The vexing problem relating to the issue of the calculation of compensation payable to commercial agents on termination of their agency agreement has arisen once more in the revolutionary judgment of the Court of Appeal in the case of Lonsdale v Howard & Hallam Limited [2006] EWCA Civ 63 made on 6 February 2006.

In order to appreciate the repercussions which will follow from this case, it is necessary to understand the history relating to claims on termination brought under the Commercial Agents (Council Directive) Regulations 1993. Under these Regulations, which are based on a European Union Directive (and thus similar, although not identical, regulations apply throughout the European Union), a commercial agent is entitled on the termination of his agency contract to claim either an indemnity or compensation from his principal. He can make such a claim even if he retires on grounds of age, infirmity or illness and this right goes so far that his estate can also claim if he should die. The only circumstances where he cannot make a claim are either if he resigns (unless due to age or illness) or where he has breached the contract so fundamentally that his principal has had to terminate the agreement.

However, in most cases it is clear that an agent will be able to claim either an indemnity or compensation.

The claim to an indemnity will only arise if it has been specifically agreed in the agency contract and then the agent will be entitled to claim an indemnity (which concept derives from German law) if he has brought his principal new business or has significantly increased the business with existing customers. The amount of the indemnity is based on average annual commission over the preceding five years of the contract or, if less, then the indemnity is calculated on the average of the actual length of the contract with a cap of one year's commission.

However, it is still relatively uncommon to find an indemnity clause in an agency contract. In default the agent is entitled to compensation. The Regulations state that the agent "shall be entitled to compensation for the damage he suffers as a result of the termination of his relations with his principal". This concept of compensation derives from French law. As the British courts did not really understand how to go about calculating the compensation, initially they looked to the French for inspiration. In the first cases on this issue, in essence, they made their calculation as French courts would, where there is a presumption of two years' loss of earnings, which clearly made compensation more attractive to a commercial agent than indemnity, which is limited to one year and quite often is substantially less.

Gradually over the last few years the English courts have tried to distance themselves from this two-year presumption and build up a new UK method of calculating compensation in a very flexible way by taking into account all the various factors relating to the agency contract, e.g. the length of the contract, the success of the agent, the manner in which termination occurred, etc. and indeed the last case on the subject spelt out a total of 14 factors which could be taken into account.

However, all these judgments have been totally swept away by this Court of Appeal decision, which is the first time a higher court has given a judgment on compensation claims.

The facts in the case are very straightforward. Graham Lonsdale was a commercial agent engaged by Howard & Hallam Limited, a shoe manufacturing company, selling its products to shoe shops in the south-east of England. His agency began on 1 January 1990 and continued until 30 June 2003 when it was terminated after a period of notice as a result of the closure of Howard & Hallam's business due to rising costs and falling sales. Howard & Hallam paid Mr Lonsdale £7,500 by way of compensation, but he did not think this represented the full amount to which he was entitled and began proceedings in the Oxford County Court claiming £19,670, which was an amount approximately equal to two years' gross commission less the amount he had already received. In other words he was claiming on the basis of the French calculation. Initially the judge at Oxford awarded him only £5,000 which he calculated was the loss of the goodwill attaching to his agency. The Court of Appeal agreed with the judge's decision and stated that all cases suggesting a presumption of two years' loss of earnings were wrongly decided and held that the correct measure of damages is the value of the agency business as at the date of termination, including whatever goodwill attaches to it. The value of the business at the date of termination ought to reflect the agent's potential future earnings which are the rewards he was entitled to receive in respect of any benefit that his principal might obtain from his activities. Therefore the agent should be adequately compensated if he is paid for the value of the business he has built up at the date of termination. This will inevitably mean in future cases that the agency business will have to be valued by an expert (probably an accountant) which will certainly not be a straightforward matter. One can imagine huge discrepancies between the experts for the two parties which may bring a lot of uncertainty.

One must not forget that this compensation claim is potentially unlimited and there could be huge awards for really valuable agencies, potentially well in excess of the two-year French compensation.

In this present case Mr Lonsdale received very little because Howard & Hallam's business was closing down and he was probably quite lucky to have been awarded £5,000 although there is every likelihood that this will have been swallowed up in legal costs!

Where do we go from here? Mr Lonsdale has petitioned for leave for appeal to the House of Lords and it is possible this issue will be finally decided by the European Court of Justice.  In the meantime, it seems likely that well-advised principals will push for an indemnity provision to be included in their agency agreements. It gives a large degree of certainty since a claim can never exceed one year's commission.

Any principals would be well advised to have a good look at their agency agreements and to consult their legal advisers to see if it would be possible to include an indemnity clause.

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