How to Recognize and Prove Bad Faith Termination of a Sales Representation Contract
Introduction
- Bad faith termination is a termination of a Sales Representation Agreement (SRA) by a Manufacturer for the purpose of avoiding the payment of a sales rep’s commissions, or in retaliation when sales reps demand their proper contract rights.
- Bad faith termination can be harmful, considering it can take years to establish sales, sales which will often continue for years also. To have the commissions on those long-term sales denied by an early termination can be a gut punch.
What Bad Faith Termination Looks Like
Sudden Termination After Major Deals
- Sudden termination after a major sale (commissions for which may not be payable for 60-90 days) is the most common type of bad faith termination. This is done to avoid commission payments when sales reps have SRAs that can be terminated on 30 day notice.
Termination for Enforcing Contract Rights
- Termination for enforcing one’s contract rights is another common type of bad faith termination, usually when a sales rep is not paid the right commission percentage on a big deal, and they object. Principals then leverage the rep, offering a take it or leave it proposition: “either accept a reduced commission, or termination of the SRA will result and you will get nothing.”
Termination after Rejecting Micromanagement by Principal
- When sales reps reject micromanaging by their Principals, bad faith terminations sometimes result. Principals are not allowed to treat sales reps as employees however and are not allowed to exert control over their schedule, processes, protocol…
Terminations after a Design Win
- When a sales rep garners a “design win” for engineered parts, so his Principal’s component parts are purchased and used by an OEM customer when they manufacture their own product, that usually results in long term sales. Bad faith, early terminations sometimes result.
Unreasonable Contract Modifications
- Unreasonable contract modifications by a principal (usually taking large customers as House Accounts or reducing commission structure) can result in another type of bad faith termination. Even though the modifications are allowed by the SRA, if they negatively impact the rep’s right to commissions, it can result in the rep’s resignation.
Lack of Legitimate Reasons for Termination
- Terminations without valid cause form the basis for most bad faith terminations; and are usually due to the principal’s desire to increase their profit margin by saving the commission.
- However, if large commissions are pending and the sales rep is terminated for some valid reason before they are payable, the bad faith theory may not apply, and they may lose the commissions.
Legal Implications of Bad Faith Termination
How Bad Faith Violates Contractual Obligations
- Bad faith terminations violate contractual obligations because most contracts include an implied duty of good faith and fair dealing. Meaning neither party is allowed to take any action that impedes the other party’s right to receive their reasonably expected contract benefits.
- If a contract allows the Principal to take a previously commissionable account as a House Account and not pay commissions on it any longer, they can still commit bad faith if they exercise this option unfairly.
E.g., taking the sales rep’s top account as a House Account, when the account was producing 90% of the sales rep’s commission income.
Damages Sales Reps May Be Entitled To
- Damages available in a lawsuit when sales reps experience bad faith terminations include lost commissions, penalties, and legal fees.
- Some states have laws that address bad faith termination and allow the sales rep to continue being paid commissions after termination, as if the contract had never been terminated.
State Variations in Recognizing Bad Faith Claims
- Certain states have case law that is much more supportive of sales reps in bad faith termination cases.
California recognizes that even though a contract has a 30 day termination provision, that option may not be exercised arbitrarily to avoid payment of commissions.
Massachusetts has excellent case law on the topic, See e.g. Fortune v. National Cash Register Co., 373 Mass. 96 (1977) (salesman awarded contractual bonus on $5 Million order although he was terminated before bonus vested due to defendant’s opportunistic discharge to avoid paying it).
- New Jersey recognizes the right to long-term commissions if the plaintiff was wrongfully terminated in Bad Faith. See e.g., Sons of Thunder v. Borden, 148 N.J. 396 (1997) (Plaintiff awarded 1 year of lost profits, $412,000, after bad faith termination).
- Other states have protections against bad faith terminations.
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Proving Bad Faith
Documenting Patterns of Unfair Treatment
- Documenting patterns of unfair treatment is critical when something goes wrong between a sales rep and their principal, the rep should keep detailed records of communications, sales activities, and commissions.
- A detailed record of contract negotiations (including drafts of contracts, email concerning drafts of contracts and final versions) emails in general, termination notices, and sales/commissions data should be kept by the sales rep.
Using Sales Data to Prove Commission Losses
- Spreadsheets should then be prepared applying the commission structure agreed to, and calculating the commissions that would have been earned had the SRA not been terminated in bad faith.
- The most key aspect of recordkeeping is to document the direct link between the sales rep’s efforts and the company’s resulting revenue.
Testimonials and Witness Statements
- Testimonials from customers, or the Principal’s management team can support claims of bad faith termination. Even a note such as “Great design win, Jim! This deal is worth $10 Million in sales. Caviar and cigars for everyone.”
- Gathering and preserving witness testimony can be difficult and may require an attorney’s involvement.
How Sales Reps Can Protect Themselves From Bad Faith Actions
Negotiating Strong Termination Clauses
- Negotiating clear and protective provisions for the payment of commissions, both while under contract and after termination, is essential.
- An attorney who understands the functions and challenges of a sales rep can pinpoint weaknesses and loopholes, and draft strong provisions to protect long-term commissions.
Consulting an Attorney Early
- When a principal does something that may be allowed by the contract but seems unfair under the circumstances, it could be a sign that a bad faith termination is coming.
- If that happens, it is critical to seek legal advice as soon as possible, since a demand letter from a good attorney can correct anticipated bad faith terminations before they occur.
Taking Action Against Bad Faith Termination
Sending a Formal Demand Letter
- Sending a demand letter that clearly states the rep’s position and cites supportive case law can result in having the termination avoided/rescinded or compensation.
- Many good business lawyers have no knowledge whatsoever about this area of law and do not know how to push the right buttons to obtain these kind of results.
Contact an attorney knowledgeable in the law regarding independent sales reps to gain the proper leverage. We have over 70 years combined experience in sales rep disputes. Contact our attorneys today for a free consultation.
Pursuing Litigation When Necessary
- When demand letters and informal negotiations don’t result in success, litigation may become the best option. Many times, the simple process of filing and serving a complaint on the defendant results in early settlement.
- We have a documented 98% success rate in commission disputes since 1990.
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