Whether you are a manager responsible for formulating a commission plan or an employee compensated by commissions, your primary interest should be that the written document clearly states the terms of the plan. If you intend to have an attorney draft or review such a plan, it is helpful to understand what the attorney will typically look for, and what information he or she will need.
California law (AB 1396) requires that all employment relationships that involve payment of commissions “shall be in writing and shall set forth the method by which the commissions shall be computed and paid.” The employee must be given a signed copy, and the employer must obtain a signed receipt from each employee. The contract and the commission terms “are presumed to remain in full force and effect until the contract is superseded or the employment is terminated by either party.”
The attorney charged with the task of reviewing or drafting a commission plan will need a complete understanding of the client’s product or service, the economics of a sale and how the salesperson earns commissions; a clear, complete and unambiguous plan can only be drafted after gaining a thorough understanding of the entire sales process and how commissions will be earned and paid. Every business has its own way of calculating and paying commissions, and the scope of the salesperson’s efforts required to earn a commission will vary by industry, product, and employer. No universal “plan” exists. The agreement of the parties controls the entitlement to commissions. Frequently, a plan document prepared internally will have logical gaps, internal inconsistencies or ambiguities, or rely on undefined jargon, without much thought given to the reality of how, by whom and when sales are made, invoiced amounts collected and commissions earned.
Three issues tend to be at the center of most disputes about commissions, and above all others should be the focus of the development of a commission plan:
- When is a commission earned?
- Are commissions paid when a commissioned employee’s employment ends?
- Are earned commissions subject to any deductions or set-offs?
What follows is a step-by-step approach that an attorney might follow in reviewing a plan. As a client, you need to identify and understand all of the financial and operational components that affect the earning and payment of commissions. Using this checklist should help you work with counsel to construct a logical, understandable and legal plan:
- Review the “Big Picture” – the broad landscape, the 30,000 foot overview. Examine the basic economic concepts – how is the plan supposed to work? This will require an understanding of the business economics as well as the sales process and payroll logistics.
- Once you understand the Big Picture, review the document again, but this time focusing on its detail and its words. Do the “1,000 words” match the “Big Picture?” Are the details consistent? Do the words make sense? Does the plan contain undefined words and phrases or industry jargon that may be subject to a variety of meanings? Identify and eliminate all of these internal and semantic problems. Understanding how the plan works, and identifying all generalities, assumptions and ambiguities will allow you to restate it in English, unambiguously and logically.
- Identify exactly when the commission is “earned.” This vital concept must be clear. Are there any conditions that should be stated very clearly, such as actual collection of the amount due on the sale? Look carefully for terms that suggest commissions are earned or paid before the sales invoice amount is collected. Understand the economic implications of this and make sure the plan matches the understanding, or accurately states the agreement.
- When you understand the plan and have eliminated the ambiguities, jargon and incorrect assumptions, review the plan again for organizational logic. Does the plan flow logically from its basic economic terms to its general conditions, leaving no confusion about what happens under any foreseeable circumstances? Eliminate, rewrite or re-order any provisions that are internally inconsistent, redundant, or confusing. Look for gaps. Make sure the policy is clear regarding its term – is it an annual “plan” that will not be effective beyond a certain date or is it valid until amended or revised.
- Check for legal issues: Are commissions subject to deductions? Do any provisions result in a forfeiture of “earned” commissions or penalize the employee in any way? Is a draw payable, and if so, how is it recovered or is it guarantied? What is the effect of termination on payment or entitlement? What exempt vs. non-exempt issues exist, if any? Is the employment “at will?” Are there any issues of notice to employees of new terms and conditions? Is there an integration clause?
- Review any other relevant employment agreements, letters, policies or procedures for consistency.
Employers in Silicon Valley are involved in a variety of industries, products and services – web-based services and software, manufacturing of hardware, equipment and devices, and printing and publishing, to name a few. Sales and marketing are as important to a business’s success as research and engineering, and commissions are the incentive that promotes sales. A good commission plan should not only match the economics and scale of the business but should also be a clear written statement of the basis for the commission, how it is calculated, when it is earned and what conditions it is subject to.