New Requirements for Commission-Based Employees Who Provide Services in California

December 27, 2012

The start of a new year frequently serves as a time for sales organizations to take stock of past sales performance and develop commission plans for the coming year.  But this year, companies with sales or other commission-based employees who provide services in California are faced with a new legal hurdle:  Effective January 1, 2013, all commission-based employment contracts must be in writing and set forth the method by which such commissions are computed and paid.  While this law–which amends and revives California Labor Code Section 2751–was purportedly enacted to ensure greater certainty and protection, it raises a number of unanswered questions employers may soon face, including questions about:  (1) the geographic reach of the law; (2) what terms should be included in commission agreements; (3) how to plan for and fill any gaps that may exist between old and new commission agreements; and (4) what potential liability employers may incur under the statute.

The Text and Purpose of Amended Section 2751

Effective January 1, Section 2751 will require that all commission contracts "be in writing and . . . set forth the method by which the commissions shall be computed and paid."  Cal. Lab. Code § 2751(a) (2012).  Under the statute, employers must also "give a signed copy of the contract to every employee who is a party [to the contract] and . . . obtain a signed receipt for the contract from each employee."  Id. § 2751(b).  It also provides that, where the parties continue to work under the terms of an expired contract, "the contract terms are presumed to remain in full force and effect until the contract is superseded or employment is terminated by either party."  Id.  The law specifically excludes from its purview short-term productivity bonuses; temporary, variable incentive plans that increase, but do not decrease, payment under the written contract; and bonus and profit-sharing plans, except where an employer has offered to pay a fixed percentage of sales or profits as compensation for the work performed.  Id. § 2751(c); see also Assem. B. 2675, 2011-2012 Sess. (Cal. 2012).  The stated purpose for amending Section 2751 was to "protect employees from fraud and abuse, as well as protect employers from unnecessary litigation resulting from vague oral contracts."  Hearing on AB 1396 Before the S. Comm. on Labor and Industrial Relations, 2011-2012 Sess. (Cal. 2011).

The California law does not apply retroactively; when it was passed in 2011, the legislature provided a "safe harbor" period for employers to meet the new requirements, delaying the effective date until January 1, 2013.  However, that time has almost come and gone, and in a matter of days, the safe harbor period will end. 

In enacting this law, the California legislature explained that it was "follow[ing] the lead" of several other states that "requir[e] that all employers put commission-based employment contracts in writing."  Hearing on AB 1396 Before the S. Comm. on Labor and Industrial Relations, 2011-2012 Sess. (Cal. 2011).

The Geographic Reach of the Law

By its terms, Section 2751 applies to any commission agreement for "services to be rendered within [California]."  But when it comes to geographic reach, the statute provides no further specifics.  For example, does Section 2751 extend only to those employees who physically work inside California, as opposed to those who make sales online, or by telephone and email?  And does it apply to those who might only engage in a single business transaction in California?  Neither the Labor Commissioner nor the courts have weighed in on these issues, and these questions are likely to be the subject of future litigation.  Cf. Sullivan v. Oracle Corp., 51 Cal. 4th 1191 (2011) (holding that California’s overtime requirements apply to work performed in California by certain non-residents but leaving open a number of questions regarding the geographic reach of California’s employment laws).  In the meantime, employers are well-advised to carefully review any commission plans or agreements that could potentially touch on any services to be rendered in California.

Recommended Contents of Commission Agreements

Although Section 2751 states that commission agreements must set forth "the method by which the commissions shall be computed and paid[,]" it does not provide further or more specific guidance as to what terms should be included in such agreements.  Nor has California’s administrative enforcement agency commented on the new requirements under Section 2751.  However, employers should consider including the following terms in commission agreements:

(1)  State how commissions will be computed and paid.  Section 2751 does not provide specifics as to how, or with what level of detail, a commission agreement should "set forth the method by which the commissions shall be computed and paid."  If feasible, however, the information provided should be detailed enough to allow the employee to calculate the commission for any given sale.  Future plaintiffs may also argue that the timing of such payments should be specified in the agreement.  In describing the method of computation and payment, it is unclear whether employers may incorporate by reference data or calculations that are set forth in another document or source, but guidance under the California Wage Theft Prevention Act suggests that this may be permissible.  See CA Dep’t of Indus. Relations, Wage Theft Prevention Act of 2011 – Notice to Employees,  Frequently Asked Questions, http://www.dir.ca.gov/dlse/FAQs-NoticeToEmployee.html (permitting incorporation by reference under the California Wage Theft Prevention Act, stating "[a]ny additional reference to or incorporation of another document or attachment must be specifically described on the notice").  Until more guidance is provided, employers are well-advised to provide as much detail in the commission agreement as possible.  In describing this information, employers must also be mindful of existing state and federal requirements governing the calculation and earning of commissions, such as rules relating to chargebacks and reconciliations, rules against forfeiture, and rules regarding the incorporation of commissions into the regular rate of pay and the payment of corresponding overtime premiums to non-exempt employees.

(2)  State how commissions will be paid at termination.  Among commission-based employees, the amount and timing of commission payments at the time of termination is often a source of contention.  And although Section 2751 requires employers to describe how commissions will be "paid[,]" it is unclear whether employers must include specifics as to how or when commissions will be paid in the event of a termination.  Because this is often the subject of dispute, employers should consider including these details in commission agreements.  In doing so, employers should also be mindful of existing state law requirements regarding termination pay.  See, e.g., Cal. Lab. Code §§ 201, 202 (2002); see also CA Dept. of Indus. Relations, DLSE Enforcement Policies and Interpretation Manual § 4.6, available at http://www.dir.ca.gov/dlse/manual-instructions.htm ("There are situations where wages (i.e., some commissions) are not calculable until after termination . . . .  The employer has an obligation to pay those wages as soon as the amount is ascertainable and failure to pay those wages at that time will result in imposition of waiting time penalties.").

(3)  Provide a specific effective date and specific expiration date for the commissions, and plan accordingly for the expiration of the agreement.  In a commission plan, as in many other agreements, it is important to include a specific effective date and expiration date.  Under Section 2751, however, where the parties continue to work under an expired commission agreement, the agreement will nevertheless be enforced unless "the contract is superseded or employment is terminated by either party."  As a result, it is more important than ever for employers to plan appropriately for the termination of such agreements.  Thus, where possible, employers should have the next year’s plan developed and distributed before the expiration of the prior year’s plan, and employers may wish to consider a contingency plan–built into the agreement itself–that would apply if the agreement expires before a new commission agreement is put in place.  For example, the agreement might provide that the employee will receive an alternative (specified) method of compensation if no new agreement is in place as of the expiration date, such as a weekly salary or reduced commission.  Of course, in describing this alternate method of compensation, the employer should consider how it might affect any applicable exemptions, such as the outside sales and commission sales exemptions.  And as always, for "at will" employees, any agreement with an expiration date should also make clear that the agreement does not create a guaranteed term of employment.

How to Combat "Gaps" Between Commissions Plans

As discussed, Section 2751 serves to fill any "gap" between the end of one commission plan and the start of a new commission plan.  These gaps can occur for a number of reasons, including administrative delay in implementing a new commission plan, the refusal by an employee to sign the commission plan (although it is questionable whether an employee could use such tactics to unilaterally prevent implementation of a new commission plan), or a desire to implement an annual commission plan that is dependent on financial data that is not available at the start of the year.  Under Section 2751, if the parties "nevertheless continue to work under the terms of the expired contract," the terms of the previous oral or written plan apply.

Where a potential "gap" presents itself, employers should act quickly to address it.  For example, an employer might implement an interim plan providing certain minimum commissions to employees, at least until such time as the details of the final plan are resolved.  Alternatively, to prevent any commissions from accruing under a prior agreement, the employer could choose to cease all "work under the terms of the expired contract[.]"  Cal. Lab. Code § 2751(b).  Such a drastic step may be necessary, particularly where the employee neglects or refuses to acknowledge the new agreement.  See, e.g., id. § 2751 (requiring employers to obtain a "signed receipt for the contract from each employee").  Employers with a traveling or remote salesforce may also consider collecting the required acknowledgements using an electronic signature, which–while not expressly addressed in Section 2751–appears to be consistent with California’s electronic signature laws.  See Cal. Civ. Code § 1633.7 (2000).        

Potential Liability for Violations of Section 2751

Although the statute is itself silent as to damages or penalties, the plaintiffs’ bar is certain to pursue various theories of liability for any alleged violations of Section 2751.  For example, where an employer implements a new commission plan on terms that are less favorable to the employee, and where the new plan does not comply with Section 2751, employees may argue that they are entitled to unpaid wages under the prior plan–or under a prior oral agreement–along with a host of derivative statutory penalties under the California Labor Code.  See, e.g., Cal. Bus. & Prof. Code § 17200 et seq. (2008) (providing for restitutionary relief for unlawful business practices, including violations of the Labor Code); Cal. Lab. Code § 226 et seq. (2012) (providing for derivative "pay stub" penalties that accrue for each pay period and for each employee).  And even where there is no dispute over wages owed, some employees may argue that they are entitled to monetary penalties for "technical" violations of the statute.  See, e.g., id. § 2699 et seq. (the California Private Attorneys General Act ("PAGA")); but see id. § 2699(g)(2) (exempting from PAGA any action based on a "notice" requirement under the Labor Code, raising questions as to whether PAGA will apply to violations of Section 2751).

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In sum, it remains to be seen how California courts and the California Labor Commissioner will interpret the language of the revised Section 2751, and what type of liability may result from alleged violations of the statute.  In the meantime, as courts begin to grapple with these and other open questions in the coming months, employers should put written commission agreements in place where necessary, carefully review any existing commission agreements, actively monitor and plan for the expiration of such agreements, and proactively address any open issues or concerns to limit any potential liability under the statute.    

Executive Compensation and Employee Benefits Practice Group:
Stephen W. Fackler – Chair, Palo Alto and New York (650-849-5385 and 212-351-2392, [email protected])
Sean C. Feller – Los Angeles (213-229-7579, [email protected])

© 2012 Gibson, Dunn & Crutcher LLP

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