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When is Sales Commission Legally Earned?

Executive Summary: This article dives into the intricacies of when sales commissions are legally earned, shedding light on:

  • Commission agreements.
  • Key legal principles that affect commission payouts.
  • The impact of termination and resignation.
  • The laws regarding commissions.

Sales commission is an important component of any compensation package.

It works as an incentive for better performance. Plus, commissions can also be used as a measure of progress.

However, the rules governing when these commissions are legally earned can be complex.  

That’s why it often requires careful consideration by employees and employers.

In this article, we’ll discuss when is sales commission legally earned while shedding light on essential principles, agreements, and compliance requirements.

When is Sales Commission Legally Earned?

At the outset, there is no single answer to when a sales commission is legally earned.

There are many factors at play like:

  • The specific laws of the state.
  • The written employee contract.
  • Any communication to do with commissions.

Additionally, specific guidelines are often kept in mind, especially in cases of legal dispute. These relate to local laws, corporate precedents, and the understanding between employee and employer.

That’s a lot of things to keep in mind!

Don’t worry. We’ll look at each of these factors in detail later.

First, let’s understand what a sales commission agreement is and what it covers.

Understanding Sales Commission Agreements

Sales commission agreements are formal documents outlining the commission-based compensation terms and conditions.

They specify how commissions are calculated, earned, and paid, as well as any relevant performance targets and responsibilities.

However, one critical aspect of understanding when sales commissions are legally earned, involves comprehending the components of these agreements.

The fact is sales commission structures can vary widely.

Some sales professionals receive a straight commission, meaning their earnings are solely based on a percentage of their sales. Others have a base salary supplemented by commission.

The type of commission specified in the agreement significantly impacts when commissions are considered earned.

This makes it a vital tool for both salespeople and employers. It provides clarity on commission terms, reducing the potential for disputes.

Adherence to key legal principles is crucial in determining when sales commissions are legally earned.

These principles help ensure that commissions are earned fairly and transparently.

1. Meeting the threshold requirements

Threshold requirements are conditions that must be met before commissions are considered earned.

These conditions can include:

Understanding these prerequisites is essential for sales professionals aiming to maximize their earnings.

2. Completion of sales

The definition of a completed sale plays a pivotal role in commission agreements.

That’s why it is crucial to establish clear criteria for what constitutes a completed sale, as this definition can vary between industries and organizations.

In some cases, customer acceptance may be a critical factor in determining whether a sale is complete.

3. The parties’ understanding

Timely commission payments are essential, and understanding the stipulated payment timelines and conditions is crucial.

In case the contract is incomplete, unclear, or otherwise subject to interpretation, the next factor is what is referred to as the parties’ understanding.

This points to the ongoing communication between the employer and employee during the period of employment relating to the payment of commissions.

For example, the company may have told the employee that commission would only be paid after the client has cleared the invoice. Or that the company policy is to pay a commission upon signing a sales agreement.

These aspects become more forceful when they have been communicated in writing.

4. Statutory timing

The fourth factor considered in commission payout cases is statutory timing.

It refers to cases when it can be shown that the salesperson carried out the necessary duties to make the sale. Yet, the deal did not occur after the termination of employment due to reasons out of the salesperson’s control.

At such times, the ruling can go in the employee’s favor.

In all the factors above, written documents and electronic records are paramount. In case of legal disputes, they are valuable elements in arriving at a decision.

The Impact of Termination and Resignation

The impact of termination and resignation depends on the following:

  • The terms of the employment contract.
  • Applicable state and federal laws.
  • The circumstances surrounding the termination or resignation.

Suppose an employee is terminated, or quits, and the employment contract does not explicitly state that commissions are forfeited upon termination. In that case, they may receive earned but unpaid commissions.

Moreover, state laws are crucial in determining how commissions are classified and when they must be paid to terminated employees.

Some states, including Maryland, have laws that invalidate or render void certain employment agreements under specific circumstances.

In the case of Medex v. McCabe, the Maryland Court of Appeals held that a provision in an employment contract requiring a salesperson to remain employed with the company to earn commissions was invalid and against public policy.

Medex v. McCabe

The Maryland Court of Appeals ruled in favor of the sales representative, McCabe.

The court found that the provision in the contract, which required the salesperson to remain employed by the company to earn commissions, was invalid.

The court held that this provision was against public policy and contradicted Maryland's labor laws, specifically Articles 3-501 through 3-507, which protect the rights of sales representatives to recover unpaid sales commissions.

2. State laws prohibiting withholding of earned commissions

Some states expressly prohibit employers from withholding commissions that were earned before the termination of employment.

They are:

  • New York: New York Labor Law Section 193 prohibits employers from making unauthorized deductions from employees' wages, including commissions. Employers in New York must pay commissions as agreed upon in employment contracts.

  • New Jersey: New Jersey law (N.J.S.A. 34:11-4.1) prohibits employers from withholding or diverting commissions that have been earned and are due to employees. Commissions must be paid according to the terms of employment agreements.

3. Commission classification

Certain states, like California, classify commissions as a form of wages.

For instance, California’s Labor Code states that wages, including commissions, must be given within a certain amount of time after earning them.

If an employee is terminated and the employment contract does not explicitly state that commissions are forfeited upon termination, they may be entitled to receive earned but unpaid commissions.

The contract terms and applicable laws will determine whether any earned but unpaid commissions must still be paid.

4. Procuring cause doctrine

If an employee's efforts were the primary reason for a sale after their termination, they may be entitled to commissions, even if the contract does not mention post-termination commissions.

This was the result of the landmark case of Perthuis v. Baylor Miraca Genetics Laboratories.

Perthuis v. Baylor Miraca Genetics Laboratories

The Texas Supreme Court ruled that terminated employees could be entitled to commissions if their efforts were the "procuring cause" of a contract with a customer.

It emphasized that:

Employers could condition commission payments on continued employment, but such conditions must be explicitly stated in the contract.

If the contract does not specify continued employment as a condition, the employee may still be owed commissions even after termination if they meet the "procuring cause" criteria.

What are the Laws Regarding Commissions?

A combination of federal and state laws governs the issue of sales commissions. These have to be weighed in the context of contractual agreements between the employer and employee.

The various laws and regulations related to sales commissions include:

1. Fair Labor Standards Act (FLSA)

The federal Fair Labor Standards Act (FLSA) relates to minimum wage, overtime pay, recordkeeping, and child labor standards. The FLSA also requires employers to pay employees for all hours worked, including commissions.

2. State laws

Many states have their own laws to do with sales commissions.

Some require that employers have written commission agreements with their employees. For others, commissions can be paid within a specific time frame after the sale.

3. Antitrust laws

Antitrust laws relate to competitive price fixing and/or allocating markets. These include agreements among employers to fix sales commissions.

4. Employee Retirement Income Security Act (ERISA)

The Employee Retirement Income Security Act (ERISA) regulates employee benefit plans, including retirement plans. Employers can use commissions for retirement plans but must comply with requirements regarding funding and administration.

In Conclusion

Understanding when sales commissions are legally earned can be complex. It involves various factors like employment contracts, laws, and industry standards.

Here are some important takeaways to remember:

  • Put it in writing: Always have commission agreements in writing. Specify the commission rate, calculation method, and payment schedule.
  • Know your commission type: Determine the type of commission – whether fixed, sliding scale, one-time, or spread over time.
  • Check company policies: Review internal company rules and employee handbooks for commission-related policies.
  • Maintain records: Keep records of past and current commission payouts. Salespeople should also retain documents related to commissions.
  • Seek legal advice: If disputes arise, consult an attorney familiar with your industry and local laws to ensure compliance with regulations.

By following these guidelines, you can navigate commission-related matters more effectively and ensure that commission agreements are fair and legally sound.

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