Determining the compensation payable to an agent on termination of an agency agreement is not a straightforward business. The Commercial Agents Regulations (the “Regulations”) fails to provide a definitive formula. But is that changing following a very recent judgment which for the fourth time has applied a multiplier of 4 or thereabouts?
The House of Lords’ decision in Lonsdale made clear that compensation is the amount which a notional third party purchaser would pay for the agency at the date of termination on the open market. That judgment also confirmed that the valuation, as a reflection of reality, can be determined by reference to the agent’s net income stream and takes into consideration factors such as the health of the agency and the market for the product at the time of termination.
Yet, subsequently there has remained an issue as to what multiplier (that is the measure of the risk of investing in an agency business) is to apply to an agent’s net income stream when calculating the agent’s compensation. However, a recent High Court judgment is the fourth in a series of cases to apply a multiplier of 4. So 4 might easily be thought the new norm, but is it?
In Monk v Largo Foods [July 2016] the valuation of an agency relationship in the retail food sector was considered.
The agent’s expert evidence was that a multiplier of 7 was correct, whilst the principal’s expert did not provide an opinion on the matter in her initial report. During re-examination at trial the principal’s expert put forward a multiplier of 2.5 to 3 on which the judge did not place reliance.
The agent’s expert’s basis for a multiplier of 7 included considerations as to the agency’s small business size compared to the principal’s; the expert further relied on a London Business School risk measurement service report that “assessments of relative market risk in the food sector were low”. The judge considered, however, that a multiplier of 7 was too high given the principal’s strong presence in the Irish market, having its own label as well as its branded business. Amongst other things, economic conditions were considered as a neutral factor but Mr. Monk’s personal connections that allowed for a “quite an unusual methodology” to approach high level contacts in the industry were a relevant factor.
In applying a multiplier of 4, the judge further rejected the principal’s argument that the agency had “no value” but conceded that the agency was a small business and that the high level contacts would remain with Mr. Monk rather than with the agency, therefore lowering the multiplier from 7 to 4.
Software Incubator Limited v Computer Associates UK Limited [July 2016] concerned the valuation of an agency relationship in the software industry. The case concerned a 12 month renewable contract terminable with 3 months’ notice. The principal’s expert evidence was that the valuation should assume that the agency would have ultimately ended after a 12 month period, whilst the agent’s expert’s evidence was to assume a 12 year agency because the product’s shelf-life was 12 years.
The judge rejected both arguments and considered instead a 4 year period for the purposes of a discounted cash-flow valuation. His reasoning was based on the “immature nature” of the market since the very nature of the product meant that customers with perpetual licences would only spend money on maintenance and upgrades. Despite rejecting both experts’ overall calculations, the judge found the method underlying the principal’s calculations more logical and reasonable and used it to reach the final compensation figure. This involved calculating the average value of each deal done and then the average customer spend per annum over 4 years. To produce a value, the judge used the principal’s expert net figures calculated in this manner and further added an additional £90,000, a sum representing the saving of costs due to a professional employed to run the agency.
Alan Ramsay Sales & Marketing v Typhoo Tea [March 2016] concerned the valuation of an agency in the tea trade. The agent’s expert thought the multiplier should be 5 rather than the multiplier of 3.5 proposed by the principal. The agent’s arguments for the higher multiplier included the fact that the agency was profitable, that it was a fixed retainer not a percentage commission dependent on sales, and that principal’s business was secure and its brand was successful. The judge agreed with the agent’s assessment but reduced the multiplier to 4 to reflect the principal’s evidence that its market share for the products was in decline. The judge also considered it relevant that the likely purchaser of the agency would be a small business or cautious individual of modest means.
Invicta UK v International Brands [June 2013] concerned the valuation of an agency in the wine trade. The principal’s expert evidence was that a multiplier of 2 was correct, whilst the agent’s expert thought it should be 7. The judge considered the agent’s expert valuation more appropriate but, with the qualification that “one must be cautious not to overstate what a willing purchaser would pay for a future income stream”, he applied a multiplier of 4.5 times the agent’s annual net income. In this case, the judge weighed the fact that the agency was a fixed fee agreement, and therefore offered a prospective purchaser more certainty as to future income, against the fact that conversely the agreement did not provided an opportunity to increase revue by earning commission on increased sales.
What do we take from all this?
The judges’ considerations that lead them to apply or agree with the application of a multiplier of 4 in all four cases are mostly coincidental. In contrast each decision was fundamentally determined by commercial realities, such as the stability of the principal’s business, it’s positioning in the market, its financial position and trading relationships. The Regulations exist to protect agents. But that does not mean that 4 is the default multiplier in all situations. Depending on the strength of the agent’s business a default multiplier of 4 could result in an agent receiving too little or too much compensation.