Section Review

Compensating commissioned sales employees: Potential pitfalls with serious and costly consequences

Donovan
Michael Donovan
Spruce
Tracey Spruce
Michael Donovan is a partner and Tracey Spruce is an associate at Manchel & Brennan, P.C., an employment law boutique in Newton. They represent management in all aspects of the employer-employee relationship.

Introduction

Before you flip to the next article convinced that this one will be a better sleep accelerator than a turkey sandwich, take a moment to think about how many of your clients employ sales people who are paid, in whole or in part, on a commission basis. Then think about the rise in the number of employment class action lawsuits being filed against employers of all sizes and the publicity surrounding court decisions or settlements of such cases (e.g. Wal-Mart). Payment of commissions to sales employees is a potentially fertile area for such class actions. With multiple damages and criminal penalties at stake for both the company and its officers and managers, this article addresses a subject your clients cannot afford to ignore.

Commissioned sales employees

Let's assume you have been contacted to advise three companies concerning their commissioned sales force: Acme Shoe Co., a shoe manufacturer ("Acme"); Washington Shoe, a retailer operating 10 shoe stores in New England ("Washington Shoe"); and Northwing Software Corp., a regional software manufacturer ("Northwing").

Susan is an Acme saleswoman who sells the company's shoes to retail stores. In fact, one of her major accounts is Washington. She spends the vast majority of her time meeting with customers at their stores or offices. Susan is paid on a 100 percent commission basis, but she receives a recoverable draw in the amount of $2,000 per month (paid bi-weekly). Her commissions are determined and paid monthly.

Mark is a Washington salesman at its Boston store. He sells shoes on the showroom floor to retail customers. Mark is paid on a 100 percent commission basis and his commissions are determined and paid every two weeks.

Kim is a Northwing saleswoman who works out of her home office or visits customers and prospective customers at their offices. Her compensation package includes a $150,000 salary and 10 percent commission on all sales exceeding her $1 million annual sales target. According to Northwing's written commission plan, commissions over the $1 million target are paid monthly, but not finally earned until Northwing closes the books on the fiscal year in which the sale was made. The plan also states that sales that are reversed before the end of the fiscal year do not count towards quota or commission calculations.

Common wage issues related to employing commissioned salespersons

Most employers are aware that the Fair Labor Standards Act, 29 U.S.C. ß201 et seq. ("FLSA"), Massachusetts Wage Act, M.G.L. c.149, ß148 ("Wage Act"), Massachusetts Minimum Fair Wage Law, M.G.L. c.151, ß1 et seq. ("Minimum Wage Law") and Massachusetts Blue Laws, M.G.L. c.136, ßß6, 13 & 16 ("Blue Laws") address workforce pay issues, including minimum wage,1 overtime, holidays, Sundays and vacations. However, many questions can arise concerning the applicability of these laws to a commissioned sales force.

Are Susan, Mark and Kim subject to federal and state wage laws?

Whether minimum wage and overtime laws apply to Susan, Mark and Kim depends on whether they perform "outside sales" or "inside sales." "Outside sales" employees are exempt from federal and Massachusetts minimum wage and overtime requirements.2 29 U.S.C. ß213(a)(1); M.G.L. c. 151, ß1A. "Inside sales" employees in Massachusetts are not exempt from either requirement. Given their duties, Susan and Kim would likely be classified as "outside sales employees." Mark, on the other hand, would likely be classified as an "inside sales employee."

Minimum wage. As an inside sales employee, the minimum wage requirements would apply to Mark. Nonetheless, Washington Shoe can pay Mark on a 100 percent commission basis as long as it is highly attuned to Mark's commission level each and every pay period. For example, assume that Mark is having a slump and earned only $440 in commissions for the last pay period, during which he worked 80 hours. Even though he is paid on a 100 percent commission basis, Washington Shoe is obligated to pay him minimum wage for the hours he worked in the last pay period. Therefore, Washington Shoe owes Mark $100 in wages on top of the $440 in commissions ([$6.75 x 80 = $540] - $440 = $100). However, if Mark earned $550 in commissions during the same pay period, Washington Shoe is not obligated to pay Mark anything more than the commissions earned, because his commissions exceeded minimum wage for that pay period.

In order to avoid the administrative burden of determining whether it must pay Mark minimum wage each week, as well as to avoid paying wages above commissions earned, Washington Shoe could institute a draw program. Washington Shoe may pay Mark a draw (i.e., advance commissions) and then reduce future commission payments by the amount of the draw, provided that Mark always receives at least minimum wage and, if applicable, overtime and premium pay for all hours worked. Thus, during weeks when Mark's draw exceeds the amount of commissions earned, Washington Shoe may carry forward the "unearned" commission amount into the next pay period. For example, Washington Shoe could pay Mark a draw equal to minimum wage at 40 hours/week ($270/week). If he earns no commissions in week one, Washington Shoe may carry forward the entire $270 to be applied against future commissions. If he earns $370 in commissions in week two, Washington Shoe may reduce the negative amount carried forward to $170 ($540 - $370). If Mark earns $300 in commissions in week three, the negative amount carried forward is reduced to $140, and so forth. The key is to ensure that Mark always receives at least minimum wage and, if applicable, overtime and premium pay.

Overtime. With respect to overtime pay, inside sales employees must be paid overtime (one and one-half times the regular rate) for all hours over 40 worked in one week, whereas outside sales employees are exempt. However, employers should be aware of two important distinctions between the FLSA and Minimum Wage Law. First, the FLSA contains a limited exemption for inside sales employees who meet certain requirements.3 29 U.S.C. ß 207(i). However, this exemption has no practical effect in Massachusetts currently because the Minimum Wage Law has no corresponding exemption. M.G.L. c. 151, ß 1A.

Second, when determining the employee's "regular rate" for purposes of calculating overtime, the FLSA requires employers to include commissions, while the Minimum Wage Law specifically excludes commissions from the definition of "regular rate." 29 C.F.R. ß 778.117; 455 C.M.R. ß 2.01. Thus, if Mark fails to meet the requirements of 29 U.S.C. ß 207(i) because his regular rate of pay is less than $7.73/hour (one and one-half times the federal minimum wage), then Washington Shoe must include his commissions in calculating his "regular rate" for purposes of overtime pay.

Timing. Like minimum wage and overtime, the requirements concerning the timing of the payment of commissions to employees depends on whether the employee performs "outside" or "inside" sales. Under the Wage Act, Washington Shoe must pay Mark, at a minimum, bi-weekly because he performs inside sales. Acme and Northwing are not so restricted in designing their pay schedule for Susan and Kim because they are outside salespeople. Accordingly, their monthly and annual commission calculation and payment plans are permissible.

Sundays/holidays. The FLSA does not require premium pay for holidays and/or Sundays. The Blue Laws, however, require some retailers to pay premium pay (one and one-half times regular rate) for Sundays and certain holidays. See M.G.L. c. 136, ßß6, 13.

Do Susan's, Mark's and Kim's commissions constitute 'wages' subject to the Wage Act?

Courts generally hold that the Wage Act only covers commissions that constitute a regular and significant part of weekly income, and not irregular, lump sum, contingent forms of compensation payable under a contract. See, e.g., Cumpata v. Blue Cross Blue Shield of Mass., 113 F. Supp. 2d 164, 168 (D. Mass. 2000); Baptista v. Abbey Healthcare Group, Inc., 1996 WL 33340740 (D. Mass. 1996); Locke v. Sales Consultants of Boston, Inc., 2001 WL 716911 (Mass. Super. 2001); Dennis v. Jager, Smith & Stetler, 2000 WL 782946 (Mass. Super. 2000). Thus, in Cumpata the court held that the employee's commissions were not covered by the Wage Act because they were (i) above and beyond the employee's base salary, (ii) the topic of a separate and distinct compensation contract and (iii) contingent on the employee exceeding his sales quotas.

Accordingly, as 100 percent-commissioned employees, Susan's and Mark's commissions will almost certainly be covered by the Wage Act. Kim's situation is different. If Northwing does not want Kim's commissions to be subject to the Wage Act, Northwing could develop a written commission plan, pursuant to which commissions over the $1 million target are paid monthly, but not finally earned until Northwing closes the books on the fiscal year in which the sale was made and sales that are reversed before the end of the fiscal year do not count towards quota or commission calculations. Given that Kim's commissions are above and beyond her base salary, are subject to a separate, written compensation plan, and are contingent on her exceeding a $1 million annual quota, the current judicial trend would indicate that her commissions are outside the scope of the Wage Act.

May Acme, Washington and Northwing make chargebacks and setoffs against omissions paid or owed to Susan, Mark and Kim?

Neither the FLSA nor the Minimum Wage Law or Wage Act address the situation when a commissioned sales employee is paid a commission and thereafter, the sale unwinds. Under the Wage Act, once a commission is earned, i.e., definitely determined, due and payable, it is likely that recovery of the payment due to a reversed sale would be treated as a failure to pay wages. However, the Wage Act does not specify when commissions are earned - only that once earned, they must be paid in a timely manner. Employers are therefore free to establish their own commission policies. It follows, then, that if the commission policy describes how previously paid commissions will be charged back against future commissions, employers should be able to "un-pay" past commissions by deducting chargebacks from pending commission payouts. See Locke, 2001 WL 716911 (commissions may be charged back both before and after payment in accordance with terms of written commission plan). The lesson here is that employers should implement written commission payment plans that make clear when commissions are earned and when commissions will be charged back. For example, assume that Kim exceeds her $1 million quota in August. In September, she makes $100,000 in sales and is paid $10,000 in commissions. In October, the $100,000 customer cancels half of its order, but Kim makes $72,000 in sales to another customer. In accordance with its plan, Northwing needs to pay Kim only $2,200 in commissions for October ($7,200 commission - $5,000 chargeback = $2,200).

What if Kim resigns in October before the commissions are paid, and fails to return her company-issued laptop and cell phone? Many employers feel that they are entitled to withhold final paychecks or commission checks until they retrieve their equipment. However, the Wage Act permits only "valid setoffs" against wages, and that phrase is undefined. According to some state officials, Northwing's only option is to pay Kim what she is owed, but then sue her to recover its equipment. Other schools of thought suggest that if Northwing had a written agreement with Kim clearly stating that if she fails to return company equipment, Northwing may withhold the value of that equipment from any wages and commissions that are due, the setoff is permissible. Given the uncertainty in this area and the possibility of treble damages if the setoff is deemed invalid, employers may be well-advised to take the conservative, if frustrating, route of paying owed commissions and suing former employees for the return of their property.

How Are Susan's, Mark's and Kim's commissions handled upon the termination of their employment?

When the employment relationship ends, all wages due and owing must be paid: (a) on the date of termination if the employee is involuntarily terminated; or (b) on the next regular pay date if the employee resigns. When dealing with salaried or hourly employees, the determination of wages due and owing is fairly straightforward. As set forth above, however, the determination of commissions "definitely determined and due and owing" as of the termination date is an entirely different story, especially if the employer does not have a clear written policy on the subject. Without a clear policy, employer-employee disputes arise. If these disputes are not resolved by the deadlines noted above, the employer subjects itself to the civil and criminal penalties of the Wage Act. In Kim's case, the written policy is clear that commissions are not finally earned until after the end of Northwing's fiscal year. Therefore, as long as Northwing pays Kim commissions due promptly after the end of the fiscal year, it is not likely to run afoul of the Wage Act.

Serious and costly consequences for violations

Liability against both the company and certain key individuals

Under federal and Massachusetts law, an employer is subject to criminal and civil penalties as well as monetary damages. In addition, under the Wage Act, the president, treasurer and "any officers or agents having the management of" the company are deemed to be an "employer" for the purposes of the act. As an "employer," these individuals are subject to criminal and civil liability for the company's violations of the act.

Criminal and civil penalties
Under the FLSA, a willful violation of the minimum wage or overtime provisions subjects the company to criminal penalties of a maximum of: (a) $10,000 fine and/or (b) 6 months imprisonment.4 29 U.S.C. ß 216(a). In contrast, an employer convicted of a violation without willful intent under the Wage Act is subject to the same fate as a second violation under the FLSA, with higher penalties for subsequent offenses. M.G.L. c. 149, ß27C(a)(2). Additionally, a first-time conviction for a willful violation subjects the employer to a maximum of: (a) $25,000 fine and/or (b) 1 year imprisonment (maximum penalties are doubled for each subsequent conviction). M.G.L. c. 149, ß27C(a)(1).

An employer is subject to $1,000 maximum fines for each willful violation of the FLSA. 29 U.S.C. ß 216(e). Under the Wage Act, the attorney general may, in place of criminal proceedings, issue written warnings or civil citations for each violation requiring that: (a) the violation be rectified; (b) restitution be made to the employee; and/or (c) a maximum civil penalty of $25,000. M.G.L. c. 149 ß27C(b)(1).5

Finally, under federal and Massachusetts law, an employer is subject to: (a) double (federal) or treble (Massachusetts) damages; (b) attorneys' fees; and (c) costs. 29 U.S.C. ßß216(b), (c). M.G.L. c. 151, ß20. At least one Massachusetts trial court has ruled that, when an employer violates the Wage Act, the employee is automatically entitled to treble damages. Duct and Vent Cleaning of America v. Van Houten, 2000 WL 1473507. In Van Houten, the jury found that the company had violated the act by failing to pay Van Houten $11,000 in commissions that were definitely determined and due and owing at the time of his termination. The company argued that the court had discretion concerning whether to treble the damages. The judge rejected this argument, ruling that treble damages were mandatory.

Conclusion

Given the significant civil and criminal penalties associated with wage act violations, it is imperative that employers understand and fulfill their obligations before they find themselves the target of the next class action lawsuit.

End notes

1. Currently, the federal minimum wage is $5.15/hour and the state minimum wage is $6.75/hour.

2. To qualify for "outside sales" status, the employee must regularly sell their company's products and services away from the company's offices/stores and only have minimal in-person contact with the office/store. 29 C.F.R. 541.500-508; G.L.M c.151, ßß1A, 2; Mass. Dept. of Labor and Workforce Dev., Div. of Occupational Safety Opinion Letter MW-2002-025.

3. Employers are not required to pay overtime to inside retail or service employees "if (1) the regular rate of pay of such employee is in excess of one and one-half times the [statutory minimum wage], and (2) more than half his compensation for a representative period (not less than one month) represents commissions on goods or services." 29 U.S.C. ß 207(i).

4. First time offenders are not subject to imprisonment.

5. The maximum civil penalty for a first-time violation is $15,000 for intentional violations and $7,500 for unintentional violations. M.G.L. c. 149 ß27C(b)(2).

©2014 Massachusetts Bar Association