Suite 2400 865 South Figueroa Street Los Angeles, CA 90017-2566 Janet L. Grumer 213.633.6866 tel 213.633.6899 fax janetgrumer@dwt.com To: Restaurant High Attendees with Commissioned Employees in California From: Janet Grumer and the California Employment Services Group Date: March 14, 2013 Subject: Best Practices for California Employee Commission Contracts AB 1396 took effect on January 1, 2013, and requires a written contract signed by the employer and a signed receipt by any employee whose contemplated method of payment involves commissions. The bill (which amends Labor Code 2751) does not provide detailed requirements for the content of the written contract, but does create an important requirement for which employers must be mindful. The following checklist outlines the general contract requirements of AB 1396: Must be in writing Must set forth the method by which commissions shall be computed and paid Signed copy of contract must be given to employee Signed receipt of contract from employee must be maintained by employer NOTE: The law also creates a presumption that the terms of the contract continue after the expiration date, unless the contract is superseded or employment is terminated. Therefore, the contract should contain a term reserving the employer s right to unilaterally change the terms of the contract prospectively, of course. It is not practical to provide a template addressing the many variables an employer may wish to include in a commission plan, but the following Q & A is intended to guide employers in the primary considerations. Enactment of AB 1396 creates an opportunity for employers to evaluate their pay practices with regard to commissioned employees. Q: Is the employee earning true commissions? Not all employees who receive pay that varies based on performance necessarily receive commissions falling under the purview of AB 1396 and Labor Code 2751. An employee is paid for commissions
only if the employee is (1) principally involved in selling goods or services and (2) paid based proportionately upon the amount or value of the goods or services sold (quoting Labor Code 204.1). The statute specifically excludes from coverage short-term productivity bonuses (such as those paid to retail clerks) and bonus and profit-sharing plans, unless the employer has offered to pay a fixed percentage of sales or profits for work to be performed. Similarly, piece-rate compensation systems are not covered by the statute. But employers would be wise to apply these same principles and put such plans in writing as well. Q: What are the requirements when the employer has a sophisticated commissions plan in place? Many employers have sophisticated commission plans that provide detailed terms under which commission-based employees are compensated. Employers with such plans should, at a minimum, draft a term sheet individualized for each California employee. The term sheet should set forth the specific details or variables so as to allow the employee to calculate his or her specific compensation. For instance, if the employee s commissions relate to a specified geographic area or product line, the term sheet should define that information. The term sheet also should incorporate by reference the commission plan dictating the compensation structure and include an acknowledgement that the employee has been provided a copy of the specific plan the contract with the employee. Q: Does the contract define the manner in which commissions are calculated? In order to meet the statutory requirements (and to avoid disputes), it is crucial to eliminate ambiguity regarding the definition of key terms used to calculate payment amounts. The contract should define all terms necessary to state unequivocally how commissions are earned and calculated. For instance, employers should specify and provide definitions of whether commissions are to be calculated based on: gross sales, net sales, revenues or profits, with clear definitions; sales of a particular product or in a particular territory, with clear definitions of each; sales attributable to the individual employee or attributable to a group of employees within a defined department or location; and straight percentage of sales or varying percentage bands based on total sales The manner in which the employer calculates commissions can vary drastically and any ambiguity will be interpreted in favor of the employee. As such, employers must consider all possible interpretations of the contract wording that could lead to unintended consequences. Q: Does the contract clearly state any conditions precedent to earning the commission? Employers may require employees to perform certain tasks as a condition to earning commissions. For example, if the employer relies on sales data in order to track inventory and forecast projections, the employer might make commission eligibility contingent upon each employee logging his or her own 2
sales. Similarly, earning the commissions might be contingent on ongoing customer service to clients, assistance with collecting payment, and soliciting order renewals. The contract should clearly lay out, however, that failing to fulfill any conditions precedent may render the employee ineligible for commissions. Otherwise, the employer may be subject to claims of forfeiture of earned commissions, which is not permitted. Q: Does the contract spell out any adjustments that factor into calculating commissions? Employers may make certain adjustments in the process of calculating commissions. The contract should include any adjustments and clearly state when such adjustments are made. If the contract contemplates that commissions will be based on net sales figures, the contract should specifically list all adjustments that are made. Employers may not, however, deduct the costs associated with doing business in calculating commissions. For example, while employers may deduct from gross sales the returns of merchandise readily identified as being sold by the employee, the employer may not deduct returns that are attributable to other employees or to customer negligence and misconduct. The latter are considered costs of doing business that cannot factor into the determination of compensation. The contract also may not provide for deductions from wages earned (including commissions earned). For example, deductions for cash shortages, breakage or loss of equipment, and other business losses that may result from the employee s simple negligence are not permitted. This is in accord with California s law prohibiting an employer from using self-help remedies to take back any part of wages earned by an employee. Q: Should the contract define when commissions are earned? Absolutely. The contract should explain exactly what triggers an employee s actually earning a commission. For instance, the contract may provide specific conditions precedent before commissions are earned, such as: (1) when the sale is made, (2) when the sale is approved by the company, (3) when the sale is invoiced to the customer, and/or (4) when the customer pays. If conditions precedent are specifically provided in the contract, they generally will be enforced. Conditions precedent will not be enforced, however, if they: (a) violate public policy, (b) the employer prevents the employee from satisfying the condition, or (c) conditions beyond the parties expectations prevent the completion of the condition. However, the contract may require the employee to exercise a duty of care to assist in assuring that the conditions precedent are met. For instance, an employee may be required to review all sales reports and follow-up with any discrepancies. Employers should consider practical implications in defining when commissions are earned. For example, if commissions are deemed earned when the order is placed but before final payment is received by the employer, the contract should clearly explain the effect, if any, of a cancelled order before payment is received. Q: Does the contract define when commissions will be paid? It should, yes. Commission wages are due and payable when they reasonably can be calculated. As noted above, there may be situations where commission wages cannot be immediately calculated when 3
the sale is made and, instead, must be calculated later, such as when the when the goods are shipped, when the customer pays, or at the end of the reporting period in which the commissions are earned. Q. May the employer require that the employee be employed on the payment date to be entitled to commissions? Yes. But once the employee fully earns the commission, it becomes wages and cannot be forfeited even if the employee s employment has ended before payment becomes due. Q: Does the contract provide a draw or advance on future commissions? Many commission arrangements provide for a draw or advance on future commissions. These amounts and payment schedules also must be well-defined. If the employee is non-exempt, the draw must be guaranteed, and must be paid at least twice a month and be at least equal to the sum required by minimum wage and overtime pay laws. Under some circumstances, commissions paid to non-exempt employees may result in a requirement to recalculate the regular rate and overtime pay based on the commission payment. The contract should specifically state that the draw or advance will be repaid out of future commissions and how it may be reconciled against unearned draws or advances over time, if such adjustments will be made. If the contract fails to include such an explicit statement, the draw may be considered to be a base wage and therefore the employee s minimum compensation. The contract may authorize deductions from the draw or advance if the anticipated sales provided by the draw are not later earned. Such a chargeback provision must be carefully crafted and cannot have the effect of bringing a non-exempt employee s wages under the minimum requirements of wage and overtime laws. The contract may provide that the employee carries the deficit from month to month until it is fully recovered by the employer from future commissions earned. Q: What happens during a leave of absence? If applicable, the contract should explain whether the employee continues to earn commissions while he or she is on a leave of absence. For instance, if the employee receives commissions based on the performance of other employees and the contract is silent on this point, the employee may claim that he or she continued to earn commissions even when on an unpaid leave. Q: What happens at termination of employment? The contract should explicitly state how commissions are handled upon the employee s separation. Any commissions that have been fully earned by the employee that can be calculated at the time of separation are due and payable at the time of separation just like other earned wages. Employers who typically calculate and pay commissions at the end of weekly, monthly, or quarterly periods may not wait at termination of employment to pay commissions in the normal course of business. If it is reasonably possible to calculate and pay the commissions at an earlier time, such as the time of separation, the employer must do so. Failure to promptly pay all commission wages due at termination (or as soon thereafter as the commission can be calculated) can trigger employer liability for waiting time penalties 4
under Labor Code section 203, which provides that daily wages continue as a penalty for as long as 30 days after termination of employment, if any wages (including commissions) are unpaid at separation. An employee who voluntarily resigns is generally not entitled to recover any unearned commissions, i.e., commissions for which conditions precedent have yet to be satisfied. Where an employee is terminated, the employee may be deemed to have been prevented from completing his or her duties and may be able to recover all or a pro rata share of earned commissions, even if the commission contract requires employment on the payment date. For that reason, employers must carefully specify all duties that employees have to complete in order to fully earn commissions, as discussed above. Ambiguities always are construed against the employer and typically to avoid forfeiture of earned commissions. Employers also should ensure that the contract explicitly states that the employer may recover unearned advances at termination, to the extent that such advances exceed minimum wage and overtime requirements. Q: What happens at the expiration of the commission contract? The new law presumes that the terms of the contract will continue after the contract expiration date, unless the contract is superseded or employment is terminated. Therefore, employers are advised to include a contract term reserving the employer s right to unilaterally change the terms of the contract. Further, employers should revisit their existing contracts with employees at the end of the term, and have the employee sign any amendment to the contract to meet the requirements of AB 1396. Q: What are the penalties for failing to have a compliant written commission plan? Failure to have a compliant written plan could result in penalties under California s Private Attorney General Act in an amount of $100 per employee per pay period for the first violation and $200 per employee per pay period for the second and each subsequent violation. Additionally, as a practical matter, a written commission plan is essential to properly administering and paying commission payments. Unclear plans or having no written plan at all may result in a court or the Labor Commissioner enforcing a plan differently from what the employer intended. This document is not intended as and should not be relied upon as legal advice. Before implementing any commission plan, California employers are encouraged to have the plan reviewed by counsel to ensure compliance with California laws. 5