With surprising regularity, principals are taking legally flawed positions when reps must resort to legal action to collect commissions due, particularly following a termination. The assertion of defenses doomed to fail increases costs to both sides, fails to advance the litigation and generally serves no one’s interests.
Based on the pursuit of commissions due and unpaid to independent sales representatives for a combined 50+ years, the authors are in a unique position to offer some (unsolicited) advice to our manufacturer friends on how to defend commission litigation, or more accurately, how not to defend such claims.
Well aware that free advice is often worth the price paid for it, we respectfully chronicle below four commonly attempted — and consistently rejected — defense arguments. While they will not disappear, by explaining the futility behind these time-wasting positions, perhaps they will be thrown against the proverbial wall somewhat less often.
Many valid, or at least colorable, defenses can be and are asserted in response to unpaid commission claims, but these four don’t cut it.
‘Best efforts’ clauses are vague and rarely enforceable
“Best efforts” clauses are not get-out-of jail-free cards. All too often, when suit must be brought to recover unpaid commissions, a principal attempts to defend by asserting that the rep firm failed to use its “best efforts” to promote the product line, as the contract requires. This is no defense and certainly does not support a counter-claim.
If reps are truly not performing, they must hear from their principals about unmet expectations. Reps are used to receiving constructive criticism, and welcome open, two-way lines of communication. In the worst case scenario, non-performance or underperformance is a sound basis for exercising the right to terminate contained in most rep contracts. It is not, however, grounds to allow the contract to remain in effect and withhold commissions.
The principal who attempts to pull out a contract’s “best efforts” provision as a legal defense or even as a counterclaim after getting sued for nonpayment of commissions is what is sometimes known as an “amputee defendant” or a defendant with no leg to stand on.
Any sales rep can be accused of failing to use “best efforts.” This is why judges look at this accusation with skepticism. It is far too easy for a principal who receives millions of dollars in new orders from the diligent efforts of its sales rep to claim that, had the rep only applied his or her “best efforts,” the yield would have been untold millions more in sales.
Part of the reason judges don’t buy it is the phrase “best efforts” is usually undefined in the contract and as a practical matter, it is undefinable. Principals know at the time of contracting that independent reps carry multiple lines. The rep’s line card is usually disclosed and often featured on the rep’s website. Principals know they will receive less than 100 percent of the rep’s time. Full-time salespersons are readily available and are known as “employees,” requiring a guaranteed salary, insurance plan and other benefits: 401(k), use of a company car, travel allowance, expense reimbursement, office space, etc.
A sale made for Supplier B could always be construed as infringing upon the efforts Supplier A expected to receive. Yet, time spent promoting Supplier B’s line is not evidence that the rep failed to use his or her “best efforts” on behalf of Supplier A; it is evidence that the rep serviced multiple lines, as virtually all independent reps do.
The solution for Supplier A is to incentivize the rep to spend disproportionate time promoting its products, not to dredge up the tired “best efforts” argument when its non-payment gets challenged in court. This argument merely gets older, not better.
The right to terminate does not also bestow a right to reduce commissions
A principal who unilaterally lowers the commission rate forces the rep to either accept the reduced rate or resign the line. Such a reduction is usually a breach of contract, of course, and when it is challenged in court, the principal may argue that because the contract enabled it to terminate (with as little as 30 days notice), it impliedly also gave it the right to take the less severe step of simply reducing the commission rate.
Such an argument ignores the economics at play for reps. Taking a product line at a 7 percent commission rate may yield enough margin for the rep, but working the same line at 4 percent was never bargained for or agreed upon. This reduced rate might well have led the rep to pass on the proposed contract altogether. Such a backdoor effort to obtain the rep’s services at a lower commission rate than agreed upon is virtually never endorsed by a court.
Were this approach to contract performance successful, consider the mischievous arguments that could follow: “We had the right to terminate the contract altogether in 30 days, Judge, and instead, all we did was demand the rep turn over her list of contacts in our territory.” Or perhaps, “Judge, we were set to terminate the relationship, but we thought we’d be nice guys and only halve the commission rate and pay it out when we had the cash on hand.”
The right to terminate is self-limiting; it does not enable the principal to rewrite the rep agreement. Contract changes must get negotiated and agreed upon, and they cannot get imposed absent express authority in the contract.
Terminated reps are in no position to identify all withheld commissions
Rep litigation often begins with the principal’s attorneys demanding the rep identify “each and every sales transaction” on which they claim commissions are due. Particularly when the rep is claiming post-termination commissions, the principal will ask, apparently with a straight face, for the rep to specify the commissionable sales at issue. “How can we be expected to defend this case,” they bellow, “if you don’t tell us which sales you are disputing?”
In other words, the same principal who previously cut off the rep’s access to their sales data, often before the effective date of termination, will now point a hypocritical finger at its former rep for “withholding” that very data, the data only it possesses. Invariably, the judge comes to understand how the process works and the ploy fails, but not before both sides burn through valuable time, legal fees and good will.
When commissions are allegedly due and unpaid, the rep needs the sales records from the principal, not the other way around. The rep cannot specify the orders on which commissions went unpaid until the principal produces the complete sales history for the relevant time period.
Customer order records are important not only to the principal, who manufactures and ships the product, but also to the rep, who creates the demand for the product and procures its sale. Although these orders are frequently directed to the principal, the rep’s compensation is equally tied to them, and they should be equally accessible.
And one more thing. The requirement to furnish the sales records is not met by producing a spreadsheet prepared after the rep filed suit. The rep cannot be expected to trust that all potentially commissionable sales will be disclosed under such circumstances. This is why, when pressed, courts will generally compel production of the underlying sales records that presumably form the basis for the spreadsheet. The integrity of the process demands no less.
Split commissions never get split with the house
Contract clauses enabling principals to split commissions among sales reps are the industry norm where, for example, the design work is performed in one territory and the shipment is into another rep’s territory. Splits are acceptable because they work both ways, and usually even out.
The customary system finds Sales Rep A, who spent years of time and countless resources procuring an order, splitting his or her hard-earned commission with Sales Rep B, who just happens to cover the faraway territory where the product is shipped. This isn’t altruism; it’s recognition that Sales Rep A may soon be the territory rep eligible for a partial commission after the design work is performed by faraway Sales Rep C. Importantly, 100 percent of the commission gets paid either way.
However, a principal without an independent rep in each sales territory may sometimes be tempted to pay only a partial commission nonetheless, keeping for itself the split for the rep-less territory. This causes the entire rep-principal relationship to break down.
Without multiple sales reps eligible to receive a split commission, the prerequisite for a “split” is not met. When no Sales Rep B is in place, the entire commission is earned by Sales Rep A. If the principal retains any part of the commission, then it is paying a reduced commission, not a split commission, in violation of the contract as well as the industry standard.
Perhaps few principals read this column, and surely few readers of any sort read it to the end, but if principals used their best efforts to obtain sound legal advice, they would find they cannot rewrite contract law to serve their interests. They should identify legitimate and sustainable factual and legal positions, rather than reduce or split valid defenses with legally flawed arguments.