2006 Neil J. Saltzman and John Warchus.
The general information contained herein is offered as a public service only and does not constitute legal advice. Every situation should be reviewed in light of its own unique fact pattern before planning a course of action.
Neil Saltzman is admitted to practice in New York and Israel.He specializes in cross-border transactions and litigation and may be reached by e-mail at: neil@lawfirminternational.com
John Warchus is a partner at Shadbolt & Co, LLP (www.shadboltlaw.com) specializing in IT, Intellectual Property and E-Business and the firm’s main offices are in London and Paris. He may be reached at john_warchus@shadboltlaw.com.
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 this process is positive and exciting, 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. Though the use of agents in this capacity is widespread, many are unfamiliar with the legal rules which apply to it in the EU. Commercial agency agreements in the UK are governed by the Commercial Agents Regulations 1993 (“the Regulations”). Similar rules apply to agency agreements throughout the European Union. Parties cannot contract out of the Regulations, and choosing a non-EU governing law will not be effective to displace the Regulations if the agent is active in the EU. If you are involved in agency arrangements, misunderstanding the Regulations could cause you to incur serious and unexpected financial losses.
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.