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Thinking About Key Terms In An Agency Contract For The Sale Of Goods

What is important to include in an agency contract for the sale of goods can vary quite considerably depending on the bargaining power of the parties, what the principal wants the agent to do, the nature of the products, the market for those products and a whole host of other issues.

In this note, we have set out what we find are usually the key issues to be discussed between the principal and a new agent. Not all of them will find their way into every agency contract, but it would be prudent to at least give them some thought. We should note that these issues apply where the agent carries out their activities within the UK – different considerations may apply in other countries.

A common complaint that we have heard from agents recently is why agency contracts have to be so long, in some case 20 – 30 pages or more. They don’t have to be, particularly where the key elements of the agency (e.g. products, the agent’s role and payment) are straightforward. One of the risks of a lengthy and complex agency contract is that neither party understands or follows it. This is when the real problems can begin! A good agency contract will deal with important points clearly and concisely so that both parties know where they stand and what is required of them.

1. What products of the principal is the agent authorised to deal with?

This may seem like an obvious point, but it is important to set out clearly in the agency contract the products that the agent is authorised to deal with on behalf of the principal. This could be as simple as specifying that the agent is authorised to deal with all the principal’s products, including any new products that may be introduced from time to time.

Alternatively, the principal might want to specify a subset of its products in the agency contract and retain the ability to add products at the principal’s discretion or with the agent’s agreement. This could be particularly important if the principal later develops new products or product ranges or diversifies into new product areas.

The principal might also want to retain the ability to remove products from the list if it decides to discontinue the supply of certain products or product ranges (ego if they become outdated).

These issues are usually covered in the agency contract by the definition of ‘Products’ and it may be that flexibility is needed in the drafting of this definition to enable the principal and agent to keep their future options open.

2. What geographical territory is the agent going to cover?

Again, this may seem obvious but it is important to clearly set out the geographical territory allocated to the agent so there is no misunderstanding. This would be particularly important if the agency contract prevents the agent from placing orders or dealing with enquiries from customers based outside the allocated territory. The agent’s right to be paid commission on sales is also likely to be limited to sales to customers within their allocated territory.

Careful thought might need to be given to dealing with national accounts, which might have their headquarters in one territory, but various retail outlets spread across various other territories and agents. The principal might decide to treat such customers as house accounts (i.e. they are dealt with internally by the principal, not by agents). If they do not, it needs to be clear to the various agents what they are permitted to do with such customers within their territory and what sales will generate commission. This can be a tricky issue.

3. What can the principal do in the agent’s allocated territory?

This can sometimes be an area of significant disagreement between the parties – the agent may want the exclusive right to generate sales within the territory they have been allocated, while the principal might want to retain some rights to make direct sales within the territory without involving the agent (e.g. to existing customers or national accounts) or might want to reserve the ability to allow third parties to also seek sales in the territory. There are a few different options here:

  • Is it agreed that the agent alone has the right to represent the principal within the allocated territory and the principal is prevented from seeking or generating direct sales within that territory itself or from appointing other agents or distributors within that territory? This type of arrangement is often referred to as an exclusive agency.
  • Alternatively, it may be agreed that the principal is prevented from appointing other agents or distributors within the allocated territory, but the principal reserves the right to make direct sales to certain customers or categories of customer in the territory without involving the agent. An agent with this type of arrangement is often referred to as a sole agent.
  • A third option is where the principal is permitted to appoint other agents or distributors within the territory allocated to the agent and the principal itself can make direct sales to customers within the territory. This type of arrangement is often referred to as a non-exclusive agency.

While the terms ‘exclusive’, ‘sole’ and ‘non-exclusive’ are used widely in agency contracts, there is actually no universally accepted definition for them. It is therefore very important to set out clearly in the agency contract the extent of the rights granted to the agent within the territory and what, if anything, the principal is permitted to do.

4. What is the agent’s role with customers?

Various terms are used to define different types of agent. Two of the more commonly used phrases for agents involved with the supply of goods to customers are ‘sales agent’ and ‘marketing agent’, but what do they mean?

A sales agent will usually be authorised by the agency contract to promote, market, negotiate and enter into contracts on the principal’s behalf, but only on terms and conditions specified by the principal. A sales agent will not be a party to the sale contract – that will be between the principal and the customer. However, a sales agent may be authorised to commit the principal to a sales contract with the customer.

In contrast, a marketing agent will be authorised to promote and market the principal’s products and solicit orders for them. They will not have authority to enter into a contract of sale on behalf of the principal.

While these two phrases are generally understood in the industry, we would not recommend that the agency contract simply states that the agent is to carry out the duties of a sales agent or a marketing agent. The extent of the agent’s authority to act on behalf of the principal needs to be set out in sufficient detail in the agency contract so that there is clarity on what the agent is permitted to do and what they are not.

5. The agent’s obligations

The parties should think carefully about how much detail is needed to set out the agent’s obligations in the agency contract.

A number of obligations will automatically apply as a result of common law and (where applicable) the Commercial Agents (Council Directive) Regulations 1993. Those obligations will apply whether or not they are set out in a written agency contract and many agency contracts will include them. This is a sensible approach because it makes clear to the agent what is expected of them. These automatic (implied) obligations would include obligations to look after the interests of the principal, to act dutifully and in good faith and to comply with reasonable lawful instructions given by the principal.

There are a whole host of other obligations that could be included within the agency contract. The extent of the list quite often depends on the bargaining power between the parties and how much control the principal wants to exert over the agent. If the principal is in a strong bargaining position and wants to be kept fully informed of what the agent is doing, the list is likely to be longer. In contrast, if the principal really needs the agent’s expertise and/or is prepared to let an experienced agent get on with things, the list of obligations might reflect a lighter touch.

In many cases, the parties might want to think about:

  • the extent of the agent’s reporting obligations to the principal
  • whether the agent is needed to provide support at trade fairs or exhibitions
  • how advertising responsibilities are to be divided between the agent and the principal (e.g. product samples, marketing materials such as brochures and whether stands etc are provided to (usually retail) customers to display the principal’s products to the best effect)
  • whether the agent has a role in issuing invoices to customers, chasing payment or dealing with complaints

6. Should the agency contract include a minimum sales target for the agent?

One obligation that deserves its own section is whether the agency contract should require the agent to meet a minimum sales target and what the effect of failing to meet such a target would be. Many agency contracts function perfectly well without sales targets but, equally, in other contracts such targets play an important and effective role.

If sales targets are to be included in an agency contract, how are those targets to be set? The principal might want to have absolute discretion to set whatever targets they see fit. Such an approach is likely to set alarm bells ringing with an agent about the risk of the principal setting the sales targets at levels that would be impossible for the agent to reach. This approach is sometimes used by principals as a mechanism to get rid of an agent that they no longer want to use, not necessarily because the agent’s performance is poor but because the principal feels they are paying the agent too much.

There might be a reasonable middle ground available, which involves the principal and agent discussing and agreeing reasonable sales targets before the start of each sales year. From the principal’s perspective, there might be concern about what happens if the agent refuses to agree any sales targets (again, this is not unheard of). Provisions could be included to protect against this, for example setting the sales targets at 5% more than the previous year’s sales targets if agreement cannot be reached by a certain deadline.

A key component of minimum sales targets is what happens if they are not met. In many agency contracts, a failure to meet minimum sales targets would entitle the principal to terminate the agency contract. However, even where the agency contract contains such a provision, care must be exercised by the principal because, although the failure enables the principal to terminate the agency contract, the principal could still be liable to pay compensation or indemnity under the Commercial Agents (Council Directive) Regulations 1993. The Regulations state that the principal can only avoid having to pay compensation or indemnity upon termination of the agency contract where it has terminated the agency contract because of default attributable to the agent which would justify immediate termination by reason of the agent’s failure to carry out their obligations. In other words, for a principal to escape having to make a termination payment, the agent’s failings must be so serious that the Court, looking at the nature and consequences of the breach, decides that the principal was justified in terminating with immediate effect.

But there could be any number of valid reasons why minimum sales targets have not been met. It might have been due to a general deterioration in the market, or orders being cancelled by customers because the principal did not make deliveries on time, or because the products have gained a poor reputation in the market place or because a competing product has entered the market. The circumstances that have arisen during the COVID-19 pandemic highlight a number of further examples, such as national lockdowns and entire industries and sectors having to close down or significantly reduce their activities at short notice. None of these reasons could be classified as ‘default attributable to the agent’.

In such circumstances, it seems likely that the agent would still have a good claim for compensation or indemnity notwithstanding that the agency contract was terminated because minimum sales targets were not reached. This does not necessarily prevent minimum sales targets from being included in the agency contract in the first place. The risk is around whether the principal actually uses its termination rights if those targets are not met.

7. The principal’s obligations to the agent

Similar considerations apply here as to the agent’s obligations above. Again, certain obligations will apply automatically through the operation of common law and the Commercial Agents (Council Directive) Regulations 1993 and whether or not they are set out in the agency contract. These automatic (implied) obligations include obligations to act dutifully and in good faith and to provide the agent with necessary information and documents. Again, many agency contracts will specifically set out these obligations to make clear to the parties what is expected of the principal.

Beyond this, the parties will need to think about what other obligations the principal might be needed to perform. There is obviously an obligation to pay the agent (which we deal with in the next section) and it would be helpful to set out what support the principal is required to provide the agent in terms of providing samples, advertising materials, display stands etc.

Other issues to consider might include placing obligations on the principal to honour sales contracts made on their behalf by the agent and, where orders cannot be completed, explaining to the agent the reasons for this.

8. What will the agent be paid under the agency contract?

In many cases this will simply involve payment of an agreed rate of commission on completed sales to customers. However, in some instances the parties might agree that the agent is to be paid a fixed retainer per month. This might be appropriate where the products involved are completely new and it might take the agent some time to build up the customer base. In those circumstances, paying a monthly retainer would help the agent to cover their initial expenses while they are building up the business. This type of arrangement could be for a fixed period (e.g. 3 or 6 months) or could be payable until sales volumes reach certain specified levels. Any degree of flexibility can be built in.

Similarly, the parties might consider whether the agent should be reimbursed by the principal for certain types of expenses they incur in performing their agency obligations. It would be very unusual for the principal to reimburse all expenses, but some principals might be willing to reimburse certain categories of expenses (such as fuel or accommodation expenses) subject to an overall cap each month. The parties might also consider whether the agent should be reimbursed travel / accommodation expenses for attending trade shows and exhibitions.

Where commission is to be paid to the agent, the parties will need to think carefully about what sales commission would be payable for. Is it payable only in respect of sales concluded by the agent or is it payable on all sales made by the principal within the allocated territory, irrespective of whether the order is actually taken by the agent? For example, in exchange for the agent agreeing to the principal making direct sales to certain customers or categories of customer within the allocated territory, the principal may agree to pay the agent a reduced commission rate in respect of sales to those customers.

In many cases the issue of what sales trigger the right to commission is quite straightforward and can be agreed easily by the parties. However, in some cases this can prove to be a complex issue which requires significant negotiation between the parties.

The rate of commission payable will also need to be considered. Is this to be a flat rate applicable across all sales, or will the commission rate vary across different products or depending on the volume of sales achieved during the year? It is not unusual for commission rates to gradually reduce as sales volumes increase, but the level of reduction might need to be negotiated by the principal and agent.

It is also important to specify clearly what ‘price’ commission will be calculated against. This will usually be the price actually charged by the principal to the customer, net of VAT or any other sales tax. The agency contract might also specify that the ‘price’ should exclude any discounts or rebates that are applied or transport or haulage costs.

The agency contract might also specify when commission becomes due to the agent (e.g. when goods are delivered to the customer, when the customer is invoiced or, most often, when the customer pays the principal) and the process to be followed leading up to payment. In many cases, this will involve the principal providing the agent with a monthly statement showing the sales on which commission is payable and the principal’s calculation of commission on those sales. When the agent has checked and verified that information, the agent will then be required to invoice the principal before payment is made. Further detail on these issues can be found in our Frequently Asked Questions document.

9. Non-compete clauses?

Some agency contracts will contain a provision which prevents the agent (during the period of their agency) from acting for other principals who have products which compete with the products covered by the agency contract. Even where the agency contract does not contain such a specific provision, if an agent takes on an agency for a third party whose products compete with those of the principal that agent is very likely to be in breach of the obligation under the Commercial Agents (Council Directive) Regulations 1993 to look after the interests of the principal. The Courts have indicated that acting for such a third party (during the period of the agency) without the express consent of the principal is likely to justify immediate termination of the agency contract by the principal, meaning that the agent would lose the right to claim compensation or indemnity.

The position is quite clear during the period of the agency, but some agency contracts also seek to restrict the agent’s ability to be involved with or sell competing products after the agency contract has been terminated or has expired. This can be a trickier issue and such a clause would have to be very carefully worded in order to be enforceable.

By way of example, the Commercial Agents (Council Directive) Regulations 1993 specify that the maximum permitted period for such a clause would be 2 years after termination of the agency contract. Even then, common law restrictions on restraint of trade clauses might make a 2-year period unenforceable depending on the circumstances of the particular case.

The Regulations also specify that a restraint of trade clause would only be valid if it relates to the territory allocated to the agent under the agency contract or the group of customers within that territory and to the kind of goods covered by the agency contract. Basically, the restriction has to be narrow and quite specific. If these requirements are not met, the restraint of clause trade would not be effective or enforceable.

It should also be noted that the existence of a restraint of trade clause would be a relevant factor when calculating the value of a compensation claim (and would likely increase the value of such a claim). A principal would need to think very carefully about whether they need this protection after the agency contract ends and for how long.

10. Should the agency contract be for a fixed term or indefinite period?

This can be a point of fierce discussion between the principal and the agent. If a fixed term is to apply, the principal might want the initial period to be quite short to see how things go while the agent would obviously prefer the security of a longer period. It can take some time and effort to build a successful agency, particularly from a standing start.

Where the Commercial Agents (Council Directive) Regulations 1993 apply to the agency contract, applying a fixed term to the agency will not enable the principal to avoid having to pay compensation or indemnity when the agency expires. However, if the duration of the agency has been quite short the value of the compensation or indemnity claim is likely to be lower.

It should be noted that if the parties continue to perform the agency beyond any initial fixed term then, notwithstanding what the agency contract might say, under the Regulations the agency contract would automatically be converted into an agency for an indefinite period. This means that when considering a compensation or indemnity claim following termination of the agency, a Court would look at the whole period of the agency and not just the fixed term specified in the agency contract.

In light of the above points (and the ability of either party to terminate the agency contract at any time by giving suitable notice), we would always recommend that the parties think carefully about whether a fixed term agency contract is actually needed.

11. Termination of the agency contract

The agency contract will need to set out the circumstances in which it can be terminated with immediate effect or upon either party giving suitable notice. In either case, the terminating party would need to give written notice of termination to the other.

The agency contract should list the various events which would trigger termination with immediate effect. Usually, these rights are reserved to the principal only although the agent would still have a right under common law to terminate for sufficiently serious breaches by the principal. The triggers for termination that a principal would often seek here might include:

  • Material breach by the agent of their obligations under the agency contract. What amounts to material breach will depend on the particular circumstances but essentially the breach would have to be serious enough to justify termination of the agency contract.
  • Failure by the agent to meet minimum sales targets.
  • Insolvency of the agent.

Either party can terminate the agency contract at any time for ‘convenience’ (i.e. without having to give a reason for termination). If the Commercial Agents (Council Directive) Regulations 1993 apply, they specify minimum periods of notice that have to be provided in this situation (between 1 and 3 months’ notice depending on how long the agency contract has been in operation).

The reason for terminating the agency contract will be an important factor in determining whether the agent is able to claim compensation or indemnity from the principal following termination. If the principal terminates the agency contract for convenience, then compensation or indemnity would be payable to the agent. Principals therefore often seek to rely on some form of breach by the agent to justify termination with immediate effect. If the principal gets this right, they would do not have to pay compensation or indemnity.

Generally, an agent would not be entitled to claim compensation or indemnity if they terminate the agency contract. The exceptions to this are where the agent is justified in terminating the agency as a result of circumstances attributable to the principal (i.e. serious breach by the principal) or the agent terminates due to age, infirmity or illness.

We have mentioned several times above that claims for compensation or indemnity could be made following termination of the agency contract. Which claim applies will depend on what, if anything, the agency contract says. Unless a written agency contract specifies that an indemnity is payable on termination of the agency contract, compensation would be the default position.

12. Is a force majeure clause needed?

This type of clause is particularly pertinent given the circumstances that have arisen during the COVID-19 pandemic. Basically, a force majeure clause excuses the parties for failing to perform their contractual obligations where that failure results from something which is beyond their reasonable control or has been caused by one of a list of specific events.

The parties should consider very carefully whether such a clause is needed in the agency contract and, if it is, how wide that clause should be. For example, a clause which simply states that a party is not in breach of contract for failing to perform their obligations due to circumstances beyond their reasonable control could, in practice, be very wide and could lead to all sorts of arguments between the parties. At the other extreme, many contracts include a specific list of force majeure events which would excuse performance of contractual obligations although, until recently, many of those would probably not have included a pandemic!

As well as the circumstances in which the force majeure clause would apply, the parties would also need to consider what effect the clause would have, particularly if the force majeure circumstances continue for a considerable period of time. Would there be a stage where the parties would be entitled to terminate the agency contract as a result of the force majeure and what would be the consequences of termination in those circumstances?

13. Check which country’s law applies to the agency contract

This may seem an odd thing to have to pay attention to, but it is important to set out clearly in the agency contract which country’s laws will govern the contract (and also which country’s Courts have jurisdiction to resolve disputes). If you are based in one country, it could be very daunting to have to deal with a dispute about an agency contract in the Courts of another country. These points are likely to become increasingly important after 31 December 2020, particularly where one of the parties is based in the EU.