Commissions or bonuses represent a significant component of the compensation package for many employees. Disputes concerning commissions and bonuses are common because both employers and employees sometimes focus myopically upon the amount of commission or bonus to be paid if certain goals are achieved, neglecting to give due consideration to other critical issues.
When creating or drafting a commission or bonus plan, employers should address several key questions:
- When does a commission or bonus accrue? Commissions and bonuses can accrue when an employee procures a customer or a purchase order, or when an invoice is issued to the customer, or when the company receives payment from the customer, or at other defined times. Designating the event that triggers accrual of the incentive compensation is one of the most important elements of a commission or bonus plan. Employers should be particularly wary of establishing plans that entitle an employee to commissions on all sales made to a customer without regard for the timing of the sale, since commissions can arguably continue to accrue even beyond the termination of employment under such plans.
- How is the commission or bonus calculated? Employers and employees sometimes focus solely on the rate at which commissions accrue on a sale without defining the base on which the commission is calculated. Commissions and bonuses may be based on gross revenue, gross profit, or some other defined base. Plans should also clearly identify any revenue excluded from the base, such as taxes or shipping costs.
- Are commissions shared if more than one employee contributes to a sale and, if so, how? In some situations, an employee may procure a sale all by himself or herself, but it’s also common for employees to work together to close a sale. Commission plans should define when and how commissions may be allocated among multiple employees who contribute to procuring a sale.
- When is a commission or bonus payable? Commissions and bonuses are sometimes paid on the next paycheck after they accrue, but it is also common to delay payment to the end of the month, quarter or fiscal year. Plans should clearly define when accrued commissions and bonuses will be paid. Many plans provide that employees must remain employed by the company until payment is made in order to be eligible for the commission or bonus or contain other so-called “clawback” provisions, but employers should recognize that some states prohibit the forfeiture of accrued compensation, so provisions that operate to divest employees of earned commissions or bonuses may be particularly vulnerable to challenge.
- What happens if the goods are returned because they are defective, or if an order is cancelled? Returns of defective merchandise are common, as are cancellations of orders. Many commission and bonus plans also do not address the effect of a cancelled or returned order upon the employee’s right to a commission or bonus.
Disputes also arise frequently from practices regarding bonuses and commissions that are unwritten or not clearly communicated to the affected employees. Many states, including California, require that commission plans be set forth in writing, so employers should be diligent in documenting all of the terms and conditions applicable to their plans.
Failure to address any of the issues described above can easily lead to controversy and litigation. Commission and bonus plans should eliminate potential sources of confusion and controversy by defining the employee’s right to a bonus or commission as clearly and precisely as possible, eliminating ambiguity and addressing foreseeable “bumps in the road” such as a customer’s failure to pay.
What Should Employers Do Now?
- Employers that have not confirmed the terms of their commission and bonus plans in writing should confer with counsel to create sound documentation of their plan.
- Employers that have not submitted their commission and bonus plans to review by counsel recently should consider doing so in order to identify any potential defects or weaknesses in their plans.
If you have any questions about the issues arising from commission plans or bonuses, or any other issue relating to employment law, please contact your Lathrop GPM attorney.