E Employment Law DRAFTING ENFORCEABLE SALES COMMISSION PLANS

Employment Law
C O M M E N TA RY
VOL. 16, NO. 10
OCTOBER 2004
D R A F T I N G E N F O R C E A B L E SALES COMMISSION PLANS
U N D E R N E W Y O R K A N D C ALIFORNIA LAW
By Donna M. Shibata
E
mployers often encounter problems in drafting
enforceable compensation plans for their commissioned sales employees. Contract provisions that
might make business sense can run afoul of state wage
and hour laws – and to further complicate matters for
employers, these laws vary considerably state to state. This
Commentary compares New York and California law governing commission plans to illustrate how legal requirements do
vary and highlights common, recurring problems encountered in drafting commission plans. Since the employer
generally drafts the compensation plan, and therefore any
ambiguities will be construed against the employer, it is particularly important that the employer draft the plan carefully
and with attention to detail.
Commission Payments During Employment
New York
Under New York law, “commission salesmen” must be
paid their commissions no later than the last day of the
month following the month in which these commissions are
earned.1 For example, if a commission plan provides that a
commission is earned in January, the commission must be
paid by the end of February. If the commission plan provides that commissions are earned at the end of a quarter,
the “commission salesman” rule would require the commissions to be paid by the last day of the month following the
end of the quarter. The employee would meanwhile receive
his or her salary at least once a month, as it is earned.
The list of problems employers must deal with is similar
state to state. Employers often confuse “commissions”
with other types of incentive pay such as bonuses and piece
rates, which can be subject to different rules. Commission
plans often do not comply with state law governing when
commissions must be paid during employment and after an
employee is discharged or quits. Commission plans often do
not comply with state law prohibitions against deductions
and “forfeiture” clauses. With care, an employer can avoid
these common problems, and minimize the disputes over the
timing and the amount of commissions owed and potential
exposure to the significant penalties for failure to pay commissions on time.
“Commission” is defined as “compensation accruing to a
sales representative . . ., the rate of which is expressed as
a percentage of the dollar amount of wholesale orders or
sales.” “Earned commission” means “a commission due for
services or merchandise which is due according to the terms
of an applicable contract“ or, when there are no applicable
contractual provisions, “a commission due for merchandise
which has actually been delivered to, accepted by, and paid
for by the customer, notwithstanding that the sales representative’s services may have terminated.”
Not everyone who earns commissions qualifies as a “commission salesman,” however. Employees whose “principal
activity” is selling goods or services are subject to this rule,
but not employees whose principal activity is of a supervi-
M O R R I S O N
sory, managerial, executive, or administrative nature. This
means that an employee whose primary role is supervising or
managing salespeople typically would not qualify as a “commission salesman.” No specific rule governs the timing of
commission payments to such employee. An independent
contractor working as a “sales representative” also is not
a “commission salesman” and is subject to different rules.
For example, a sales representative must be paid his or her
earned commission in accordance with the agreed terms of
their contract, but no later than five business days after the
commission has been earned.
California
California’s Division of Labor Standards Enforcement
(“DLSE”) takes the position that commissions must be paid
on the next regular payday after they have been earned
and are “reasonably calculable.” An employer has the flexibility to deem commissions earned either when the sale is
made or when the customer pays for the product or service.
“Commission” is defined as “compensation paid to any
person for services rendered in the sale of such employer’s
property or services and based proportionately upon the
amount or value thereof.”2 To be a “commission” under
California law, the compensation must arise from the sale of
a product, not the making of a product or the rendering of a
service or service; and the compensation also must be a percentage of the price of the product or service.
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control of the employee. Employers may not make deductions from commissions for cash shortages, breakages, or
losses of equipment that result from simple negligence. An
employer is also prohibited from making deductions from
commissions to cover the cost of workers’ compensation.
Following this line of reasoning, the DLSE issued an opinion
letter, dated October 4, 1990, which invalidated an employer’s practice of reducing its employees’ earned commissions
for losses incurred through “slow paying accounts” (e.g.,
bad debts, uncollectible accounts). In this opinion letter,
the DLSE found the employer’s practice to be unenforceable
because it, in essence, held employees liable for business
losses that were beyond their control.
Commission deductions for products that are returned
within a certain period of time are generally permissible
if it is possible to identify the specific commission at issue
and the employee who received that commission. A commission plan that permits deductions for returned products
that cannot be attributed to a particular salesperson likely is
unenforceable, however.3
Commission Payments on Termination
New York
Deductions from Commissions
Under New York law, if employment is terminated, the
employer must pay the wages, including earned commissions, no later than the regular payday for the pay period
during which the termination occurred.4
New York
California
New York law generally prohibits an employer from
deducting any sum from an employee’s commissions and
other wages, except for deductions for the benefit of the
employee (e.g., pension, health benefits). Examples of prohibited deductions are deductions for spoilage or breakage,
cash shortages or losses, and fines or penalties for lateness,
misconduct, or quitting by an employee without notice. The
reasoning is that the employer should bear the risk of such
losses rather than the employee.
California employees who are discharged, or who resign with
72 hours’ notice, are entitled to all wages due at the time
of termination.5 If the resigning employee fails to provide
California
In California, as a general rule, an employer is prohibited
from making deductions from its employee’s commissions
and other wages for business losses that are beyond the
notice, the employer has 72 hours after the resignation to
make payment. According to a DLSE opinion letter dated
January 9, 1999, if commissions have been “earned” on or
before the date of termination, the employer must complete
the necessary calculations and pay the commissions at the
time of termination. An employer may not wait until the
customary time for calculating the commissions of current
employees, nor delay payment of earned commissions until
the next regularly scheduled pay date. The DLSE recognizes,
however, that there are some situations in which commissions are not calculable until after termination and thus are
not due until that time.
E M P L O Y M E N T
In California, an employer should evaluate whether a terminated employee should receive pro rata commissions on
any of his or her pending sales. Each situation needs to
be considered on a case-by-case basis. For example, if an
employee is terminated after performing substantially all of
the work necessary to earn a commission, an employer may
be required to pay at least a pro rata portion of the commission. If the employer discharges an employee and the
employee is thereby prevented from completing his or her
duties, the employee may be able to recover all or a pro rata
share of his or her commissions.
Forfeiture Provisions
New York
In New York, an employee’s right to commissions turns on
interpretation of the commission pay plan. Once commissions are earned, they cannot thereafter be forfeited.
Commissions, absent an agreement to the contrary, are not
generally forfeited by the employee’s discharge or resignation.
California
A California court of appeals has upheld the enforceability
of a provision whereby an employee forfeits his or her right
to commissions on sales generated during employment
where payment for the sales is received after termination of
employment.6 This decision appears to be inconsistent with
the predominant view of California courts and the California
Labor Commissioner, however.7 Where an employee had
done some work, for example, the Labor Commissioner
would be unlikely to enforce a forfeiture provision and
instead would deem the commission earned on a pro rata
basis.
Penalties for Failure to Properly Pay Commissions
A poorly drafted commission plan can lead to disputes over
the timing and amount of commissions owed. In both New
York and California, employees can seek to recover unpaid
commissions and significant penalties for failure to pay commissions on time.
L A W
C O M M E N TA R Y
New York
New York imposes strict penalties for failure to pay commissions and other types of wages. Employees have the right
to recover wages (including commissions) earned during the
six years preceding the start of the legal action.8 Aside from
recovering the amount of the unpaid wages, an employee
can seek an additional penalty equal to 25% of the amount
owed and recover his or her attorneys’ fees if the failure
to pay was willful. Additionally, such an employer may be
required to pay the state labor commissioner a penalty of
$500 per violation. Beyond these monetary liabilities, New
York law provides that the employer may be considered
guilty of a criminal offense. The employer’s first offense
would be considered a misdemeanor, and any subsequent
offense would be a felony, with each offense punishable by
a fine of between $500 and $20,000 and/or imprisonment
for up to one year.
California
In California, an employee must file a wage claim with the
DLSE or in court within four years if the claim is based on
a written agreement.9 If the employer willfully fails to pay
any wages of an employee who is discharged or quits, the
employer can be liable for up to 30 days’ wages for the
period of the delay, unless the employer can demonstrate
that a good faith dispute exists as to whether any commissions were due. The employer also could be subject to a
civil penalty for each such missed or untimely payday: $100
for an initial violation, and $200 for each subsequent violation. In addition, for any willful or intentional violation the
employer is subject to a penalty of $200 per day plus 25%
of the amount unlawfully withheld. The prevailing party
also can recover its reasonable attorneys’ fees and costs. In
addition, under the Private Attorneys General Act (Cal. Lab.
Code § 2699), employees can now bring lawsuits to pursue
penalties that in the past were only available to the Labor
Commissioner.10 Beyond these civil penalties, California law
provides that any employer who willfully refuses to pay, or
falsely denies the amount of, wages is guilty of a misdemeanor.
Tips for Drafting Enforceable Compensation Agreements
As this review of New York and California law illustrates,
understanding the applicable state law is essential when
M O R R I S O N
drafting compensation agreements. Care needs to be taken
to spell out exactly how and when commissions are earned
and paid. Employers can draft clear and enforceable commission plans by keeping in mind the following tips:
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4
N.Y. Lab. Law § 191(3).
5
Cal. Lab. Code §§ 201, 202.
6
American Software, Inc. v. Ali, 46 Cal. App. 4th 1386, 1393-94
(1996).
7
• Have a written plan;
See, e.g., Ellis v. McKinnon Broadcasting Co., 18 Cal. App. 4th
1796, 1805-06 (1993).
8
• Draft the payment formula to be clear that the payments
are “commissions” under the applicable state law;
• Specify when and how a commission is earned, and when
the commission will be paid in accordance with applicable
state law;
• Specify the deductions, if any, made from commissions in
accordance with applicable state law;
• Specify how and when draw arrangements will be reconciled; and
N.Y. Lab. Law § 198.
9
Civ. Proc., § 337(1). The statute of limitations for unpaid wage
claims based upon oral agreements is two years. Cal. Civ. Proc.
Code § 339. The statute of limitations is three years for statutory
claims such as waiting time penalties under Lab. Code § 203.
10
For more information about the Private Attorneys General Act,
please refer to the Employment Law Commentaries, “Sense and
Sensibility”: Legislative Amendments to the California Labor
Code’s Private Attorney General Act (August 2004), and Legislative
Updates: Governor Davis’s Last Hurrah (November 2003).
This newsletter addresses recent employment law developments. Because of
its generality, the information provided herein may not be applicable in all
situations and should not be acted upon without specific legal advice based on
particular situations.
Editor: Lloyd W. Aubry, Jr., (415) 268-6558
SAN FRANCISCO
• Specify that all commissions earned on or before the date
of termination will be paid when the final base salary payment is made, in accordance with applicable state law.
Because of the stakes involved, especially for national
employers, legal review by counsel is a good way to avoid
problems based on inadvertent drafting ambiguities.
Donna M. Shibata is an associate in our San Francisco office
and can be reached at (415) 268-7518.
Elizabeth P. Allor
Lloyd W. Aubry, Jr.
James E. Boddy, Jr.
Judith Droz Keyes
James C. Paras
Linda E. Shostak
Walter M. Stella
PALO ALTO
David J. Murphy
Eric A. Tate
Raymond L. Wheeler
Tom E. Wilson
LOS ANGELES
Sarvenaz Bahar
Michael Chamberlin
Timothy F. Ryan
Janie F. Schulman
B. Scott Silverman
Marcus A. Torrano
NEW YORK
Miriam H. Wugmeister
CENTURY CITY
1
N.Y. Lab. Law § 191(1-c) provides:
A commission salesman shall be paid the wages, salary, drawing account, commissions and all other monies earned or
payable in accordance with the agreed terms of employment,
but not less frequently than once in each month and not
later than the last day of the month following the month in
which they are earned; provided, however, that if monthly or
more frequent payment of wages, salary, drawing accounts
or commissions are substantial, then additional compensation
earned, including but not limited to extra or incentive earnings,
bonuses and special payments, may be paid less frequently
than once in each month, but in no event later than the time
provided in the employment agreement or compensation plan.
2
3
Cal. Lab Code § 204.1.
Hudgins v. Neiman Marcus Group, Inc., 34 Cal. App. 4th 1109,
1117-24 (1995).
Ivy Kagan Bierman
ORANGE COUNTY
Robert A. Naeve
Steven M. Zadravecz
SAN DIEGO
Rick Bergstrom
Craig A. Schloss
DENVER
Stephen S. Dunham
Steven M. Kaufmann
Tarek F.M. Saad
LONDON
Ann Bevitt
Simeon Spencer
David C. Warner
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