Legal Updates

Commit To Carefully Crafted Commission Plans

August 2008 by Sara Goldsmith Schwartz

Too often, employers focus up front on the financial incentives of the commission payment arrangement with a sales employee and, unfortunately, fail to address what will happen to an earned commission or advance on a commission following the employee’s termination of employment. As a result, disputes over sales commissions have become fertile ground for wage and hour complaints.

Because most state statutes define the term “wages” to include sales commissions, a dispute over what a current or former employee is owed can result in a non-payment of wages complaint to the state attorney general and, potentially, liability in the form of civil and criminal penalties, multiple damages and attorneys’ fees. It is absolutely critical that employers carefully craft written sales commission plans that address certain key definitions and payment mechanisms, particularly given the recent court opinions and legislation discussed briefly below. In addition, employers should develop, maintain and communicate consistent sales commission payment practices that reflect the terms of written commission plans.

A March 2008 opinion by the Connecticut Supreme Court provides the most recent illustration of the importance of written sales commission plans and policies. In Ravetto v. Triton Thalassic Technologies, Inc., 285 Conn. 716 (2008), the Connecticut Supreme Court held that, absent a specific contractual provision, an employer could not recover an advance on future commissions from a sales employee by withholding salary owed upon termination of employment. In Ravetto, a sales executive who received an annual six-figure salary, plus commissions, had been allowed to take a draw (or an advance) against future sales commissions. When the employer experienced poor financial performance, several employees, including the sales executive, remained with the employer despite the employer’s inability to meet its payroll obligations. Ultimately, the company furloughed all remaining employees, including the sales executive, and the sales executive elected to cease his employment with the company.

The sales executive filed a claim under the Connecticut Wage Act, seeking double damages and attorneys’ fees, alleging that he was owed unpaid salary plus interest. The company contended that it had withheld all salary due to the fact that the employee had not repaid $40,000 in commission draws in excess of the commissions earned. The company claimed that the term “advance” in the employee’s employment agreement, which was not defined, sufficiently entitled the company to withhold salary for the unreturned draw on commissions.

The Connecticut Supreme Court disagreed. Specifically, the Court held that the employer generally has “superior bargaining power” in the employment relationship, thereby making it the employer’s obligation to expressly define repayment terms. Moreover, the Court concluded that terms such as “advance” and “draw” are not self-explanatory and therefore do not, without express defining language, obligate repayment by the employee. Significantly, citing Massachusetts and Georgia case law, the Connecticut Supreme Court stated the general rule that “if no express or implied contract for repayment is established, the employee is not liable to the employer for repayment of advances that exceed earned commissions.” Ravetto, 285 Conn. at 738.

This decision by the Connecticut Supreme Court is reflective of the trend in many other states with regard to commission plans. For example, effective October 16, 2007, New York law will require all employers, regardless of the industry, to reduce sales commission agreements to writing, signed by both the employer and employee. Moreover, the New York law will require the written commission plan to:

describe how wages, salaries, draws on commissions, commissions and other amounts earned and payable are calculated;
state the frequency of reconciliation between draws and earned commissions, if the employer allows recoverable draws; and
describe what happens upon termination of employment to the salesperson’s wages, salary, draw, commissions and other monies earned and payable.

Employers in New York are required to maintain copies of the signed written commission plans for three (3) years. Notably, successful plaintiffs in actions under this new law are entitled to attorneys’ fees and liquidated damages. Finally, consistent with the recent Connecticut Supreme Court decision, an employer’s failure to reduce the commission plan to writing as set forth above creates a presumption against the employer seeking to enforce its interpretation of the commission plan.

Similarly, under the Massachusetts Wage Act, employees can seek recovery of unpaid sales commissions. Generally, under Massachusetts law, commissions must be paid when they are “definitely determined” and have become “due and payable.” Significantly, then, a Massachusetts employer that fails to provide an employee with a carefully-drafted sales commission plan and withholds commissions may arguably violate the Massachusetts Wage Act. Under an amendment to the Massachusetts Wage Act effective July 13, 2008, the employer would be liable to the employee for mandatory treble damages (i.e., three times the monetary damages), interest and attorneys’ fees.

Given these recent developments in state wage laws, employers are strongly encouraged to:

Reduce their sales commission plan to writing and require the signature of the employee and the employer representative;
Clearly define key terms such as “draw,” “advance” and “sale”;
Ensure that commission calculation mechanisms are understandable and consistent so that they can be easily interpreted by the employee, management and payroll;
Explain what will happen to a commission upon an employee’s termination of employment, whether voluntary or involuntary, and address whether there will be a different outcome if the employee is terminated for cause;
Identify when commissions will be paid, in accordance with state laws governing timely wage payments;
Consider integrating an at-will employment provision as well as an arbitration clause obligating the employee and employer to submit a commission dispute to a third-party neutral instead of the courts; and
Revisit commission plans and require employees to re-execute commission agreements annually.

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Because commissions have become an increasingly frequent basis for wage complaints, we encourage employers without written sales commission plans to promptly draft a commission plan in compliance with all applicable state laws. In addition, we urge employers to review their current written sales commission plans to ensure state law compliance and to reduce the risk of potential claims under state payment of wages statutes. As noted above, failure to take such measures may expose the employer to liability and substantial monetary damages.