Hedging my bets in a sales agency contract – is it a good idea?
"Hedging your bets" between the options of compensation or indemnity has come to prominence again in a new case.
This is the second time this issue has come before the courts in less than two years, yet the two cases reached completely opposite results.
In last year's case (Shearman v Hunter Boot Limited (2014) EWHC 47 (QB)) the Court found the clause that effectively provided that the agent would be entitled to whichever result was the cheapest out of indemnity or compensation was wholly unenforceable so the agent was entitled to compensation, the default option under UK Law.
Conversely, this year's case (Brand Studio Limited v St John Knits Inc  EWHC 3143 (QB)) concluded that it was possible to sever that portion of the contract wording which offended against the Commercial Agents (Council Directive) Regulations 1993 ("the Regulations") and leave the rest of the clause in place. This meant that the agent was entitled to indemnity.
The practical problem arises fairly frequently in practice. Principals, who in many cases have the greater bargaining power, want to ensure that when the agency ends they pay the lowest amount possible under law. Very generally speaking, indemnity is subject to a cap of a year's commissions whilst compensation is not and is instead based on the resale value of the agency, so indemnity provisions have often turned out to be the cheapest form of termination payments for principals. However, this is not the case in all circumstances. A forthcoming article will look at cases where compensation is likely to yield the lower result – watch this space.
Because of the potentially high sums at stake some principals have wanted to hedge their bets between indemnity and compensation, and this has been particularly the case since the Lonsdale decision in 2007 which ruled that compensation was based on the resale value of the agency. The contract clauses in the Shearman and Brand Studio cases both tried to ensure that the principal was liable for whatever form of termination payment turned out to be the lowest.
The recent Brand Studio Limited case reached a result that most of the clause opting between indemnity and compensation was upheld and the result the principal favoured (an indemnity payment) was found to apply.
The clause in question was as follows: "[The Agent] shall have the right to be indemnified as provided for in Regulation 17 of [the Regulations]. For the avoidance of doubt [the Agent] shall have no rights to compensation under those Regulations upon termination or expiry of this Agreement provided that if the amount payable by way of indemnity under this clause would be greater than the amount payable by way of compensation [the Agent] shall have the right to receive compensation instead of an indemnity under the Regulation]."
This clause was agreed to be unenforceable as a whole, which followed last year's Shearman decision. However, fortunately for the principal in this case, the Court did not strike down the whole clause (which would have meant the agent was entitled to compensation), but ruled that it was appropriate to sever the latter wording of the clause form the earlier part. The Court found that the earlier part of the clause in which the parties opted for indemnity still made sense without the latter part and this severance did not turn the Agreement into one that the parties would not have made.
On a superficial level therefore one might conclude that "hedging your bets" has worked in this latest case and might be worth considering.
However, we advise against this for a number of reasons:
- Although the principal got what it wanted, eventually, the result was achieved after the uncertainty over how the clause should be interpreted caused both agent and principal to incur significant legal costs to have the matter determined at Court;
- The "hedging your bets" clause in question was accepted by both parties to be void and unenforceable as a whole because, following Shearman, the term did not provide for a particular type of payment to the agent in terms that were capable of being clearly understood at the outset of the agency. Hence, the principal won the case only through the offending contract wording being cut out and the whole clause being found to be void.
- Any clause which hedges your bets in this way is inherently uncertain and carries a significant risk of litigation and of getting precisely the more expensive result the principal was trying to avoid.
- The Brand Studio case turned on its own facts and the particular sequence of wording within the clause was found to still make sense even if the Court cut out the latter part of the wording. Each case turns on its own facts and the particular syntax of the clause in question.
In passing, it is perfectly permissible under the Regulations to provide that a different termination payment might apply in different circumstances, providing those circumstances are clearly set out at the point the agency commences (as the Judge in the Shearman case noted). Thus, for example, a contract might provide that an agent was entitled to an indemnity payment in the event of the agent's death during the contract or in an insolvency situation, but for a compensation payment to apply in all other circumstances.
However, apart from considering if there is any merit in prescribing different solutions for different factual scenarios, we strongly advise against hedging your bets in an agency contract as it carries substantial risk of disputes and of not getting the result you intended. It is better to take proper legal advice at the outset, to carefully consider the pros and cons of each type of termination payment against your business circumstances and then opt decisively for either indemnity or compensation to apply.