Now is the time to review overtime exemptions and pay plans for sales employees to be ready for 2024. The changing tech economy has created a class of sales employees who may not fit traditional overtime exemptions. Moreover, poorly drafted commission and bonus plans ("Plans") often leave employers exposed to potential legal liability, especially to departing employees. Common mistakes include re-using boilerplate Plans without sufficient customization, not addressing state law issues, and failing to include language that protects the employer against ambiguities in the Plan. Disputes regularly arise when, for example, the Plan unexpectedly provides a windfall to employees that the employer seeks to withhold, and/or when employees leave the company and claim ongoing commissions for prior sales.
These common errors in Plans are especially problematic in a state like Washington where employees who sue to collect on these Plans can also obtain their attorneys' fees and double damages.
Employers can protect themselves by ensuring their employees are properly classified as exempt or nonexempt, carefully reviewing their Plans for compliance with the law, and by following these tips:
1.) Analyze whether sales employees are exempt from overtime.
When drafting or reviewing a Plan, it is important for the employer to ensure the subject employees are correctly classified as either an "exempt" or "nonexempt" from overtime, meal, and rest break requirements. Any incentive compensation earned by a nonexempt employee will need to be considered when calculating the employee's regular rate of pay for overtime purposes.
The basic rule is that everyone gets overtime absent a specific exemption. For salespeople who do not supervise anyone, the most likely exemptions are "inside/commissioned" salespeople, or "outside" salespeople. For the inside sales exemption to apply, the employer would need to be a "retail or service" establishment, selling mainly to non-enterprise customers. For the outside sales exemption to apply, the employee needs to be customarily and regularly at the customer's place of business (i.e., the classic "traveling salesperson.")
Some employees who perform sales as part of their job may also qualify for the administrative exemption if their primary duty is not sales, they earn a minimum salary ($67,000 in Washington, $66,560 in California in 2024). To meet the administrative exemption, 1) the employee's primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer's customers; and 2) the employee's primary duty includes the exercise of discretion and independent judgment with respect to matters of significance. For these reasons, the application of the administrative exemption to a sales employee is not common.
The bottom line is that a business-to-business salesperson who does not travel regularly is likely not exempt.
2.) Put the Plan in a signed document before it goes into effect.
One of the most important steps to take when implementing a Plan is to put the Plan into a clear, unambiguous written document before the Plan takes effect. This is important for several reasons.
First, it is important that the written document be explicit and precise. If there is ambiguity, contract law provides that the language is to be construed against the drafter (the employer) in favor of the other party (the employee/applicant). It is critical to present the Plan to employees prior to the Plan term starting to avoid ambiguity. This can occur, for example, when the employer does not have its annual Plan ready to present until mid-February, and there are changes from the prior year's Plan that are adverse to employees.
Second, it is best to make sure the Plan is drafted clearly and correctly from the outset, because if the employer later determines that it wants to make changes to the Plan, the employer may have to offer additional consideration (e.g., a bonus, a pay increase, etc.) to make the Plan enforceable.
Third, some states, including California, require commission Plans to be in writing and state the method by which commissions shall be computed and paid. California further requires employers to provide a signed copy of the Plan, but also obtain a signed acknowledgement of receipt of the Plan.
Fourth, several states, including Washington, recognize the "procuring cause doctrine." The "procuring cause doctrine" is a gap-filling provision that applies where a Plan does not state whether the employee is entitled to post-employment commissions. Where the Plan is silent, the "procuring cause doctrine" requires the employee to be paid for all commissions they "procured." In other words, if a sale is completed after an employee is terminated, the employee would still be entitled to the commission if the terminated employee's efforts led to the sale.
3.) Make clear when incentive compensation is "earned" or "vested" and therefore not subject to recovery by the employer. Avoid commission advances if possible.
Many courts, including Washington courts, look to the terms of the Plan to determine whether the employee "earned" incentive compensation or whether that incentive compensation is "vested." It is therefore crucial that Plans identify the specific conditions under which commissions or bonuses are "earned" or "vested," including how the timing of customer payments, employee splits, customer returns, and windfalls affect whether the bonus or commission is "earned" or "vested" under the Plans. Illustrative examples of when and how incentive compensation is "earned" or "vested" are helpful.
The Plan should also make clear whether the employee has ongoing customer service or other responsibilities after a sale is made (i.e., "servicing the account"). Outlining these responsibilities can protect an employer from paying commissions on an account, sometimes for years, after an employee has left because otherwise the employee can argue he or she "earned" the commissions when the sale was made. If it is a requirement for an employee to remain employed through a certain date to earn a commission, that must be stated prominently, and preferably supported by ongoing customer service requirements that the employee can only meet while employed.
Employers are also cautioned against offering advances under Plans as they can create accounting issues and potential wage claims. For example, under California law, employers are prohibited from structuring advances in a way that could lead to unpredictable deductions beyond the employee's control.
4.) Reserve discretion for employer.
It is hard for a Plan to foresee all contingencies that may arise, such as company mergers, territory re-organizations, or multiple employees claiming credit for a sale. Therefore, Plans should prominently state that the employer reserves the right to interpret, modify, or cancel the Plan at any time. Still, note that any compensation earned prior to the change must be paid. The Planshould also indicate that it supersedes all prior Plans, and that the employee's employment remains at will, meaning either the employee or the company can terminate the employee's employment at any time, with or without notice or reason. Finally, if the employer has an arbitration plan that covers any dispute under the Plan, it should be referenced in the Plan.
5.) Get the Plan reviewed by Human Resources and/or legal prior to presenting it to employees/applicants.
Before presenting a Plan to an employee or applicant, employers should verify the Plan complies with current federal, state, and local laws. The end of the year is also a great time to review the legality of existing Plans and determine whether any of the provisions are unenforceable due to legal developments. By taking the time to review new and current Plans, employers can potentially correct any issues relating to enforceability of the Plan's terms ahead of any legal battles. One frequent dynamic is that a Plan drafted by sales leadership focuses too heavily on making employees think they are going to make a lot of money, without including the necessary protections for the employer.
Further, these Plans should be reviewed to ensure they do not create implied promises of specific treatment. It is common for Plans to be drafted in a way to make the position appear as attractive as possible. Sometimes this includes promises relating to undated events in the future, such as a payout for a large sale that may or may not occur. These are the types of provisions that can potentially create a claim for implied promise of specific treatment; in other words, the employee may bring a claim alleging that it was implied in the Plan that the employee would eventually receive a certain amount.
For more information on Plans, please contact a Davis Wright Tremaine employment attorney.
This advisory is a publication of Davis Wright Tremaine LLP. Our purpose in publishing this advisory is to inform our clients and friends of recent legal developments. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.