Elaine Pachter is like thousands of other workers–which is why her case is so worrying to New York employers.

The senior sales representative successfully sued Bernard Hodes Group Inc. for nearly a quarter of a million dollars in damages and prejudgment interest. She claimed the Manhattan-based staffing services company unlawfully deducted some of its business costs from her monthly commission checks during the 11 years she bought advertising space for Hodes’ clients.

Two years ago a federal judge in Manhattan rejected her ex-employer’s defense. The company had argued that because Pachter was an executive, she was not an “employee” covered by the state law that restricts wage deductions, and that it had deducted the expenses from her gross commissions, not from her protected “wages” or net commissions.

On hearing Hodes’ summary judgment appeal, the 2nd Circuit on Oct. 12 punted Pachter v. Bernard Hodes Group Inc. over to the New York Court of Appeals. The 2nd Circuit explained that New York’s highest court needs to address two questions of state law that continue to confuse the lower courts: Does Article 6, Section 193, of New York’s Labor Law, which strictly limits deductions from the wages of “employees,” protect executives? And absent a written agreement, when are commissions deemed to be “earned” such that Sec. 193 treats them as protected “wages”?

Both questions trouble numerous employers across America who face “unlawful deduction” claims based on various state wage-and-hour laws.

“It’s an area in which a lot of employers that have compensation plans are being sued because most compensation plans pay a commission net of certain costs–they don’t pay a gross commission,” says Allan S. Bloom, partner with Paul Hastings. “One reading of Pachter certainly seems to be that if you don’t pay someone a salary–if you pay only commission–then you can’t make those deductions, which I think is a very dangerous proposition.”

Wreaking Havoc
The appeal brief filed by Hodes warns, “Applying s. 193 to commission formulas would wreak havoc on commonplace industry practices, especially with respect to executives.”

Companies routinely expect their sales representatives to shoulder certain business costs and expenses, explains employment lawyer Michael Weber, a shareholder with Littler Mendelson. “This arrangement, while it’s in the marketing and advertising field [here], applies to all industries,” he notes.

Hodes’ compensation formula garnered Pachter more than $100,000 of income in some years. It was based on a 6.5 percent slice of the gross billings for the ads she placed for clients. She also received a cut of the billings related to preparing and producing the ads.

When calculating her “commissions payable,” Hodes subtracted from Pachter’s gross billings finance charges for clients’ late payments, a portion of her assistant’s pay, as well as deductions for errors, bad debts, travel, entertainment, marketing and out-of-pocket expenses. Hodes insists it wasn’t reducing Pachter’s “wages.” Rather it was deducting certain costs and expenses from the plaintiff’s percentage stake in the gross revenues she generated. While Hodes and Pachter never agreed in writing to the compensation formula, Pachter contends that even if she did acquiesce to the “draconian practice,” the deductions were illegal.

Unfortunately for employers, the 2nd Circuit expressed its opinion that the challenged deductions were illegal because Pachter “earned” her commissions before Hodes deducted its costs. The 2nd Circuit also noted it was inclined to agree with the U.S. district judge that the labor law’s plain wording suggests that Sec. 193 “applies to all employees regardless of their position.”

The case “presents features of a conventional brokerage relationship,” reasoned the 2nd Circuit panel. And because the parties didn’t stipulate in writing when Pachter’s wages were “earned,” the common law deems that her commissions were earned “upon sale.”

Revamped Commissions
Pachter’s counsel predicts that the New York Court of Appeals will come to the same conclusion. If it does, “employers will have to revisit their commission plans,” says Salvatore Gangemi of the New York-based Gangemi law firm. He suggests the safest course for some employers could be to revamp their commission plans by lowering the percentages paid to employees to reflect the company’s costs.

Bloom says employers also should be aware that Hodes was unable to take shelter under a leading case from 1980 that is arguably in its favor: Dean Witter Reynolds Inc. v. Ross.

In Dean Witter, New York’s Appellate Division determined that the deduction of expenses from commission payments by a brokerage firm was not illegal since the deductions were from the plaintiff’s “incentive compensation” rather than from the employee’s guaranteed base salary or “wages.” However, the District Court distinguished Dean Witter on the basis that Pachter was compensated solely by commission.

Companies should therefore consider paying their commission employees some form of guaranteed draw or a salary in addition to their incentive compensation. “I think that is a business solution as well as a legal solution,” Bloom says.

The case underscores once again that “contract is king,” Weber argues. “The takeaway is the need to have a clear written agreement setting forth in detail the arrangement between the company and its sales executives. Smart employers will now clarify that in great detail.”