February 11, 2006
As the world economy becomes increasingly global, it has become commonplace for businesses to seek growth outside of the countries in which they are primarily based. While international business is a positive and exciting phenomenon, it can carry serious risks for the businessperson who does not become familiar with the legal regulations of the new markets in which he or she seeks to operate prior to acting there. The European Union (25 States and growing) is a heavily regulated environment which requires those doing business within its borders to comply with uniform rules. These rules are often quite different from those in effect outside the EU.
One area which deserves special attention is the use of third party agents to represent a business in negotiations for the sale or purchase of goods in the European Union, and in particular the rules which apply to post-contractual compensation. Though the use of agents in this capacity is widespread, many are unfamiliar with the legal rules which apply to it in the EU. EU Directive 86/653 (“the EU Directive”) regards the terms and conditions involved in the use of self-employed commercial agents. It is the responsibility of EU members to promulgate provisions that comply with the Directive. Among the other requirements which the Directive imposes is the agent’s non-waivable entitlement to indemnification and/ or compensation for damages at his contract’s termination, even if this termination is the result of the agent’s illness or death. This “indemnity” is capped at one year’s worth of commissions, as calculated based on the average commissions earned over the previous 5 years, while the “compensation” is not. By the Directive’s own terms parties cannot contract out of these obligations, and choosing a non-EU governing law will not be effective to displace them if the agent is active in the EU. If you are involved in agency arrangements, misunderstanding the Directive’s terms as they apply in the country in which you wish to operate could cause you to incur serious and unexpected financial losses.
By way of example, it is worth focusing on the EU Directive as it has been adopted in the United Kingdom, not least of all because of a recent decision given by that country’s judiciary which emphasizes the risk involved in commercial agency agreements for the unwary. Commercial agency agreements in the UK are governed by the Commercial Agents Regulations 1993 (“the Regulations”).
On termination of a commercial agency arrangement, agents are normally entitled to damages from the principal. These damages are available even if the agency agreement has simply expired. An agent will only lose the right to damages where it is in material breach of the terms of the agency, it terminates the agreement without justification or it willingly assigns the agreement to another.
PJ Valves v. Audco India Ltd., a recent decision of the Queens Bench Division of the High Court, establishes that the Commercial Agency Regulations in the UK apply in a much wider number of situations than was previously thought, and precludes the use of a formulaic approach to calculating the damages due an agent upon termination of the relationship. As a result of the ruling, it will be harder for principals to avoid the payment of damages to their agents in the future, and it will be harder for them to predict how much those damages will be.
Under the Regulations it is clear that an “agent” will not include any company officer, partner, insolvency practitioner, or unpaid operator. The question that arose in PJ Valves, however, was whether an “agent” who lacks the authority to conclude terms of a transaction is covered by the Regulations. The Court determined that managing or conducting a negotiation on behalf of a principal is sufficient to bring an “agent” within the scope of the Regulations even though he or she may have lacked the authority to conclude terms. The Court’s reasoning was based on the idea that the aim of the Regulations is to “provide protection to agents by giving them a stake in the goodwill which they have generated for the principal”. As a result of this broad interpretation the Regulations will apply in more situations, and it will be harder for principals to avoid the payment of damages to an agent whose services have terminated.
Another question addressed by the Court in PJ Valves was the method of calculating the “damages” due an agent. Under the Regulations damages may take the form of either an “indemnity” or “compensation”. Where the agency agreement is silent as to the type of damages payable, the agent shall be entitled to “compensation” rather than an indemnity. Compensation is likely to be a higher figure. In P J Valves, the principal materially breached the contract one year before its expiration. The agent was found to be entitled to compensation to reflect the amount it would have earned during the relevant 12 month period had it remained the principal’s agent. Compensation was calculated on the basis that the overall evidence suggested that the agent would have made one further successful introduction during the relevant period, and the value of that commission was assumed to be the average commission earned from the 6 successful introductions previously made. The Court firmly rejected a formulaic approach (based on the sum of the last two years’ commission, as is the custom in France) and stressed that the Court should retain a broad discretion and flexibility to award “proportionate compensation” in the circumstances. Given that the use of formulas has been rejected in this context, it will now be more difficult, for principal and agent alike, to predict the size of compensation that a Court will award in the UK. In other EU countries, such as Germany and France, the formulaic approach has not been as thoroughly rejected, so the amount of damages awarded there is more predictable, though arguably less just.
Some of the risks associated with the agency relationship can be mitigated or avoided entirely by the careful review and drafting of agency agreements. The distinction, for instance, between whether an agent is entitled to an “indemnity” or “compensation” is significant, with “indemnity” generally being a more favorable formulation for the principal since the calculated damages will be more certain and probably lower. The agency agreement can specify which type of damages the agent will be entitled to. The Court also has the discretion to calculate “compensation” by reference to gross or net commission payments made to the agent. Finally, it should be considered whether the risks associated with an agency agreement are worthwhile, or whether the creation of an alternate non-agency relationship, such as through the use of a distribution agreement, may just as adequately address the principal’s needs.
It should be noted that the EU Directive includes an additional number of non-waivable obligations that a principal has toward his agent, such as notice requirements concerning termination, obligations to pay commissions earned at certain set times, and the validity of non-compete or “restraint of trade” clauses that appear in a commercial agent’s contract. It is wise for the businessperson who intends to engage commercial agents in the EU to become familiar with these rules as they apply in the markets in which he wishes to participate prior to entering into any contracts for this purpose. The rules which apply to agency agreements in the EU are very different from those applying non-EU countries, such as the United States, and they bear a price tag which is best understood before the principal has committed to pay it. | |
