

Contact Michael Morse in our Employment Team for further information on 0113 2258852.