What happens to an agency contract if the principal goes out of business?

Kevin Manship

This is an important question in the current economic climate, but it has become more difficult to answer since the Corporate Insolvency and Governance Act 2020 (CIGA) came into force in June 2020.

Termination of the agency contract?

Prior to CIGA, in the vast majority of cases the principal going out of business would have enabled the agent to terminate the agency contract.

However, CIGA makes it more difficult for an agent to terminate in these circumstances because it prevents agents from terminating their agency contracts by relying on the following:

  • Any provision in the agency contract which would allow the agent to terminate as a result of the principal becoming subject to a 'relevant insolvency procedure' (which includes a company entering administration or liquidation, appointing an administrative receiver or provisional liquidator or entering into a Corporate Voluntary Arrangement); or
  • Past breaches of contract by the principal which are unconnected with the principal's insolvency, where the agent did not exercise the right to terminate before the start of the relevant insolvency procedure which the principal has become subject to.

While CIGA (dramatically) limits the circumstances in which the agent can terminate their agency contract where the principal is going out of business, there are still some circumstances in which termination could take place. For example, the agent can terminate the agency contract if the principal (or the insolvency practitioner dealing with the relevant insolvency procedure) consents to termination. Alternatively, if the principal commits a breach of contract that would justify termination of the agency contract after the relevant insolvency procedure has begun, the agent would then be permitted to terminate the agency contract.

What claims would be available to the agent?

Unpaid commission

Irrespective of whether the agency contract is terminated, the agent would be entitled to claim any unpaid commission which has fallen due from the principal.

There might be some argument as to the value of this claim, particularly if the agent claims commission on incomplete orders which have not been fulfilled for a reason for which the principal is to blame. Where the Commercial Agents (Council Directive) Regulations 1993 ('the Regulations') apply to the agency contract, the agent would still be entitled to commission on such orders.

Compensation or indemnity

If the Regulations apply to the agency contract the agent may be able to claim indemnity (if this is specified as a remedy in the agency contract) or compensation following termination of the agency contract. In order to do this, the agent would first need to establish that they were entitled to terminate and did terminate the agency contract due to a substantial breach by the principal. This point needs to be considered carefully in any discussions with the principal or insolvency practitioner about getting consent to terminate.

Unfortunately, in circumstances where the principal goes out of business there is a real risk that the indemnity or compensation claims would have no value (if they could be pursued at all). The reasons for this are as follows:

  • The Regulations state that the agent is entitled to an indemnity if and to the extent that, after termination of the agency contract, the principal continues to derive substantial benefits from the business it does with new customers brought in by the agent or existing customers where the agent has significantly increased the volume of business done by the principal. If the principal has gone out of business, it would no longer be doing any business with those customers and would not derive any ongoing benefit. This situation has not been tested before the Courts, but the likely outcome seems to be either that the agent could not pursue an indemnity claim because there is no ongoing benefit to the principal or that the value of any claim would be 0.
  • There is a similar outcome for a compensation claim under the Regulations, but for slightly different reasons. The purpose here is to compensate the agent for the damage they suffer as a result of the loss of their relations with their principal. In the leading case in this area (Lonsdale v Howard & Hallam), the House of Lords determined that the damage suffered by the agent is the future income stream (i.e. commission) that the agent would have earned if the agency contract had continued. However, in the situation where the principal goes out of business, there would be no future income stream even if the agency contract had not been terminated. On that basis, it is difficult to see how the value of the compensation claim could be anything other than 0. This point has not been specifically dealt with by the Courts either, although in the Lonsdale case the House of Lords made some comments to this effect (albeit as an aside to their decision).

Practical issues

Even if an agent is able to overcome the legal issues outlined above, if the principal has gone out of business as a result of insolvency, in practice the agent is unlikely to recover the full amount owed (particularly if the principal is a limited company).

If a limited company is put into liquidation, its assets would be collected in by the appointed insolvency practitioner and distributed to creditors in accordance with a recognised order of priority. That order of priority is categorised by the status of each creditor's claim and would generally be as follows:

  1. The expenses of the relevant insolvency process (including the fees of the insolvency practitioner);
  2. Preferential creditors (which may include employees of the principal);
  3. Secured creditors, such as banks, who have taken out security against assets of the principal (e.g. a mortgage over the principal's premises or a floating charge over the principal's general assets);
  4. Unsecured creditors (which would include the agent's claims).

As a general principle, each category of creditor has to be paid in full before any distribution can be made to the next category. Much would depend on the specific financial circumstances of the individual principal, but in many cases unsecured creditors receive nothing or only a small proportion of what they are owed because there is little or nothing left in the financial pot after higher ranking creditors have been paid.

What should an agent do in this situation?

If the principal is encountering financial difficulties but has not yet entered into a formal insolvency process the agent will need to take such steps as they can to ensure that commission due to them is paid on time. If the agent places an order, the goods have been delivered and the principal has received payment from the customer it would be very difficult for the principal to justify late payment of commission. It will be important for the agent to keep on top of this (if possible), to avoid a significant debt building up. This might involve consideration of the legal action the agent can take to protect their position and how this is impacted by CIGA.

Similarly, the agent might want to ensure that any expenses that are usually reimbursed by a principal under the agency contract (e.g. petrol costs, mileage payments, or the expenses associated with attending trade shows) will still be paid. This could involve securing advanced payment from the principal.

If the principal is in the process of going into liquidation, the agent will need to notify the appointed insolvency practitioner of their claims and in particular the amounts owed. The agent is likely to be asked to provide proof of the sums being claimed and will therefore need to be able to set out clearly any overdue commission payments or the value of any compensation or indemnity claims (if applicable). The agent may need to take legal advice at this stage to consider their options, or for assistance with the evidence needed to support their claims. For unpaid commission claims, they might need to provide evidence of completed sales for which the agent is due commission or to explain why they are entitled to be paid commission on sales that have not been completed.

This stage of the insolvency process is important because if the agent's claims are not disputed by the insolvency practitioner (who will probably rely on information provided to them by the principal), those claims will be included within the pot of 'accepted' debts owed by the principal. It is only accepted debts that would be eligible for payment through the liquidation process. If any of the claims are disputed, the agent might need to consider what steps they need to take to get those claims accepted. Clearly, the cost of taking those steps is going to be a very important factor for the agent - they won't want to incur costs here unless there is a very good chance of getting a significant sum back from the distribution of assets under the liquidation process.

Conclusion

When a principal does go out of business, it can be a very difficult and stressful time for all those involved with the business. The combined effects of COVID-19 and Brexit are likely to permanently alter the economic landscape of the UK and, unfortunately, this will invariably result in a number of business failures.

For the principal, what happens with agency contracts is just one of a number of issues that they will have to deal with.

For an agent, what happens with their agency contract and whether they are likely to be out of pocket (and by how much) will be big issues to consider. It is clear from the above that tough decisions may need to be taken. Getting legal advice at an early stage can help an agent make informed decisions and avoid making mistakes which could prove to be very costly, particularly where CIGA comes into play.

 

 

13 January, 2021
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