Font Size:

A company hires a salesperson and agrees to pay her a 1 percent commission on each sale she makes for the company.

Both parties are pleased with the arrangement. On the employer's side, there is an incentive for the employee to make more sales. On the employee's side, there is the potential for additional earnings.

The salesperson works for the employer for a year, quits and sues under the state's wage payment law, claiming the company has not paid her all commissions she is owed and demanding not only her unpaid commissions but also attorney fees, costs and penalties.

What went wrong?

What went wrong is that ambiguity in the commission arrangement caused the employer and employee to interpret differently the terms of the arrangement:

• Where the employee assumed the 1 percent commission was of gross profits, the employer intended it to be of net profits.

 • Where the employee assumed she would be paid the commission as soon as a customer committed to a purchase, the employer intended that the commission would not be earned and paid until the buyer had paid for the product and that product cancellations and returns would be offset against future commissions.

• Where the employee assumed she would get the 1 percent commission regardless of whether she was the only one involved in the sale and regardless of whether she was still employed by the company when the bill was paid, the company intended otherwise.

Ambiguity is an employer's enemy when it comes to commissions. Employers are sued over commission payments when there is uncertainty as to the terms of their employees' commission arrangements. These claims -- which are typically brought under state wage payment laws -- are costly to lose as employers may be responsible not only for the unpaid commissions but also for the employee's attorney fees and costs, interest and often significant penalties.

To minimize the risk of litigation over commissions and to maximize the likelihood of success if there is litigation, employers should put all commission arrangements into writing. The commission plan should be both clear and thorough, addressing at a minimum the following:

1. Commissions Relative to Other Compensation

 Some employees are eligible for commissions on top of their base compensation. For such employees, commission payments may be calculated independent of the employees' base compensation, or commissions may be offset by the employees' base compensation. For example, an employee may receive a base salary of $500 each week and a $100 commission for each sale, or an employee with a base salary of $500 may receive a $100 commission credit for each sale but not actually earn any commissions until the employee's commission credits for the week exceed her $500 salary.

Some employees are paid on a commission-only basis and receive no other compensation from their employers. To give such employees some earnings consistency, their employers may pay them a draw against their commissions. For example, an employee may earn a $100 commission for each sale and typically make between 10 and 15 sales each week, and each week the employee may be paid a $750 draw against the commissions. There are multiple variations to each of the scenarios described above, and each arrangement has its pros and cons. For example, employers who satisfy the federal definition of a "retail or service establishment" and whose sales employees earn more than 50 percent of their compensation in commissions can treat their sales employees as exempt from federal overtime requirements, provided certain other conditions are met.

2. Commissions Earned vs. Paid

An employee cannot be owed a commission that he or she has not earned. Therefore, it is important to be clear about when this occurs. Is it when a customer orders a product? Is it when the company receives payment from the customer? Is it 30 days after the company has received payment from the customer provided the customer has not received a full refund for the purchase?

It is also important to be clear about when a commission will be paid relative to when it is earned. Is it paid in the first paycheck after it is earned? Is it paid on the first of the month following the month in which it is earned?

The commission plan also should address what happens to an employee's commission if his or her employment terminates before the commission has been earned and/or paid. Will employees continue to earn and be paid commissions for a certain period of time -- for example, 90 days -- following termination? Will an employee's continued eligibility to earn and be paid commissions depend on the reason for the termination - for example, termination without cause? After termination, will an employee receive only those commissions which were earned as of his or her termination date?

3. Commission Reconciliations

Sometimes sales do not go through or there is a full or partial refund. If an employer intends to adjust an employee's commissions accordingly, this should be addressed in the commission plan, along with the timing of the adjustments and the compensation source from which the adjustments will come.

The safest approach typically is for commission adjustments to come from future commission earnings. Deductions from non-commission earnings -- for example, from an exempt employee's fixed weekly salary or a non-exempt employee's wages -- can be problematic under federal and state law. For more information on deductions, see The Deductions Dilemma, Law.com, April 30, 2008, by Jennifer Blum Feldman.

4. Commission Calculations

Commissions can be calculated in many different ways. The approach an employer takes may depend not only on the employer's industry and the result the employer is trying to achieve but also on what makes sense in terms of the employer's accounting and payroll systems.

Whatever approach an employer decides to take, it is in the employer's best interest to be as specific as possible when describing how an employee's commissions will be calculated. The items on the following list (which includes those items addressed in more detail above) should be considered and, if applicable, addressed in any commission plan:

• Are there eligibility criteria which an employee (or the company) must satisfy before commissions may be earned?

 • What is the interplay, if any, between commissions and any other compensation to which an employee is entitled and/or receives?

• Will commissions be calculated based on an employee's sales, the company's sales or both?

• When are commissions earned, and when are they paid?

• What impact does an employee's departure from the company have on commission earnings and payments?

• Will commissions be reconciled and, if so, how often will the reconciliations be done?

• What formula will be used to calculate the commissions, and are all ambiguous terms in the formula defined?

• Where decisions will need to be made by the company, is it clear that these decisions will be made in the company's sole discretion or may an employee challenge these determinations and, if so, what is the process for doing so?

• Are employees eligible for pro-rated commissions? For example, will an employee earn a commission if he or she was involved with but did not close a sale?

Employers should be aware that commission payments to non-exempt employees generally must be included in regular rate calculations for overtime purposes. This means that employers must pay non-exempt employees overtime on any commissions earned during work weeks where, for purposes of federal and most state laws, a non-exempt employee works more than 40 hours. For more information on overtime calculations, see Overtime 101, Law.com, March 31, 2008, by Jennifer Blum Feldman.

5. State Laws Affecting Commissions

Many states have laws affecting commission payments. For example, state law may affect when commissions are deemed to be earned and when earned commissions must be paid. They may also affect what deductions may be made from commissions. Even in states which do not have laws directly addressing commissions per se, the state's wage payment law may impact employer commission plans. Employers are therefore advised to consult with counsel when drafting commission plans.

6. Beyond Commissions

Many of the issues to consider when drafting commission plans also come into play when drafting incentive compensation and other bonus plans. The key when drafting any such plan is to be as specific as possible without depriving the company of the discretion it needs for operational purposes. The best way to avoid claims for unpaid commissions and bonuses is to make sure both employer and employee are on the same page when it comes to these payments.

Jennifer Blum Feldman is a partner in the Philadelphia office of WolfBlock LLP, specializing in employment law compliance, in particular with regard to EEO and wage and hour issues. She also provides training to in-house counsel and human resources professionals and has significant experience litigating employment cases.