How Do You Calculate Commission?

How should a principal calculate the commission payable to its commercial agent? Must every cost and item of income be matched to an individual sale? Can the principal use estimates, averages, and later adjustments?

These questions arose in the recent High Court judgment in Contract Natural Gas (Marketing) Limited v The Joint Liquidators of Contract Natural Gas Limited.

Contract Natural Gas (Marketing) Limited (“the Agent”) had acted as agent for Contract Natural Gas Limited (“CNG”) a natural gas supplier under an agreement made in 2004. Following CNG’s insolvency, the Agent submitted a proof of debt exceeding £6m. Much of the claim represented commission which the Agent said should have been paid between 2014 and 2021.

At the centre of the dispute was the question how the amount of commission should be calculated.

The contractual formula

Clause 6 created CNG’s obligation to pay commission and referred to clauses 9 and 10 for its calculation. Clause 9 governed Gas Supply Agreements. Clause 10 concerned agreements for the installation of meters and associated equipment. Clause 11 dealt with payment.

For gas supplies, clause 9 distinguished between wholesale and retail business and between new and existing business.

Clause 9.1 defined CNG’s yearly Wholesale Gross Gas Margin. In broad terms, it comprised wholesale gas sales income received in cleared funds, less Gas Costs, including storage, and gas transportation costs. Clause 9.2 defined the yearly Retail Gross Gas Margin in the same way by reference to retail sales income.

Under clause 9.8, Marketing was entitled to 25% of CNG’s yearly Wholesale Gross Gas Margin for new wholesale business and 25% of its yearly Retail Gross Gas Margin for new retail business. The applicable rate for existing wholesale and retail business was 15%. Business was generally treated as new during the first 12 months following the customer’s connection to the gas network.

The commission was therefore not 25% of the amount invoiced to a particular customer. It was a percentage of the relevant yearly margin after the deductions allowed by the agreement.

Clause 9.6 separately provided for certain individually authorised one-off transactions. Marketing received 50% of the gross margin on the particular transaction.

What could be deducted?

Although clauses 9.1 and 9.2 contained a formula, “Gas Costs” was not exhaustively defined. Storage was expressly included, but the agreement did not list every permissible expense.

The Agent argued that CNG had deducted costs which should not have reduced the margin used to calculate commission. These included finance costs and expenditure on revenue assurance. The Agent added these amounts back when preparing its proof of debt.

The court treated the issue as one of contractual interpretation. The words “including Storage” indicated that storage was an example rather than the complete category. Finance costs could be included, particularly as earlier arrangements between the parties showed that such expenditure had historically formed part of the calculation. Revenue-assurance expenditure was also sufficiently connected with managing and collecting customer debts.

Accordingly, the expression “gross margin” could not be considered separately from the formula agreed by the parties. Its meaning depended on the income and costs which clauses 9.1 and 9.2 brought into the calculation.

Did the Commercial Agent’s Regulations require a calculation for each supply?

The Agent’s argument for a transaction-by-transaction calculation did not arise from an express term of the agreement. The ordinary gas-supply provisions used yearly margins and estimated annual performance.

Instead, the Agent relied on the Regulations. Regulation 7 identifies the transactions on which an agent earns commission.

Ther Agent argued that these references to transactions overrode the yearly-margin formula. On its case, CNG had to calculate commission separately for every supply to each customer, using only the income and costs attributable to that supply.

The court disagreed. The Regulations identify the transactions attracting commission and regulate when the resulting entitlement arises. They do not prescribe the financial components which must be used to determine the amount.

Principal and agent may therefore agree a formula incorporating wider business costs or averages applied across several sales. Commission can be earned on a transaction without every part of the calculation being exclusive to that transaction. The use of yearly Wholesale and Retail Gross Gas Margins was therefore permitted.

CNG still had to apply the contractual rates correctly. Its spreadsheets appeared to use weighted percentages between 15% and 25% instead of applying the specified rate to the relevant category of business. This might amount to a breach of contract, but it did not make the agreed formula void under the Regulations.

Take home point

For principals and agents, the practical point is that the agreement should identify the applicable margin, percentage, deductions and payment timetable. If estimates will be used, it should state when they will be reconciled and when any balance must be paid. Showing that a calculation may have been wrong does not, without the necessary figures, establish the commission which remains due.