Challenges valuing termination of agency
In this blog I explore the challenges when valuing the termination of agency for compensation using a recent reported case to illustrates these difficulties. Compensation is payable by a principal to a commercial agent by Regulation 17 (2) of the Commercial Agents (Council Directive) Regulations 1993 (“the Regulations”).
The Regulations define a commercial agent as a “self employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of their principal or to negotiate and conclude such transactions on behalf of and in the name of that principal”.
In this blog I use the Software Incubator case, for which I wrote expert reports and provided oral evidence in court, to illustrates some of the difficulties in estimating the profitability of the agency before assessing the compensation due.
Why the Software Incubator case is controversial
Much has been written about the fact that HH Judge Waksman decided that software fell within the Regulations, even though the Regulations only applied to the sale of goods in certain circumstances, and not to the sale of services. My instructions from the agent’s solicitors were, and in most of my cases generally are, to quantify the compensation on the assumption the Regulations apply. This meant I did not have to address this controversial legal question.
In his Judgment, HHJ Waksman stated: “These days I would suggest that the essential characteristics of a piece of software like the Product cannot depend on its mode of delivery any more than the nature of tangible goods depends on whether they are transported by rail, sea or air.”
This question remained controversial and the case progressed to the Supreme Court in March 2019. The Supreme Court decided to refer this and another point arising from the case to the CJEU.
Examples of difficulties in quantifying compensation
Quantifying the compensation due to agents under the Regulations always require the valuer to establish the appropriate income stream and to place a value on the income the agency would have generated and which it has now forfeited. In the Software Incubator Judgment, HHJ Waksman provided an excellent illustration of why these quantifications are difficult. In that case this was because:
(1) the product was itself relatively new and had uncertain future prospects at the valuation date;
(2) the industry and particular key players like the Defendants saw that it had significant potential, however there was no contemporaries evidence of how much this potential was.
(3) the agreement itself was terminable on 3 months’ notice and was non-exclusive; but the agent was also credited with deals brought about wholly or partly by the Defendants’ own staff;
(4) results in the termination year were particularly strong year because a number of deals which had been worked on for a long time beforehand (thus depressing the earlier years’ figures) finally closed;
(5) the pipeline deals as at the valuation date that were likely to close were small in number;
(6) No evidence was provided of forecasts as at the termination date, even though these were probably available.
In my experience, apart from difficulties such as these, it is rare even in well-established agencies for the income stream to be stable over a long period. However the valuer is obliged to assess:
(a) The appropriate figure for the income stream as at the valuation date; and
(b) whether at that point the income stream was likely to grow, remain stable or decline, and the extent of this change.
These are some of the potentially large number of factors that the valuer has to take into consideration when trying to arrive at the right income figure for the valuation.
The next stage in the valuation process
Normally operating expenses are deducted to arrive at the agency’s profitability. Fortunately, Incubator Software only had one agency and so there was no need to consider the fair proportion of operating expenses that had to be apportionment over this and other agencies.
As I reported in the news post on 1 April, I provided the chapter on the valuation of commercial agents for the latest edition of Bloombury Professional’s recent book: Commercial Agency Agreements: Law and Practice.
The laws for commercial agents’ agreements are materially different across the EU. For instance, in France and Italy, the equivalent laws implementing the same EU Directive cover services as well as goods. Also, the way in which the payments to agents on termination are calculated varies enormously across the EU. The UK continue to observe EU laws even though the country left the EU on 31 January 2020 and it is not clear whether the law will be retained or modified following the transition period. Software providers with agents governed by the UK Regulations should assume these will continue for the foreseeable future.
In a future blog I shall discuss my experience of issues connected with the allocation of expenses and also the appropriate multiplier to apply to the profit figure when valuing the commercial agency on termination.
6 April 2020