Sudden termination: quantifying your loss using the gross margin method

A distributor that made 40% of its business with a single supplier receives an email announcing that orders will stop within thirty days. An industrial subcontractor finds that its longstanding principal has stopped approaching it, with no explanation and no written notice. In both cases the relationship had been in place for years, and the victim is left with fixed costs, employees and production capacity sized for a flow of business that collapses overnight. The real question is not whether the termination is wrongful, but what it is worth, and above all how to quantify it in a way the court will accept. This guide sets out the method based on margin on variable costs (marge sur coûts variables), the documents to assemble and the calculation errors that prove costly, from the standpoint of the victim, whether supplier or distributor.

The legal basis: the abruptness, not the termination itself

French law does not penalise the fact of ending a commercial relationship. Everyone remains free to choose their partners and to end a flow of business. What the law penalises is the abruptness of the termination, that is, the absence of written notice or its inadequacy. The conditions of application of the provision, the notice period and compensation are set out in our article on the sudden termination of established commercial relationships.

The applicable provision is Article L. 442-1, II of the French Commercial Code, resulting from Ordinance No. 2019-359 of 24 April 2019. It took over, while rewording it, the former Article L. 442-6, I, 5°, on which most of the case law still cited today is based. The principle is as follows:

Any person carrying on production, distribution or service activities who suddenly terminates, even partially, an established commercial relationship, without written notice that takes into account in particular the duration of the commercial relationship, by reference to trade practice or inter-trade agreements, incurs liability and must compensate the loss caused.

Three notions structure the litigation. An established commercial relationship presupposes a continuing, stable and habitual flow of business whose continuation the victim could reasonably expect. A regular flow of orders over several years meets that test; a few isolated transactions do not. The termination may be total or partial: a sudden and substantial drop in the volumes ordered falls under the same regime as an outright stop. Finally, the abruptness is assessed against the notice that should have been given, taking into account mainly the length of the relationship. The way in which a partial termination is recognised, in particular in the case of a drop in orders or delisting, is dealt with separately in our dedicated article.

The 2019 Ordinance introduced a safeguard for the party that terminates: its liability cannot be engaged for insufficient notice if it gave eighteen months' notice. This eighteen-month ceiling is therefore the theoretical maximum of the compensable period, even in the oldest and most dependent relationships.

What the court compensates: the lost margin, not the turnover

This is where most quantifications go wrong. The victim's reflex is to think in terms of turnover: "I was losing so many orders a month, I claim the equivalent over the missing notice period." That reasoning leads to an inflated claim, which the courts systematically reject.

The loss that is compensable when calculating loss for sudden termination is not the loss of turnover, but the loss of the margin that the victim would have earned had the notice period been observed. The logic is economic: during the notice period, the victim would have continued to sell, and so to collect turnover, but it would also have continued to bear the costs necessary to produce or deliver. What it actually loses is the balance between the two, in other words its margin.

Gross margin or margin on variable costs

The terminology is confusing and must be handled with precision. Gross margin in the accounting sense is the difference between turnover and the purchase cost of the goods or materials consumed. It is useful as a first approach, which explains why the expression gross margin over the missing notice period is widely used in exchanges between practitioners.

But the reference adopted in the case law of the Commercial Chamber of the Cour de cassation is finer: it is the margin on variable costs, that is, the lost turnover reduced by all the variable costs that the victim did not have to incur because the activity stopped. The reason is logical: these variable costs (materials, subcontracting, transport, commissions, production energy directly linked to volume) disappear when the activity stops, the victim does not bear them, and they are therefore not part of its loss.

By contrast, fixed costs (rent, depreciation, salaries of permanent staff, insurance) remain payable even after the termination. They must not be deducted, since the victim continues to bear them without the turnover that covered them. It is precisely this distinction that explains why the margin on variable costs is higher than a "net profit" and is the right reference for compensation for termination of a commercial relationship.

The calculation method, step by step

The quantification rests on a formula that is simple in principle: average monthly margin on variable costs, multiplied by the number of months of missing notice. The whole difficulty lies in justifying each of the two terms.

Step 1: determine the notice period that should have been observed

There is no statutory scale. The duration is assessed case by case, under the control of the lower courts. The central criterion is the length of the relationship, but several other factors lengthen the reasonable notice period:

• the victim's state of economic dependence, that is, the share of the terminating supplier or customer in its total turnover
• the specificity of the products or dedicated investments (specific tooling, allocated stock, bespoke development)
• the difficulty of finding an equivalent partner on the relevant market
• the existence of exclusivity, which weakens the victim further

Practitioners often use, as a starting point, an order of magnitude of one month of notice per year of relationship, but this is only an indicative grid that the court adjusts in either direction. A long relationship combined with strong dependence may justify a markedly longer notice period, within the eighteen-month ceiling set by Article L. 442-1, II. On the reading of the criteria applied by the courts, see our analysis of the calculation of the sufficient notice period.

The duration of the missing notice is then obtained by difference: the notice that should have been given, less the notice actually observed. If the terminating party gave one month's notice when twelve were required, the missing notice is eleven months. That missing period, and only that period, serves as the multiplier.

Step 2: establish the reference margin

The margin on variable costs earned on the terminated relationship must be reconstructed over a representative period. Practice and experts generally use an average calculated over the last three financial years, in order to smooth out cyclical fluctuations and neutralise an atypical year.

The calculation proceeds as follows: start from the turnover achieved with the partner concerned, deduct only the variable costs, and the result is the margin on variable costs. Divided over the period, it gives an average monthly margin.

Take a numerical illustration, presented purely for teaching purposes to show the mechanism. Suppose a parts supplier achieved with a principal an average annual turnover of €600,000 over the last three financial years, with a margin rate on variable costs of 35%. The annual margin on variable costs is €210,000, or €17,500 per month. If the missing notice is eleven months, the compensation for termination amounts to €192,500. These amounts are given for the example only: in a real case, every figure must be taken from the victim's accounts.

Step 3: the complete formula and its adjustments

The consolidated formula is therefore: compensation = average monthly margin on variable costs × number of months of missing notice. Two adjustments are frequently discussed.

First, the trend of the business. If the flow of business was growing steadily, the victim may argue for an upward projection; if it was already declining, the terminating party will argue for a downward adjustment. A three-year average naturally tempers these effects.

Second, the duty to mitigate. French law does not require the victim to reduce its own loss, but if it has actually redeployed its resources to other customers during the period, the opposing party will try to rely on that to reduce the lost margin. Hence the value of documenting precisely the real situation of the business during the months concerned.

The documents to assemble to prove the loss

The burden of proof rests on the victim. A quantification, however rigorous, is worth only the documents that support it. The evidence is built on two fronts: proving the relationship and its abruptness, then proving the margin.

To establish the established commercial relationship and its termination, the following should be assembled:

• purchase orders, invoices and account statements over the whole duration of the relationship, year by year, to show its length and regularity
• any framework agreement, general terms and conditions, listing or exclusivity agreements
• the correspondence that evidences the termination (email, letter, minutes of a meeting) and its date, a decisive element for measuring the notice actually given
• earlier exchanges showing confidence in the continuation of the relationship (shared forecasts, investment plans requested by the partner)

To establish the reference margin, the accounts are paramount:

• the tax returns and annual accounts for the last three financial years
• management accounting isolating the turnover and variable costs attributable to the partner concerned, or failing that a documented reconstruction
• the detailed breakdown of fixed and variable costs, item by item, since this is the opposing party's preferred ground of discussion
• a certificate from the chartered accountant, or even a private expert report, which lends credibility to the margin rate used

In significant cases, producing a note from a chartered accountant setting out the method and the rate of margin on variable costs often makes the difference, because it turns an allegation into a quantified demonstration that can be relied on against the other side.

The most frequent calculation errors

Some errors recur systematically and weaken, or even ruin, an otherwise well-founded claim.

Claiming turnover rather than margin. This is the cardinal error. It leads to a claim two to three times higher than what the court will award, discredits the whole case and gives the opposing party an easy line of attack.

Confusing margin on variable costs with net profit. Conversely, deducting fixed costs from the calculation base understates the claim. Fixed costs remain payable after the termination and must not be deducted. A poorly advised victim under-compensates itself.

Choosing the wrong reference period. Using a single year, either particularly good or particularly bad, invites immediate challenge. The three-year average is the expected standard.

Adding the notice given to the missing notice. Only the missing notice is compensable. If notice was partly observed, it must be subtracted from the theoretical duration, failing which the multiplier is artificially inflated.

Ignoring the eighteen-month ceiling. A claim calculated over a period longer than eighteen months is bound to be brought back within that limit. It is better to base the reasoning on that ceiling from the outset.

Failing to classify variable costs item by item. Relying on an overall rate without justifying what is variable and what is fixed weakens the quantification. Transport, commissions, materials and direct subcontracting are generally variable; management, rent and depreciation are fixed. Each item must be argued.

Ancillary compensable losses

The margin lost during the missing notice period is the foundation of compensation for termination of a commercial relationship, but it does not always exhaust the loss. Depending on the circumstances, the victim may claim additional heads of loss, provided they are proved separately.

Unamortised specific investments made for the partner (a dedicated machine, bespoke tooling, site fit-out) may be compensated where they become useless because of the termination and could not be amortised for lack of sufficient notice. Their exclusive or main allocation to the terminated relationship must be shown.

Stock that has become unsaleable, built up in anticipation of orders that will not come, may also give rise to compensation, on proof of its specific nature and of the impossibility of selling it elsewhere.

The social costs of an economic redundancy made necessary by the loss of the flow of business may, in some cases, be attributed to the termination. Demonstrating a direct causal link is demanding here.

Finally, if the termination is accompanied by separate breaches (disparagement, diversion of customers, failure to comply with contractual obligations), these rest on independent grounds and are cumulative with compensation for the abruptness, without merging with it.

Conclusion: quantify accurately rather than aggressively

The natural reflex of the victim of a sudden termination is to claim a great deal. That is a strategic error. Before the courts, a claim calibrated on the margin on variable costs, supported by three financial years and documented by the chartered accountant, always prevails over a spectacular claim built on turnover. The credibility of the quantification determines the outcome as much as the substance of the law.

The position is therefore clear: an exact and unassailable compensation for sudden termination is better than an inflated claim that invites the court to start again from a lower figure. The method comes down to a rigorous equation, monthly margin on variable costs multiplied by the months of missing notice, within the limit of eighteen months, surrounded by a solid body of evidence.

Before bringing the action, have your margin on variable costs reconstructed by your chartered accountant and have each cost item classified as variable or fixed: it is this document, more than the principle of fault, that will determine the amount you obtain.

Frequently asked questions

What is the basis for calculating the loss in the case of sudden termination of a commercial relationship? The basis adopted in the case law is the margin on variable costs, that is, the lost turnover reduced by only the variable costs that the victim did not have to incur because the activity stopped. Fixed costs are not deducted, since they remain payable. The compensation corresponds to that margin applied to the duration of the notice that should have been observed. Gross turnover is never the right reference.

What notice period does the court use? There is no statutory scale. The duration is assessed mainly according to the length of the relationship, the victim's economic dependence, the specificity of the products and the difficulty of finding a partner. An indicative benchmark often used is about one month of notice per year of relationship, which the court adjusts freely. Article L. 442-1, II of the French Commercial Code nevertheless caps the compensable period at eighteen months.

Should the calculation use gross margin or margin on variable costs? The accounting gross margin (turnover less purchase cost) serves as a first approach, but the legally relevant reference is the more precise margin on variable costs. It isolates exactly what the victim loses, namely the turnover reduced by the costs that disappear with the activity. Using net profit would wrongly understate the claim, because it would deduct fixed costs that continue to be borne.

Over how many financial years should the reference margin be calculated? Practice generally uses an average of the last three financial years. This three-year average smooths cyclical variations and neutralises an atypical year, which makes the quantification harder to challenge. Using a single, particularly favourable year invites an immediate reduction by the opposing party.

What documents should be assembled to prove the loss? The relationship and its termination must be proved first: invoices and purchase orders over the whole period, any framework agreement, the dated letter or email of termination. The margin must then be proved: tax returns, management accounting isolating the partner, a detailed breakdown of fixed and variable costs and, ideally, a certificate from the chartered accountant. That last document lends credibility to the rate of margin on variable costs used.

Can anything other than the lost margin be claimed? Yes, subject to separate proof. Depending on the circumstances, the following are compensable: unamortised specific investments, unsaleable stock and, sometimes, the social costs of an economic redundancy directly caused by the termination. Independent breaches such as disparagement or diversion of customers rest on separate grounds and are cumulative with compensation for the abruptness.

Is notice already given deducted from the calculation? Yes. Only the missing notice is compensable. The theoretical notice period is determined, then the notice actually observed is subtracted from it; the difference serves as the multiplier of the monthly margin. Adding the two periods together is a frequent error that artificially inflates the claim and weakens the whole case.