How sales representative agreements can provide both a shield and a sword Featured

11:07am EDT September 1, 2011
How sales representative agreements can provide both a shield and a sword

Your company’s sales representatives have contact with two of your most important assets: your customers and your technical knowledge.

Because of that, an up-to-date and enforceable sales representative agreement is critical to appropriately defining your company’s relationship with your salespeople to maximize protection of your critical assets and avoid liability, says James Giszczak, a member at McDonald Hopkins PLC.

“A simple review and update of agreements can provide the needed preventive measures to protect these assets and minimize risk,” says Giszczak.

First, determine whether your agreements with your sales representatives are legal and enforceable. It varies by state, but many have laws that impose certain requirements on the relationship between you and your sales representatives, says Timothy Lowe, an associate at McDonald Hopkins PLC.

“Nearly every state has enacted a statute that governs the relationship between companies and sales representatives,” says Lowe. “These statutes primarily govern the payment of commission during the representation relationship and following termination of the relationship. If a company violates these provisions, the penalty can be severe.”

Smart Business spoke with Giszczak and Lowe about how to stay on the right side of the law with your sales representatives.

Does it matter how a company compensates its sales representatives?

Yes. Whether or not the sales representative is compensated in whole or in part with commissions is a gateway question for applicability of many states’ sales representative statutes. Michigan, for instance, defines a ‘sales representative’ as a ‘person who contracts with or is employed by a principal for the solicitation of orders or sale of goods and is paid, in whole or in part, by commission.’

If the sales representative is not compensated at least in part with commission, the statute —and its penalty provisions — may not apply. Be clear from the outset what form of compensation has been agreed upon so that you can determine which, if any, statutory requirements may apply.

How much flexibility does a company have when deciding when its sales representatives have earned commission?

This date can typically be set by the parties in the sales representative agreement. It may be the date new orders are received, the date payment is received from a customer, or something else. If the date that compensation is earned is not specified in the contract, state statutes usually include a ‘gap filler’ provision, often the past practice between the parties or the ‘custom and usage prevalent’ for the particular industry.

Ambiguity concerning when commission is earned may lead to problems after termination of the parties’ relationship, especially if customers that the representative was targeting order goods or services after the representative relationship ends. In most states, ambiguity is construed against the drafter of the agreement, typically you, the employer.  Moreover, absent specific language, the sales representative may be able to rely on the common-law ‘procuring cause doctrine’ and recover commission for an extended period of time.

Some states require commission to be paid within a certain number of days after it is earned. Michigan has no such provision. In New York, however, commission must be paid within five days of the date that it is ‘earned.’ Other states, such as Massachusetts, refer to custom, usage or practice within the state or business.

It is important to know whether the applicable statute has such a requirement and if the parties can contract otherwise.

Can a company terminate its sales representatives if it doesn’t believe they provide value to it?

Yes, but almost all statutes require that earned commissions be paid within a certain time after the sales representative relationship ends. Some states also specify payment terms for a commission that becomes due after termination of the representative relationship.

In Michigan, all commissions due at termination, and any that become due after termination, must be paid within 45 days of coming due. Payment of commission post-termination is a frequently litigated issue. If your agreements do not comply with the applicable statutes, extreme and unnecessary penalties can result.

What are the penalties for failing to comply with the statutes?

Failure to comply can lead to substantial penalties. Nearly every state allows the representative to recover two or three times the actual amount of commission owed. To add insult to injury, the representative is also typically entitled to recover attorneys’ fees incurred in recovering the commission due.

In Warring v. Total Mfg. Systems Inc., the company failed to pay commissions on certain sales and failed to properly calculate the amount of commissions. The sales representative was found to be entitled to $30,340 in actual damages for unpaid commission. The court, however, then doubled the amount owed pursuant to Michigan’s statute and awarded the sales representative $60,680 in damages.

You can avoid or greatly minimize much of this risk by having your agreement revised, or drafted, by an expert who will manage most of these risks through provisions in the agreement.

What other provisions should be included in a company’s sales representative agreement?

Companies may wish to include noncompete, nonsolicit and trade secret protection, provisions dealing with HIPAA and HITECH, performance standards, fraud and abuse prevention, insurance requirements, geographic scope of representation, modification and termination provisions, among others.

With a detailed agreement, you can later avoid litigating each party’s interpretation of the relationship.

James Giszczak is a member at McDonald Hopkins PLC. Reach him at jgiszczak@mcdonaldhopkins.com. Timothy Lowe is an associate at McDonald Hopkins PLC. Reach him at tlowe@mcdonaldhopkins.com.