The definition of “commission” can mean the difference between an employee who is entitled to overtime pay and one who is exempt from overtime and other wage-hour laws. Both federal and California law exempt retail salespersons who earn at least 50% of their wages via commissions (along with other requirements). An incentive payment that does not qualify as a “commission” is not counted towards the 50% threshold.

The “commission” definition also is significant in the vehicle sales context. Employers are permitted to pay commissions monthly, rather than at the more frequent intervals applicable to other forms of wages.

So what is a “commission”? Labor Code Section 204.1 says it is “compensation paid to any person for services rendered in the sale of such employer’s property or services and based proportionately upon the amount or value thereof.” Section 204.1, the provision permitting monthly commission payments, expressly applies only to licensed vehicle dealers. However, courts apply the statute’s definition of commission outside the automobile sales context.

The Court of Appeal in Areso v. Carmax, Inc., ____ DJDAR ____ (May 20, 2011), interpreted Section 204.1’s definition of “commission” in a way that may surprise employers and their lawyers, and even the state Labor Commissioner.

Areso and a class of Carmax salespersons brought a class action lawsuit against their employer. Areso sold used vehicles, warranty plans, and appraisals. Up until 2005, Carmax paid its sales personnel a flat $150 per sold car. Carmax later changed its commission plan to a complex formula of percentages that ended up approximating the same payment per car-about $154. Carmax also paid Areso fixed sums for each warranty sold, each car leased, and other services. Carmax’s intention was to avoid creating an incentive for employees to favor selling higher-priced items to value-oriented customers.

Areso asserted she was mis-classified as exempt from overtime based on the “inside sales” exemption discussed above. Her principal argument was that a fixed payment per unit (e.g., car, warranty, etc.) sold is not a commission, but rather a “piece rate” or other incentive payment.

The resolution of the case therefore turned on the definition of commission contained in Labor Code Section 204.1. Areso’s claims’ viability depended on whether Carmax’s system compensated Areso “based proportionately upon the amount or value” of the cars, warranties, etc. If so, she was “exempt;” if not, she and the class would be due overtime pay and other damages.

Agreeing with the trial court, the appellate court held that Carmax’s fixed payment per unit sold is a commission. The court deemed the analysis of Carmax’s commission plan under Section 204.1 to present an issue of first impression. The court decided that a fixed payment per item is “based proportionately on the amount” of items sold, in that each sale generates a corresponding payment. The commission did not vary based on the value of the sold goods and services. But, the court reasoned, Section 204.1 says “amount” or “value.”

The Carmax court did not consider itself bound by a line of authority standing for the proposition that a commission must be a percentage of the sales price. The state Division of Labor Standards Enforcement has written in its Enforcement and Interpretations Manual that a commission is a percentage of gross or net sales. The agency has said that other forms of incentives are bonuses or piece rates.

The Division’s enforcement position is based on two judicial opinions. The Court of Appeal wrote in Keyes Motors, Inc. v. Division of Labor Standards Enforcement, 197 Cal. App. 3d 557, 563 (1987): “Labor Code section 204.1 sets up two requirements, both of which must be met before a compensation scheme is deemed to constitute ‘commission wages.’ First, the employees must be involved principally in selling a product or service . . . . Second, the amount of their compensation must be a percent of the price of the product or service.” The state Supreme Court quoted this definition with approval in Ramirez v. Yosemite Water Co., 20 Cal. 4th 785, 804 (1999).

The Carmax decision recognizes payments per unit sold can be commissions, but does not alter other requirements. For example, even compensation based on a percentage of sales is not considered a “commission” if the employee is not involved in selling the item. In Keyes Motors, the dealership paid mechanics a percentage of the fees charged for servicing automobiles. The court decided these mechanics were not “exempt” commission-based workers. The court noted they were not selling the repair services to the customer, but were simply sharing in the revenue generated by their work. In Ramirez, the dispute was over whether water delivery drivers primarily were involved in selling water, or simply delivering the number of bottles the customer requested. Unless they were selling they could not be considered commission-based sales workers.

Employers who calculate commissions as a percentage of the “value” of an item must ensure the calculation comports with the commission definition. As discussed, the courts have held a true commission is a percentage of the sales price. It may be lawful to pay commission on the “net” sales price, after adjustments for discounts. But payment of a percentage of profits (e.g., sales minus expenses) may be deemed a bonus. Deducting expenses, such as overhead costs, from sales prices also may disqualify the payment as a commission. The consequences are significant, because it can result in either late payment of wages that do not qualify as commissions under Section 204.1, or mis-classification of an inside sales worker.

Finally, even employers who pay bona fide commissions do not escape potential liability. Problems can arise when sales workers leave or are discharged and wish to collect unpaid commissions, when customers return or do not pay for previously sold goods and services, and when commissions are generated over time. Employers should have a properly drafted commission plan that clearly explains when commissions are earned, the applicable rates paid, and the consequences of non-payment or termination of employment. Commissions are a form of wages. Therefore, disputes can result in penalties for underpayment.

The definition of “commission” can mean the difference between an employee who is entitled to overtime pay and one who is exempt from overtime and other wage-hour laws. Both federal and California law exempt retail salespersons who earn at least 50% of their wages via commissions (along with other requirements). An incentive payment that does not qualify as a “commission” is not counted towards the 50% threshold.

The “commission” definition also is significant in the vehicle sales context. Employers are permitted to pay commissions monthly, rather than at the more frequent intervals applicable to other forms of wages.

So what is a “commission”? Labor Code Section 204.1 says it is “compensation paid to any person for services rendered in the sale of such employer’s property or services and based proportionately upon the amount or value thereof.” Section 204.1, the provision permitting monthly commission payments, expressly applies only to licensed vehicle dealers. However, courts apply the statute’s definition of commission outside the automobile sales context.

The Court of Appeal in Areso v. Carmax, Inc., ____ DJDAR ____ (May 20, 2011), interpreted Section 204.1’s definition of “commission” in a way that may surprise employers and their lawyers, and even the state Labor Commissioner.

Areso and a class of Carmax salespersons brought a class action lawsuit against their employer. Areso sold used vehicles, warranty plans, and appraisals. Up until 2005, Carmax paid its sales personnel a flat $150 per sold car. Carmax later changed its commission plan to a complex formula of percentages that ended up approximating the same payment per car äóñ about $154. Carmax also paid Areso fixed sums for each warranty sold, each car leased, and other services. Carmax’s intention was to avoid creating an incentive for employees to favor selling higher-priced items to value-oriented customers.

Areso asserted she was mis-classified as exempt from overtime based on the “inside sales” exemption discussed above. Her principal argument was that a fixed payment per unit (e.g., car, warranty, etc.) sold is not a commission, but rather a “piece rate” or other incentive payment.

The resolution of the case therefore turned on the definition of commission contained in Labor Code Section 204.1. Areso’s claims’ viability depended on whether Carmax’s system compensated Areso “based proportionately upon the amount or value” of the cars, warranties, etc. If so, she was “exempt;” if not, she and the class would be due overtime pay and other damages.

Agreeing with the trial court, the appellate court held that Carmax’s fixed payment per unit sold is a commission. The court deemed the analysis of Carmax’s commission plan under Section 204.1 to present an issue of first impression. The court decided that a fixed payment per item is “based proportionately on the amount” of items sold, in that each sale generates a corresponding payment. The commission did not vary based on the value of the sold goods and services. But, the court reasoned, Section 204.1 says “amount” or “value.”

The Carmax court did not consider itself bound by a line of authority standing for the proposition that a commission must be a percentage of the sales price. The state Division of Labor Standards Enforcement has written in its Enforcement and Interpretations Manual that a commission is a percentage of gross or net sales. The agency has said that other forms of incentives are bonuses or piece rates.

The Division’s enforcement position is based on two judicial opinions. The Court of Appeal wrote in Keyes Motors, Inc. v. Division of Labor Standards Enforcement, 197 Cal. App. 3d 557, 563 (1987): “Labor Code section 204.1 sets up two requirements, both of which must be met before a compensation scheme is deemed to constitute ‘commission wages.’ First, the employees must be involved principally in selling a product or service . . . . Second, the amount of their compensation must be a percent of the price of the product or service.” The state Supreme Court quoted this definition with approval in Ramirez v. Yosemite Water Co., 20 Cal. 4th 785, 804 (1999).

The Carmax decision recognizes payments per unit sold can be commissions, but does not alter other requirements. For example, even compensation based on a percentage of sales is not considered a “commission” if the employee is not involved in selling the item. In Keyes Motors, the dealership paid mechanics a percentage of the fees charged for servicing automobiles. The court decided these mechanics were not “exempt” commission-based workers. The court noted they were not selling the repair services to the customer, but were simply sharing in the revenue generated by their work. In Ramirez, the dispute was over whether water delivery drivers primarily were involved in selling water, or simply delivering the number of bottles the customer requested. Unless they were selling they could not be considered commission-based sales workers.

Employers who calculate commissions as a percentage of the “value” of an item must ensure the calculation comports with the commission definition. As discussed, the courts have held a true commission is a percentage of the sales price. It may be lawful to pay commission on the “net” sales price, after adjustments for discounts. But payment of a percentage of profits (e.g., sales minus expenses) may be deemed a bonus. Deducting expenses, such as overhead costs, from sales prices also may disqualify the payment as a commission. The consequences are significant, because it can result in either late payment of wages that do not qualify as commissions under Section 204.1, or mis-classification of an inside sales worker.

Finally, even employers who pay bona fide commissions do not escape potential liability. Problems can arise when sales workers leave or are discharged and wish to collect unpaid commissions, when customers return or do not pay for previously sold goods and services, and when commissions are generated over time. Employers should have a properly drafted commission plan that clearly explains when commissions are earned, the applicable rates paid, and the consequences of non-payment or termination of employment. Commissions are a form of wages. Therefore, disputes can result in penalties for underpayment.

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