Essential Contract Clauses To Protect Commissions
Introduction
- The importance of a well-drafted contract for safeguarding a manufacturer sales representative’s commissions cannot be understated. It is the most critical aspect of a sales rep’s business.
- Missing or poorly drafted terms lead to disputes and loss of commissions for sales reps.
- The most critical clauses in any sales rep contract are:
1) Exclusive or non-exclusive appointment.
2) How commissions are earned.
3) When commissions are payable.
4) Termination rights.
5) The right to commissions on post-termination sales.
6) Dispute Resolution.
- Sales reps uncertain about the effectiveness of their contracts should review them with an attorney knowledgeable about the law concerning sales, and sales reps.
Key Contract Clauses Every Sales Rep Needs
Territory Development Fee
- A territory development fee is a monthly stipend paid to a sales rep who takes on a virgin (or nearly virgin territory). It allows the sales rep to survive without earning sales commissions, until sales commissions become substantial.
Exclusivity
- Exclusivity is one of the key protections in any sales rep contract. Exclusivity should be demanded, at least within the geographic or account based territory.
- Otherwise, you may find that the accounts you developed become assignable to another sales rep, or taken in house and made non-commissionable.
Commission Structure and Payment Terms
- Commission structure, formula and payment terms are also key. In fact, many States require certain minimum provisions to be provided in a contract.
- Commission percentages, when a commission becomes earned, and when a commission becomes payable are key provisions.
- If language on commission structure and payment terms is not laid out concisely and clearly it can lead to disputes over commissions.
- Sales reps are well advised to seek the counsel of an attorney knowledgeable in this area of law BEFORE negotiating or signing a sales representation contract.
Termination Provisions
- Termination provisions can be the most important clauses in a sales rep contract, because highly successful sales reps often earn commissions on monthly sales where the distribution goes on for many years.
- Principals then sometimes look to terminate the contract on a 30 day notice provision to avoid payment of commissions for the years after termination.
- Termination provisions that prevent or dissuade a Principal from terminating the contract are thus essential. These include:
Minimum duration contracts. Where the contract stays in existence for at least X number of years.
Longer termination notice such as 90, 120, 180 days or longer.
Liquidated buyout provisions. Rep gets paid a negotiated sum for the principal to terminate the contract early (often based on prior year’s commissions).
Post-termination commission rights. On sales for which the rep was the procuring cause.
Protection for Life of Customer. So the rep continues to earn commissions on all sales to a particular customer, if the sales rep generated the Company’s first sales with that customer.
- Termination for good cause is another concern. Many sales rep contracts State that the Principal is allowed to terminate the contract “for good cause.” However few of these contracts define what good cause means.
- If termination for good cause is included in a contract, that term needs to be defined, and thus limited.
Post-Termination Commission Clauses
- It is critically important for a sales rep contract to specify clearly whether commissions will be paid on orders received after termination.
- Don’t let manufacturer’s strong arm you into a 30-day termination agreement, without any further compensation. Protect your post-termination rights for the work you performed prior to termination.
- A contract which does not address post-termination commissions at all is better than a contract which clearly cuts off termination rights after a 30 day notice period (which is the typical contract provision).
- The Procuring Cause doctrine allows a sales rep to make a claim for commissions on any post-termination sales which were the result of their pre-termination efforts, IF their contract does not explicitly limit their post-termination commission rights.
Dispute Resolution Clause
- Dispute resolution clauses can bind the parties to first Mediate and then to Arbitrate a dispute, if it cannot be resolved informally by settlement.
Mediation is a formal settlement conference attended by the parties and presented to a “neutral,” who is usually a retired judge or an attorney with expertise in the area of law. Mediation is a preferred dispute resolution method, because it often results in settlements without filing a lawsuit.
Arbitration is like a lawsuit, but it is not filed within the Public Court system. It is instead presented to a private arbitrator. Arbitration is not a preferred dispute resolution method for plaintiffs because their legal remedies are extremely limited, they have to pay the arbitrators by the hour which can become prohibitive, and there is usually no right to appeal.
- Lawsuits are another dispute resolution method. They can be filed in either State or Federal Court (depending on the circumstances) when there are no dispute resolution provisions in a contract, limiting lawsuits.
Audit and Reporting Rights
- Although it is not mandatory, sales reps would be well advised to negotiate and include a provision that allows them to audit the Principal’s sales records, occasionally, to ensure accuracy of reporting.
- Lack of audit rights can mean lack of access to sales data, which often leads to Principals underpaying or failing to pay commissions.
Common Contract Pitfalls That Leave Reps Vulnerable
Vague or Missing Payment Guidelines
- Vague or missing payment guidelines lead to the risk of open-ended or unpaid commissions.
- Commission provisions should include language such as:
Commissions earned. “Rep will be entitled to commissions on all sales within the assigned territory.” Or,
“Rep will be entitled to commissions on all sales which they procured within the assigned territory.”
Commissions payable. “Commissions will become payable by the 15th day of the month after receipt of payment from customer.” Or,
“Commissions will become payable by the 15th day of the month after shipment to customer.”
One-Sided Termination Provisions
- Contracts that allow the Principal to terminate “at will” on only 30 day notice are the most prevalent contracts presented to sales reps by their Principals.
- Contracts that allow the Principal to terminate “at will” in an industry where it might take the sales rep six months, one year, or longer to make sales (engineered products for example) can result in substantial unpaid commissions.
- Good sales reps are not order takers. They are sales and market developers.
- Post-termination protection must be written into contracts or sales rep will find themselves terminated prematurely, after doing great work to set up sales.
Negotiating Stronger Contract Terms
A checklist of key provisions to negotiate.
- Territory development fee (negotiable).
- Exclusivity (negotiable).
- Audit rights (negotiable).
- Defined and expedient payment of commissions (non-negotiable).
Protection against early termination (non-negotiable).
Effective negotiations
- Listing the optimal or required provisions is one thing, but negotiating them may be quite another. A sophisticated approach is sometimes required.
- It is best to hire an attorney knowledgeable in this area of law to assist with the negotiations. Our attorneys have major experience assisting sales reps in these negotiations both behind the scenes and by working directly with the company’s attorneys.
- A good starting point is to send the Principal a list of requested provisions, and required provisions. That way, the parties can see if they agree on critical provisions before drafting a contract.
- It is essential to balance flexibility with required safeguards.
How to Identify Red Flags in Proposed Contracts
- Red flags in sales rep contracts include:
Non-exclusive appointments (company employees or other sales reps will be competing with you for business).
30-day “at will” termination (especially if there is no minimum duration and no protections for commissions on post-termination sales).
House accounts (Principal allowed to grab key accounts as non- commissionable, after sales rep lands monumental sales. Causes a loss of the big commissions).
Right to renegotiate commission percentage (Principal allowed to reduce the commission rate to offer better price point, to garner a sale. Only agreeable if done with consent of rep).
How to Amend Contracts to Address Missing Protections
Identifying Gaps in Existing Agreements
- Identifying gaps and ambiguities in current contracts can result in an amendment to the contract for the clarity and benefit of both parties.
- Most sales rep contracts have provisions allowing the parties to amend the contract if there is mutual consent.
- Sales reps should thus audit their representation contracts to check for protections against termination and on post-termination commissions.
Proposing Amendments to Your Principal
- Proposing a contract amendment to a Principal can be a tricky proposition. Sometimes a sales rep needs to offer other value to the Principal when they seek to amend or add provisions that protect their commissions.
- It is also important to present amendments as mutually beneficial, and to draft appropriate language for the amendment before approaching the Principal. That way, the Principal can see something in writing and hopefully agree.
Preparing for Pushback During Negotiations
- Principals may resist certain proposed amendments, so it is advisable for the sales rep to have a list of negotiable and non-negotiable provisions that need to be added to the contract.
- Then, the rep needs to be ready to have logical and fair discussions why the suggested new provisions must be included in an amendment.
Conclusion
- Well-structured and drafted representation contracts will prevent commission disputes and protect a sales rep’s commission structure.
- Be proactive in negotiating and reviewing agreements. Strong contracts may have an out of pocket expense to begin, but can later provide long-term financial benefits and security.
- Our attorneys have drafted sales representation contracts for almost every industry imaginable. Custom preparation of these contracts is essential to address each particular situation.
Contact us for a free consultation and advice on your contract.
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FAQs for This Article
Commission clauses in a sales rep contract should include a commission %, payment triggers, commissionable products/territory, and timelines for payment of commission.
A sales rep can still recover commissions on sales that close after termination, IF they negotiate protective termination clauses; or IF there is no contract language limiting the right to commissions on post-termination orders.
Termination clauses are critically important because they define the conditions for termination, as well as the length of notice needed, and if properly negotiated and drafted protect reps from unfair business practices to avoid payment of commissions.
An audit clause is a contract provision that grants a sales rep the right to review their Principal’s sales records. They are advisable because sales reps don’t always have access to purchase orders, invoices and other documentation of sales.
Better contract terms can be negotiated by a sales rep espousing their marketing and sales acumen; and then asking for stronger protections in proposed contracts because they are worth it.
Legal protections for 1099 independent contractors (such as independent sales reps), versus true W-2 employees of a manufacturer vary drastically.
If you’ve been misclassified or denied commissions or employee compensation, contact our attorneys today for a free consultation.
Sales reps should have an attorney review their sales representation contracts because the legal expertise of an attorney who understands the law concerning sales and sales reps can help identify risks, red flags, and ambiguities in proposed contracts, and clear up these problems before the parties sign. Or through amendments to existing contracts.
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