Many employers elect to pay salespersons commission-based wages. Employers can benefit by this arrangement as the salespeople are paid based on the amount and quality of their work. The salespeople also have the opportunity to earn higher wages for their hard work. Employers, however, need to ensure they are following the correct legal procedures for commission payments. Otherwise, they run the risk of owning considerable wages, fees, and penalties.
A. Commissions Defined
In 1998, the California Courts handed down the decision of Keyes Motors, Inc. v. DLSE. This case defined commissions as those payments arising from the sale of a product, not the making of a product or the rendering of services. For a payment to be considered a commission, it must also be based on the amount or value of the goods or services sold. As such, commission payments are not discretionary.
B. Written Commission Agreements are Required
Labor Code § 2751 requires a written employment contract between the employer and employee whenever an employee is paid, in part or in full, on commission. To be valid, the employer must give the employee a signed copy of the contract. The employee shall have the opportunity to review the contract and then return a signed copy to the employer. The contract should be clear and unambiguous such that the employee can calculate the earned commissions.
C. Defining How Commissions are “Earned”
Like other forms of compensation, commissions are considered “wages” such that employees have a property interest in the “earned” commissions. Therefore, one of the most important aspects of the commission agreement is defining how commissions are “earned.” How an employee earns a commission may vary from company to company. Examples of how an employee can earn a commission includes:
• Execution of a sales agreement
• Delivering a product to a client
• Billing a client for a product or services rendered
• Receipt of payment from clients for a product or services rendered
Employees must be paid commissions in the pay period when they are earned.
If the employer fails to clearly define how a commission is earned in the commission agreement, the employee may be able to successfully argue for a broader definition that entitles the employee to additional compensation.
D. Forfeiture Provisions
One of the most common conflicts in commission-based compensation is payment of commissions after separation from employment. Upon separation, employees are entitled to all commissions earned up to and including the date of separation. Generally, this means an employee is entitled to all commissions that have been “earned.” But what about situations where a commission-based employee has essentially done all of the work necessary to earn a commission, but the commission has not yet vested?
For example, say that Charles works for Acme Products and is paid commissions. Charles earns commissions only after the client makes a payment for a product. ABC Industries purchased a product from Acme. Acme delivered the product and invoiced ABC. Two days prior to ABC’s payment, Acme fired Charles. Is Charles entitled to the commission payment for the sale to ABC?
Charles may be entitled to the commission payment if the contract does not include a forfeiture provision. Under California law, if an employee performance all of the actions required to “earn” the commission, the employee has a right to receive the commission. Here, Charles performed all of his actions to earn the commission. The only action left was on the part of ABC to pay the invoice. Therefore, Acme would be responsible for paying Charles the commission amount once payment is received from ABC.
ABC, however, could have potentially avoided this commission payment to Charles if it had included a forfeiture provision in the employment agreement. A forfeiture provision essentially states that an employee must be employed by the employer at the time a commission is earned, otherwise the commission if forfeit. Forfeiture provisions have largely been upheld by California courts, but because the provisions can lead to unfair results for employees, the provisions are often challenged in litigation.
E. Clawback Provisions
A clawback is a provision in an employment agreement where an employer seeks to recoup commission payments from an employee. Clawback provisions can take multiple forms. For example, an employer that pays commissions once a client has been invoiced for services may later try to clawback this amount if the client ultimately fails to pay. Or an employer may attempt to clawback commissions if a client does not utilize an employer’s services for a certain length of time. In most cases, clawback provisions are not enforceable in California.
Clawback provisions, however, may be used in limited circumstances when merchandise has been returned. For example, say that Claire works for Smith’s Department Store. She is paid 10% commission on all merchandise she sells. She sells a watch for $200 and earns a $20 commission. A month later, the customer returns the watch. Smith’s can deduct $20 from Claire’s future paycheck if it can directly trace the watch to Claire’s sale. If Smith’s, however, cannot directly trace a commission payment to a certain sale, it cannot seek to recoup the commission payment.
Some employers may attempt to circumvent clawback provisions by classifying payments as advances or draws. Advances and draws can take a few forms. One example is when an employer pays an employee in advance of the commission actually being earned. For example, an employer may pay an employee when a customer is invoiced for services, but the commission is not actually earned until the customer pays. If the customer fails to pay, and the employer can trace that amount to the employee, the employer can deduct this commission payment from a future paycheck.
Another option is to pay employees an advance with the expectation that the employee generates a certain level of sales during the pay period. If the employee fails to generate the necessary sales, the employer may seek to recover the unearned amounts. Advances, however, are prohibited if the amount an employee is likely to earn is unpredictable and the factors related to a lost sale would be beyond the employee’s control. Further, an employer cannot deduct amounts such that the employee would earn less than minimum wage for hours worked.
F. Non-Exempt Commissioned Employees
Like all other employees, salespeople must be classified as either exempt or non-exempt employees. Some salespeople may be classified as exempt under the commissioned dales exemption. This exemption applies to employees who:
(1) Earn at least one-and-a-half times the minimum wage;
(2) Earn more than half of their income in the form of commissions; and
(3) Work in the mercantile industry, which includes retail jobs, or in some professional, technical, clerical, mechanical, and similar jobs.
Other employees may be classified as exempt under other provisions of the Industrial Welfare Commission’s Wage Orders depending on the industry.
Salespeople who do not fit within an exemption must be classified as non-exempt employees. Employers are responsible for tracking the hours worked by commission-based employees. The employees are entitled to minimum wage for all hours worked. They are also entitled to overtime if they work in excess of 8 hours in a day or 40 hours in a week. The employer must include an employee’s commission earnings when calculating overtime rates. Non-exempt salespeople are also entitled to paid rest breaks and unpaid meal breaks, as well as reimbursement for all necessary business expenses.
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Matthew Wallin is a senior associate in the Los Angeles office where he practices labor and employment law. He has extensive experience defending private business and public entities in litigation and advising clients on labor compliance issues.
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