Employment protection rights and the increasing expectations on employers to provide for their employees have led some to consider alternative arrangements. But a recent Court of Appeal decision has highlighted the fact that care should be taken to ensure that the alternative does not involve the potentially far more costly obligations under the Commercial Agents Regulations 1993 (SI 1993/3053) (the Regulations) (Graham Lonsdale v Howard & Hallam Limited [2006] EWCA Civ 63).

Lonsdale clarifies (often contradictory) guidance on how compensation on termination of the agency relationship is assessed under the Regulations. It marks a move away from the French courts’ approach, which broadly sets compensation at two years’ gross commission, subject to adjustment in light of the circumstances of each case.

The Court of Appeal in Lonsdale held, instead, that a commercial agent should be entitled to compensation assessed on the basis of any damage that he has actually suffered as a result of termination of his relations with his principal (rather than a right to receive a payment that is fair and reasonable having regard to all the circumstances of the case): this will normally equate to the loss of his agency business (including goodwill).

For the Regulations to apply, the relationship has to be one of agency, where the agent is a self-employed intermediary with continuing authority to negotiate the sale or purchase of goods (but not services) on behalf of the principal. An agent cannot also be an employee.

Under regulation 17(1), the parties can either agree an indemnity in advance, or pay the agent compensation on termination. While the indemnity is subject to qualifying requirements, and is capped at one year’s annual remuneration averaged over a maximum five-year period, no guidance is provided in the Regulations on how compensation should be calculated on termination.

Termination includes on notice, in breach, or by effluxion of time, on retirement, ill-health or death. If the indemnity option is not chosen, the agent will be entitled to compensation by default.

If compensation is payable, Lonsdale concludes that the purpose of regulation 17(6) is to compensate damage to the agent’s business, using “damage” in its widest sense, to extend beyond a breach of duty of the principal (for which a claim could be made outside the terms of the Regulations in any event). A primary consideration is to provide compensation for loss of goodwill, for which a claim would not otherwise arise.

Compensation should therefore be paid for damage suffered by the agent as a result of the termination, which will normally be assessed on the value at the date of termination of:

The value of unamortised expenses incurred in performing the agency will also be taken into consideration.

There can be no reduction for mitigation. Also, notice payments under the Regulations of up to three months are payable and may not be offset against any compensation award.

Practical implications. Based on the Lonsdale assessment of compensation, the goodwill could be significant, for example, in the case of a principal in good financial health that is restructuring and, as a result, ceases to focus on the market previously covered by the agent. Similarly, if the principal has concerns about the performance of the terms of the agency agreement which do not entitle him to terminate for breach, termination would again give rise to an assessment of the goodwill which attaches to the agency. There is no allowance for reasonable or just and equitable compensation as was previously the case. Lonsdale makes clear that the value of the agency, based in part on the value of the principal’s business on termination, is what matters.

By contrast, employment may be terminated fairly, and with no greater exposure than contractual (or statutory) notice period payments on various grounds including redundancy, conduct, ill-health or performance.

Termination of employment does, however, involve compliance with statutory procedures and there is the risk of unfair dismissal proceedings for employees with more than 12 months’ service. Currently, the cap on compensation for a successful unfair dismissal claim is £58,400.

Employees may also make discrimination or whistle-blowing claims on termination and compensatory damages may be awarded, based on loss of remuneration and benefits from the date of dismissal. Such awards may be substantial, particularly if an employee was highly remunerated, or the prospects of mitigating their loss by finding alternative employment are slight. “Injury to feelings” awards may also be made following a finding of discrimination. These tend to range from £500 to £25,000, depending on the severity of the injury.

There is arguably more widespread understanding of, and reliance on, such employment tribunal claims, resulting in 39,727 claims being brought in Great Britain for unfair dismissal for the year ended 31 March 2005, of which 47% were settled through the conciliation service, ACAS.

If an employee recovers damages for breach of notice provisions, these may be offset against a compensatory award for unfair dismissal or discrimination claims, which is not the case under the Regulations.

Although most commonly invoked in employment relationships, it should be noted that discrimination claims may be brought by those who are self-employed, provided that they contract personally to execute the work. Exposure therefore exists even where the contract is one of agency.

Where an indemnity has not been agreed in advance, the termination costs of employment may prove to be cheaper than risking a compensation award under the Regulations. Exposure is primarily for unfair dismissal, although discrimination claims are more likely to be brought under the ambit of an employment relationship.

Provided that a party is willing to undertake the greater procedural obligations of terminating an employment, rather than an agency agreement, greater scope exists for terminating employment and so avoiding a compensation payment. While a poorly performing agent may, conversely, be entitled to less goodwill, this could equally be achieved through careful drafting of the fixed and variable components of an employee’s remuneration package. In addition, probationary provisions applying in the first year of employment allow for termination for unsatisfactory performance before exposure for unfair dismissal arises.

Whether an agency or an employment relationship is ultimately chosen, the relative costs of exiting both should be weighed up at the outset (see box “Engagement vs employment”).