Avoid Common Mistakes When Creating Commission and Bonus Plans

Commissions and bonuses represent a significant component of the compensation packages of many employees. California Labor Code section 2751 requires commission agreements to be set forth in writing, and requires employers to provide signed copies of the agreements to their 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 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 commission is perhaps the most important element of a commission or bonus plan. Employers should be particularly wary of establishing plans that link the accrual of commissions to the procurement of a customer, since commissions can arguably continue to accrue even beyond the termination of employment under such plans.
  • 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.
  • How is the commission or bonus calculated? Employers and employees sometimes focus solely on the rate at which commissions or bonuses accrue on a sale without defining the base on which the commission or bonus 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.
  • When is a commission or bonus payable after it accrues? 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. In the wake of the California Supreme Court’s decision in Peabody v. Time Warner, Cable, however, employees classified as exempt under the sale exemptions must receive wages during every pay period that (a) equal or exceed 150% of the minimum wage, and (b) consist primarily of commissions. Additionally, 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, but employers should recognize that California law generally prohibits forfeiture of accrued compensation, so provisions that operate to divest employees of earned commissions or bonuses because their employment terminates prior to payment may not be enforceable.
  • 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.

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 do so immediately in order to comply with Labor Code section 2751.
  • Employers that have not submitted their commission and bonus plans to review by counsel in the past two years, would be wise to do so at this time.

If you have any questions about the issues arising from commission plans or bonuses, or any other issue relating to employment law, please contact one of our attorneys:

Daniel F. Pyne III 
Karen Reinhold 
Ernest M. Malaspina
Richard M. Noack 
Shirley Jackson 
Jasmine Anderson

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