Bad Commission Agreements—Lawsuit Magnet

Sales compensation litigation is especially tricky because commissioned salespeople are particularly litigious. They are trained to read complicated agreements, and they will find the bad provisions.

Furthermore, sales personnel are very persuasive speakers—that’s why you hired them—and they’re likely to be able to convince the court of their interpretation of the commission agreement.

Kato, who practices employment law in San Francisco, offered his tips at a recent Sales Compensation Bootcamp hosted by BLR.

A Commission Agreement That Holds Up

What does it take to have a commission agreement that will hold up legally? Unfortunately, says Kato, there’s no magic bullet—you can’t avoid the hard work of crafting your commission agreement because it has to be closely tied to your business.

Start with your compensation strategy from a business standpoint. Will incentives encourage sales personnel to work harder? On the other side, you must think through whether incentives may have adverse consequences.

In any case, Kato says, questions will arise about interpretation, and they can be extremely costly, so it is critical to avoid ambiguity in commission agreements.

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Legal Background

Commission agreements are largely a creature of standard contracts law and that means you have to consider both federal and state law.

Agencies and courts give employers substantial latitude in setting conditions for vesting of commissions at the beginning of a relationship or plan year.

However, once conditions for vesting are satisfied, agencies and courts do not allow employers to avoid their commission obligation (in other words, no chargebacks, clawbacks, or forfeitures). (“The law abhors a forfeiture,” Kato says.)

Commissions Defined

It’s important to clarify whether the payments you make to salespeople are truly commissions, because the difference may affect contract enforcement and exemption analysis, Kato says.

Federal and state can differ. For example, under federal law, in one case, auto mechanics who received a flat percentage of repair charges were deemed to be receiving commissions, while in a California case with the same parameters, the mechanics were not receiving a commission because they were the people rendering the service.

As for the auto mechanics exemption, their paid “commissions” may exempt them under the FLSA but not under California law.

Litigation

The number one basis for litigation is that the employer did not clearly state conditions for vesting and tries to take back vested commissions, says Kato.

Employers also create legal problems where conditions (albeit clear) are so one-sided as to be “unconscionable” and, as a result, unenforceable as a matter of law.

Key Elements of Commission Agreements

In drafting your agreements, says Kato, focus especially on the definition of “vesting” and when commissions are earned or vested. (It’s also important to state what happens when an employee terminates or transfers out of the sales role.)

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Vesting of Commissions

When is a commission deemed “earned”? Since the employer is afforded significant latitude to define the conditions, use that opportunity, says Kato.

Be sure your agreement adheres to three basic requirements:

• Must be clear. Keep it simple
• Must be done in advance. In addition, the agreement should be in writing and signed by the employee.
• Must be tied to the employee’s actual job duties (e.g., collection of revenue). Where the commission is not earned until the customer pays—collection of the revenue—make the collection of revenue part of the employee’s job description. The salesperson doesn’t have to be totally responsible. Accounts receivable, for example, may do much of the work, but the salesperson should be required to assist as needed. This avoids an employee argument that the condition of revenue collection was not a “real” condition but a subterfuge by the employer to avoid or delay payment.

In tomorrow’s Advisor, more on sales compensation agreements, plus we announce a timely webinar on salary communication.