California law requires that commission agreements be in writing, explain the method by which commissions will be computed and paid, and be signed by the employee. While this seems relatively straightforward, commission agreements have earned a fair amount of attention as employers have, as is sometimes the case, failed to fully comprehend their responsibilities under the law. This article will help define commission and some common terms and concepts that should be included in any commission agreement.
What is a commission?
It is generally accepted that a commission is an amount paid to an employee which represents a percentage of the value of goods or services sold. The meaning of commission has also been extended to situations where an employee is paid under a formula that takes into consideration adjustments and revenue. Profit-sharing and bonus plans are not considered commissions nor are short term bonuses paid to retail clerks. And while not considered commissions under the law, these forms of compensation do have their own rules and regulations employers should familiarize themselves with.
When a commission is earned?
This is the first of a few very important issues that must be addressed in a commission agreement. A commission is considered earned once all the criteria for employee compensation have been satisfied. These conditions are dictated by the goods or services rendered and the employer’s policies. Most often though, commission agreements will indicate a commission is earned once the customer has paid in full for the goods or services. The importance of clearly identifying when a commission is earned can’t be overstated. I have seen incomplete commission agreements that left open for dispute whether a commission was earned when the employee did all the work necessary under the agreement for goods or services or when the employer was paid. More to come on how this problem can haunt an employer.
When is a commission paid?
Second in line of important issues to address in the commission agreement is when the commission is paid. Naturally, it will occur after the commission is earned. While the law leaves the employer and employee to arrive at the terms of how a commission is earned, the law provides guidance on when a commission must be paid. Commissions are treated like wages; commissions earned between the 1st and the 15th must be paid between the 16th and 26th, while commission earned between the 16th and end of the month must be paid between the 1st and 10th of the following month.
In some instances, it may take an extended period of time to satisfy the requirements for earning a commission. It is not uncommon in this situation for employers to advance commissions, or a portion thereof, to ensure employees have a steady flow of income. This is perfectly acceptable in California. But, any employer that advances commissions should explicitly detail in the commission agreement what conditions can give rise to an advancement, what happens if a commission is never earned, and what occurs upon termination.
Related to advancements is the notion of recoupment. Commissions are considered wages and employers are therefore prohibited from deducting or taking back commissions. On the other hand, advancements are not considered wages, so it is appropriate to recoup advances from future advances if the conditions for earning a commission are not satisfied. Here’s how that works practically. The employee sells sweaters. A commission is not earned until the return policy time period has elapsed. However, to ensure cash flow, the employer advances commission on the sale of the sweater. If a sweater is returned, the employer can recoup the commission previously advanced on the returned sweater from any future advances paid on other sales. And like advancements, courts will only uphold this employer right when the information is in the written commission agreement.
Nearly all disputes over commission arise upon termination, whether voluntary or involuntary. Even if an employee is not getting paid as expected under a commission agreement, the employee may fear retaliation and not say anything during the course of employment. However, upon termination, the gloves come off. Here are the two most common situations that arise. First, the employee believes they earned the commission, and would therefore be entitled to payment upon termination, and the employer does not feel all conditions for earning have been satisfied and therefore no commission is due. Or, the employee was paid a commission but the employer believed they were advances and therefore the employer is going to reduce the employee’s final paycheck to recoup the advancement. In either situation what frequently follows is a wage and hour claim with the Division of Labor Standards Enforcement. Fortunately, these can be easily avoided as indicated above.
It must be in writing and include the above provisions if applicable. The agreement must also include the method by which a commission is computed. That is, what factors are considered when determining how much commission is earned. In our sweater example, it is likely a percentage of the sweater sales price. Not only must the percentage be listed, but the agreement must also acknowledge that the percentage is applied to the sales price of the sweater, as opposed to possibly the retail price. Most importantly, it must be signed by the employee and the employee must be given a copy.
Failure to comply
If an employer fails to prepare a commission agreement, or otherwise adhere to the content requirements of a written commission agreement, the penalties can be severe. In addition to any compensatory damages awarded to an employee, a court can also award treble damages…effectively tripling the amount of the compensatory damages. As such, it is critical for employers to regularly assess commission agreements for legal compliance and to ensure that actual business practices match the terms of the commission agreement.