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VOICES FROM THE INDUSTRY: Employers: Are commission plans putting you at risk?

October 29, 2007

Many employers compensate their sales representatives, in whole or in part, through commission agreements or plans.

The various benefits of such plans are readily apparent. Among other things, they can provide powerful incentives for salespersons to generate business, and they can assist employers in managing their costs and cash flow.

However, lurking within these plans may be significant legal issues. Ill-defined or poorly-worded compensation plans can cause a number of legal problems and expose employers to significant liabilities.

Generally, commissions constitute "wages" covered by Indiana's wage payment statute. Sanctions for failing to comply with that statute can be severe. Specifically, if an employer fails to pay wages due in a timely manner, the employee is entitled to recover the unpaid wages, plus a penalty of 10 percent per day up to a maximum of 200 percent of the unpaid wages. In addition, the employee (but not the employer) is entitled to recover attorneys' fees incurred in successfully litigating a wage claim.

There is no "good faith" defense for failing to pay wages due. When considering the penalties and costs of litigation, a relatively small wage claim can explode into a large liability. Accordingly, in order to avoid costly commission disputes, it is vital that employers clearly and thoroughly describe in writing how commissions are earned and calculated, when they become earned or vested, and when they become due and payable.

Making a plan

First, careful consideration should be given to the intended scope and meaning of the commission plan. Does the plan clearly articulate how commissions are calculated? Does the plan describe which sales will be attributed to the representative for the purpose of calculating commissions? For example, is the employee credited with sales to specific customers or instead with sales to all customers within an exclusive sales territory? What happens if more than one employee contributes to a given sale? And, finally, what happens if the customer fails to make full payment for the product sold or returns the product and the employer issues a credit? Having a clear understanding of the answers to these questions will eliminate many of the uncertainties that lead to litigation.

Second, employers should define, in writing, precisely when a commission becomes vested or earned. Under Indiana law, the general rule is that a salesperson earns or vests in a commission when the sale is made; that is, when the employer has agreed to sell and the customer has agreed to buy the product. This is true even if the product has not yet been delivered to the customer and payment has not yet been received by the employer. However, this general rule may be altered by an agreement that clearly describes a different earning or vesting arrangement. For example, it is within the employer's power to alter the general rule by providing in writing that a commission on a sale is not earned or vested unless and until the product is delivered or the employer receives full payment on the sale.

Indiana law

Similarly, unless the parties have agreed otherwise, Indiana law generally concludes that the employee is owed commissions, even after termination of the employment relationship, on any sale that is made prior to termination of employment. It often surprises employers to learn that they could be required to pay commissions to a terminated employee on product that is delivered and paid for several months after employment has ended. In one well-known Indiana case, for example, a manufacturer's representative sold metal trim used by appliance manufacturers. A single sales order signed at the beginning of the year covered the manufacturer's sales to a customer throughout the year. When the sales employee terminated in the middle of the year, the court determined (in the absence of an agreement otherwise) that the employee was entitled to commissions on all sales completed during that year, including those completed after the employee's departure. This result could have been avoided if the employer had addressed the issue in writing in advance.

Finally, it is equally important for the parties to describe not only how and when commissions become earned or vested, but also when they become due and payable to the employee. Indiana's wage payment statute penalizes employers for the late payment of wages, as well as the failure to pay wages. In other words, ambiguity as to when commissions are due can be just as costly to an employer as uncertainty concerning whether a commission has been earned. Employers are permitted to pay commissions on a monthly, quarterly or other basis; however, the payment schedule should be set forth in writing.

In Indiana, employers are permitted a significant degree of freedom in creating commission plans that fit their particular business models. Employers can avoid many of the legal risks associated with commissions by considering them in advance and carefully defining the terms in a written agreement. Failing to do so, however, can lead to significant liability under Indiana wage and hour laws.

Terrell is chairman of the Labor & Employment Law Group at the Indianapolis law firm of Sommer Barnard PC. Views expressed here are the writer's.
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