An Unusual Brew? 

Alan Ramsay Sales and Marketing Limited claimed breach of contract when an agency agreement with Typhoo Tea was brought to an end in May 2013. The contract terms were that 12 months’ notice had to be given, whereas Mr Ramsay was given notice of only 3 months. 

We might therefore have languidly speculated that the quantum of the claim would have been the lost profits for the offending 9 months of the notice period. 

However the claim before the Court was not solely for damages in respect of this missing notice period: the claimant also sought financial recompense for the loss of the capital value of the agency. 

Reading the Tea Leaves

Any precedent bearing the imprint of Lord Hoffman will deservedly have considerable power in common law. The relevant case was that of Lonsdale v Howard & Hallam Limited  [2007] UKHL 32; [2007] ICR 1338. 

Lord Hoffman reverted to the French legal principles which were at the root of the Council Directive. He stated: 

“The French jurisprudence from which the terms of the article is derived appears to regard the agent as having had a share in the goodwill of the principal's business which he has helped to create. The relationship between principal and agent is treated as having existed for their common benefit. They have co-operated in building up the principal's business: the principal by providing a good product and the agent by his skill and effort in selling.”

Lord Hoffman then explained that the French courts had never attempted to compute the goodwill of the principal and then to apportion it. They had instead followed the path of determining the future commissions which would have been procured from proper performance of the agency contract. 

Selecting the Blend 

The Judge, having cited Lord Hoffman at some length, recognised that this was therefore in the nature of a business valuation. He stated the following: 

“For this purpose it is obviously necessary to assume that the agency would have continued and the hypothetical purchaser would have been able properly to perform the agency contract. He must be assumed to have been able to take over the agency and (if I may be allowed the metaphor) stand in the shoes of the agent, even if, as a matter of contract, the agency was not assignable or there were in practice no dealings in such agencies: compare Inland Revenue Comrs v Crossman [1937] AC 26. What has to be valued is the income stream which the agency would have generated.”

The Judge also made the point that the hypothetical buyer would have obtained an asset which was not assignable. The discount rate to be used to determine the present value of future income should be based on the real world circumstances as closely as possible. 

The Views of the Expert Valuers on P/E Ratios

Both valuers started with price earnings ratios from the public markets. The method of one valuer was preferred by the Judge; it can be summarised:

The point was made that the choice of a P/E ratio of 5 was coloured by the profitability of the agency, the existence of a fixed retainer and the financial standing and success of Typhoo Tea. 

We can all recognise that an initial decision point in a business valuation is to determine the nature of the likely buyer. The Judge was persuaded that in this instance the buyer was likely to be an individual or a small business. Such a buyer would be cautious and conservative. The Judge therefore reduced the above P/E ratio from 5 to 4 to allow for this factor. 

An Unexpected Flavour

One of the valuers maintained that the valuation should take account of the 12 months’ notice period in the agency agreement. He made a nuanced point: if there was a possibility of termination in the foreseeable future there was the prospect that the buyer might not be able to operate the agency sustainably. This was another reason why he had used a low P/E ratio of 1 or 2. 

It appears that Counsel for Typhoo Tea may have broadened this point beyond the intentions of his valuation expert: we can all recognise that any termination would have required the business to have been valued at that date in accordance with Article 17 of the Council Directive. Therefore the buyer should have obtained similar value, either from the operation of the agency or in compensation for its termination. 

The Judge was not persuaded by this argument; he reverted to the views of Lord Hoffman who had stated that the buyer should be assumed to be able properly to perform the agency contract. 

Assessing Maintainable Profits

The fixed retainer was £260,000. One valuer considered that the maintainable profits after tax would have been £42,100. The other valuer looked at the figures very differently: he concluded that the results would be from a loss of some £23,000 to very marginal profits of £1,307. One of the points seized on by the Defendants was a note in the financial statements of the Claimant:

"Following the year end a material contract has been cancelled which will have the effect of reducing turnover by approximately £400,000 in the following year. Whilst the contract represented a significant proportion of turnover, it was at relatively low margin so that the effect on profitability is expected to be fairly minimal."

The Judge did not allow this note to dominate the considerations of profitability. 

There were not time sheets allocating time to work for various principals. The Judge preferred the approach of one expert which was to compare the wage costs for the last year of the Typhoo agency with those for the following year, after making adjustment for the reasonable remuneration for Mr Ramsay. This adjustment was based on evidence from the Annual Survey of Hours and Earnings ("ASHE").

The Judge computed pre-tax agency profits of £42,625. This had to be subject to tax with a P/E ratio of 4 then being applied. In addition to this the lost profits for the 9 months of the notice period were assessed at £45,459 before taxation and these lost profits were to be added to the claim.

Final Thought

In the crucible of cross examination there was some uncertainty expressed as to whether or not P/E ratios included any allowance for inflation. 

In the calm of our offices we can recognise that a P/E ratio, although a single number, wraps within it all of the complex market expectations regarding probable growth in future earnings in different territories, currencies and inflation regimes.

Andrew Strickland