A well-written sales compensation plan document clearly defines when the commission* is officially “earned,” and this may or may not be at the same time that it is paid. Many companies will pay some or all of the commission for a sale following the booking of the order, but reserve the right to reverse sales credit and payment if the order is cancelled, the product is returned, or the sales value is not collected from the customer within a certain timeframe.

Typical “triggers” for payment include:

• Booking/Order: The customer has agreed to purchase a specific product or service at a specific time for a specific price with specific terms, all documented in writing (e.g., booking)
• Shipment/Work completed: The product is shipped from the warehouse, or the service is delivered and accepted by the customer
• Revenue: Revenue for the sale is recognized in the company’s account in system (which may be triggered by shipment or service delivery as well)
• Cash: Some or all of the payment for the sale is received.

In the case where some or all of the commission is withheld until the company receives payment from the customer, some states (Illinois and Maryland) are beginning to adopt what is called “substantial procurement” doctrine, recognizing the right of sales people to be paid commission for booking a sale, even if their plan document states that payment is not earned or made until cash is received.

Despite this clearly defined “trigger” for earning and payment in the plan document, former employees in Illinois and Maryland can now argue otherwise. Their argument is rooted in the significant investment of time and effort on their part culminating in the successful close of the sale. They argue that a booked order “substantially procured” the commission because they (1) were able to convince the customer to agree to the sale, (2) processed the order, and (3) knew the company was prepared to ship or deliver the product or service to the customer.

In today’s economy, with companies struggling to maintain their cash flow, sales reps are not typically in the business of securing payment, leaving this task to their friends in accounts receivable.

Bottom line: In at least two states in the US, your sales people have the right to their commission payment if they obtained the order, regardless of the wording of your sales compensation plan document. Thus far, the practical implications have extended only to terminated employees. Watch for similar actions in other states, and for sales people making the claim that payments may not be withheld until cash is received if their job is done once the order is obtained.

For more details see the article on the SHRM web site by Joan Deschenaux (SHRM Senior Legal Editor), visible only to SHRM members.

*To date, this issue has arisen only with true commission plans (communicating compensation as a percent of the value of what is sold). However, the principles apply and the issue may shortly arise with other forms of sales compensation including quota-based incentives or bonus-type plans.

Question

What do we do when a sales person leaves the company before the last payment is made for a contract closed by the sales person? Do we still pay after termination?

Answer

There are three reasons most often cited for paying over several years on a multi-year deal:

1. The value of the deal is not really clear at contract signing. This would be the case if the contract were really for a rate vs. for a guaranteed total price paid at pre-specified dates. For example, one client in the business of delivering online testing contracts for a rate per test, but the total test volume can be very hard to predict. In such cases, even if the sales person is really mostly responsible for closing the deal, and someone else picks up the delivery/client management, the payment needs to be made after revenue is recognized.
2. The sales person needs to stay involved to keep the customer happy and make sure the contract “goes.” This is the case in a combination sales/client management role where the deal could end up not being as-signed if delivery is not managed carefully, and the organization wants the sales person involved in ensuring things go as planned (or another way of saying this that things go as that sales person promised they would).
3. The company believes the promise of future payments is a good tool for retaining top sales talent. (You’ll find that we question this assumption, but that’s the topic of a future post.)

In case of #1 above, you might consider continuing payment as the rationale for not paying up-front is that you don’t know how much to pay. However in cases #2 and #3, you probably would prefer to avoid paying the terminated employee. Depending on the nature of your sale and your compensation plan, and local (state) laws, you may have no choice but to pay the terminated employee. However, for many sales roles a helpful approach is to include language in your sales compensation plan document (you do have one, and it’s signed by your sales people and their managers, and a record of this is kept by the company, right?)… anyway, include language in that plan document that says that that…

The commission is earned when the final payment on the contract is made, that the sales person must be employed at the time the commission is earned to be eligible for payment, and that all payments in advance of that event are advances against those future earnings.

So, for example, if your sales person sells a 3 year deal with annual payments, and if your compensation plan pays annually when payments are received from the customer*, and if the sales person leaves the company after receiving the 2nd of those three expected payments, then technically you would be owed the first two payments. However, you should probably make it standard practice to “forgive” that “debt.” But it would be quite clear that you do not owe the third payment.

We are not attorneys and cannot give legal advice, but have recommended this approach to many of our clients, and their attorneys have felt it was a good idea and legally defensible.

*Note that annuity tails in compensation plans like the one described in this example have their own issues, and we do not generally recommend them. Check back for a future post on the topic of compensation for multi-year contracts.