Beginning Jan. 1, 2013, all companies that pay commissions to employees providing services in California must have written contracts detailing how commissions are computed and paid. This potentially burdensome law was passed at the end of last year, and so far has received little attention.

The specifics of the new law

Under the new law: (1) All employees paid at least in part by commissions must be provided with a written contract that includes an explanation of how the commissions are calculated and when they are paid; and (2) a copy of the signed contract must be given to the employee and the employer must keep a signed acknowledgement of receipt of the contract.

Short-term productivity bonuses, bonus and profit-sharing plans are specifically excluded from the definition of “commissions” under the new law. However, if the employer has promised to pay a fixed percentage of sales or profits as compensation for work, that is considered a “commission” that falls under the new legislation. Because bonuses often are based on a percentage of sales or profits, we expect disputes to arise from the ambiguity of the definition of “commissions.” The best practice, irrespective of the wording of the statute, is to have a written bonus plan as well as a commissions plan, to avoid misunderstandings with employees.

Because the statute will requires employers to now have written agreements with at-will employees with whom they would not otherwise have had a written contact, employers should include a recital in the contract stating that the employee’s “at will” employment status is not altered by the existence of the written commissions contract.

Calculation of commissions

All written commissions plans must include a calculation of the commission. Typically, commissions are a percentage of sales or profits, but the words “sales” or “profits” must be defined and applied consistently. As an example, “profits” can mean the amount of the sale as written, less the cost of goods, returns, refunds, discounts, cancellation of orders and rebates.

Some companies have run afoul of the law by deducting the cost of doing business, such as a portion of all store returns, from the commissions otherwise earned by employees. Additionally, cash shortages, loss of equipment and other business losses that result from an employee’s negligence may not be deducted from an employee’s commission, just as they may not be deducted from regular wages.

Because all paychecks must show the basis of the calculation of pay, we encourage employers to provide a summary of how the commissions were calculated with each check in addition to explaining how commissions are calculated in the written commission contract.

When commissions are earned

Of paramount importance is the determination of when the commission is considered earned. At the moment the commission is deemed earned, it is a wage that is due and payable to the employee. Commissions can be earned when: (1) the customer places a purchase order; (2) the company issues an invoice; (3) the goods are shipped; or (4) the customer pays. While you can provide that any returns will be taken out of future earnings, if the employee leaves before the product is returned, it will be impractical to chase the employee for return of the commission for that sale.

The timing of payment of commissions

Under the new law, the written contract must address when the commissions are actually paid to the employee. Companies have some flexibility here and may indicate that it will calculate the commissions after the close of a period of sales, such as a month, and that the commissions will then be paid within two weeks (or some other time frame) after it is calculated. Upon termination of employment, companies must calculate the amount due as soon as reasonably practicable after the termination, and pay the employee at that time. A thoughtfully drafted contract provision can help manage expectations — and avoid disputes — as to when a final commission check may be due to an employee.

Termination versus resignation

Often there are disputes as to whether a company, upon termination of a commissioned employee, is required to pay commissions for sales that did not close prior to termination. Generally speaking, if an employee resigns, or is terminated for cause, the company may abide by its written commissions contract as to when a commission is due. If, however, a salesperson is the procuring cause of a sale that is not yet technically “earned” at the time the employee is terminated without cause, a court may frown upon the withholding of the commission.

In the end, having a carefully drafted commissions agreement with employees avoids misunderstandings and serves to reinforce the company’s goals for its commissioned salespeople.