When Is a Sales Commission Legally Earned?
On behalf of Morris E. Fischer, LLC posted in Articles on January 15, 2014
It is not uncommon for sales representatives who experience transition in their careers, either voluntarily or otherwise, to close sales while in the company's employ but not get compensated for their successes. Whether compensation is purposely or unintentionally withheld by the company, the effect is the same. A legal dispute will arise as to the sales person's right to earn the commission. For example, what if a sales representative closes a sale, but the customer doesn't send in payment until after the sales person has left the company? In other words, when does a sales representative, in the legal sense, earn the commission?
Unfortunately, there is no single answer to this issue. Many factors such as a particular state's law, the written contract and other communication can all influence the earning's timing. There are certain universal guidelines that federal and state courts will look to in deciding the timing issue, however. Sales representatives should be familiar with them in order to prepare themselves well in advance of any dispute, thereby providing them a serious edge in any future litigation.
The Employment Contract
When sales representative are hired, the initial employment contract, coupled with an incentive or commission schedule, will usually describe the obligations of both the company and the sales representative. My office litigated two cases, both against the same manufacturer, who contended that it was understood that sales were earned only when the customer sent in payment. The problem with that defense was that the employment agreement didn't say that. Instead, it stated in plain English that the sales manager was to be paid 1% of sales. The contract could have expressed the very provision the defense attorney contended during the litigation, that the commission earnings were contingent upon the customer sending in payment. However, it didn't. The company wound up paying a total of $100,000.00 in sales commissions before a single deposition was ever taken.
The Parties' Understanding
In the absence of express provisions in the employment agreement, the Courts will consider communications between the company and the sales person over the course of their dealing throughout the sales representative's employment at the company. For example, in response to a sales person's inquiry about a commission due, the company may respond that the particular customer never sent in payment for the goods and, as such, it cannot yet make payment to the sales person. If that response goes unchallenged, the Courts may look at that as an admission by the sales person of the company policy.
The parties' understanding as to the timing of earned commissions can also surface when the sales person is negotiating a severance agreement, which will typically provide for the payment of "earned commissions." We knew of at least one case where the salesperson sent an email to the company representative to clarify that "earned commissions" meant even those for which the customer sent in payment following his termination. The company representative responded that the company in accordance with its policy would not pay commissions on monies not yet received. The sales representative signed the release anyway and put himself in a serious disadvantage of persuading a Court that "earned commissions" meant what he claimed it meant.
In a case recently decided by a Federal Court in Michigan, Shaw v. MRO Software, Inc., 2006 U.S. Dist. LEXIS 78456 (E.D. Mich. 2006), both parties agreed that a compensation plan, including earned commissions, was to be interpreted consistently with the US Generally Accepted Accounting Principles ("GAAP"), and the US Generally Accepted Auditing Standards ("GAAS"). As such, the controlling principles of revenue recognition are: 1) Persuasive evidence of an arrangement exists; 2) Delivery has occurred; 3) The vendor's fee is fixed or determinable; 4) Collectibles are probable. The sales person argued since he had a secured a signed license agreement, that alone satisfied the applicable GAAP and GAAS standards.
The Michigan Court rejected the salesman's argument. It pointed to the Plaintiff's deposition in which he conceded that if the customer didn't issue the purchase order before the quarter ended, he didn't have a deal for revenue recognition purposes within that quarter. He also admitted that his understanding while employed with MRO Software, was that a valid purchase order before the end of the quarter had to be in MRO's possession to earn the commission. In fact, the Plaintiff even offered to drive from his home in Howell, Michigan, to Kokomo, Indiana, to pick up a hard copy of the customer's purchase order on September 30, 2004, to ensure receipt by the company. Consequently, the sales person had a very difficult time arguing that he didn't have any reason to believe that commissions weren't earned until the customer sent in payment.
Certain states, such as Maryland, invalidate employment agreements in which the earnings of sales commissions are predicated by factors beyond the sales person's control. In Medex v. McCabe, 372 Md. 28; 811 A.2d 297(2002), the Maryland Court of Appeals held that a provision in a contract requiring the sales person to remain in the company's employ to earn his commissions was invalid, against public policy and an anathema to Maryland's Labor & Employment Articles 3-501 through 3-507, which permit a sales representative to recover up to three times the amount of the unpaid sales commission and attorney fees.
Other cases brought in Maryland using this principle compelled one Maryland Federal District court to analyze the legitimacy of certain company requirements for the payment of commissions based upon whether the requirements are arbitrary or within the control of the sales person. The Court's attitude was favorable to the sales person if such sales representative completed all of his duties to secure the commission and an arbitrary event out of the sales rep's control occurred after the sales person's termination from the company.
In conclusion, sales people, upon anticipating separation from their current company, should immediately secure a copy of any document signed upon being hired. This will inevitably include employment agreements, and possibly supplements. Additionally, he or she should secure copies of employment handbooks and any written communications that may impact each party's understanding of when commissions are earned. It's best to have those reviewed by an employment lawyer before separation. Don't sign any release or separation package before receiving legal advice as to the unpaid sales commission issues.