Sales commissions can lead to wage-hour disputes. Commissions are wages. Wages are due when they are earned. Employees naturally want to be paid as soon as possible. Employers desire control over when a commission is “earned” to avoid premature payment. Some sales transactions take time to complete. Products can be returned and payment refunded.

To help employees with cash flow, employers may advance commissions to employees before they are “earned.” Advances in essence are loans, rather than wages. So, employers may either credit an earned commission against the advance, or recover the advance if the sale is not finalized or if a product is returned for credit.

Employees sometimes argue that the employer is not allowed to recoup wages previously paid. The validity of that argument turns on whether the previously issued commission is deemed an earned or vested wage or merely an advance.

Determining When a Commission Becomes an Earned Wage

California Labor Code section 221 prohibits an employer from collecting or receiving any part of a previously paid wage. If a commission is deemed an earned wage, therefore, it is unlawful for an employer to recoup the commission in the case of, for example, a return, refund or chargeback.

The difference between an advance or loan and a commission typically depends on the sales commission agreement. A commission agreement is a type of contract. California courts apply contract principles in analyzing chargeback claims. They consistently approve of agreements that clearly address how chargebacks affect commissions. For example, in Koehl v. Verio, Inc., the court upheld a charge-back policy that allowed Verio to recover commissions advanced when the customer canceled the account before the customer had made three months of payments. And, in DeLeon v. Verizon Wireless, LLC, Verizon prevailed in litigation based on a policy that allowed chargebacks if a customer canceled a cellphone service contract within one year. The commission agreement in both of these cases clearly stated that commission payments were advances that could be charged back to the employee if a customer canceled in the specified time period.

On the other hand, if the commission agreement does not expressly address chargebacks, California courts likely will consider chargebacks unlawful wage deductions. In Harris v. Investor’s Business Daily, Inc., an employer used a points system to determine sales employees’ compensation. The employees could earn and lose points based on certain events, such as meeting sales goals or selling more expensive subscriptions. The employer deducted points from an employee if a customer canceled their subscription within 16 weeks. But unlike the Verio and Verizon agreements discussed above, Investors’ commission agreements did not expressly characterize commissions as advances or describe the terms upon which the company could deduct a chargeback. The court held the chargebacks were unlawful wage deductions.

In another case, Sciborski v. Pacific Bell, Pacific Bell charged back $19,000 in commissions paid to an employee after it discovered a clerical error. The employee had satisfied all of the conditions contained in his commission agreement (here, a collective bargaining agreement) to earn a commission. Neither the CBA nor any other document allowed the employer to charge back wages based on a clerical error in assigning accounts. Therefore, the court of appeal did not allow the employer to make the deduction.

Tips for Employers

California law requires written commission agreements in most cases. As discussed above, courts generally apply contract principles to the interpretation of these agreements. For employers to avoid wage-hour law problems, the devil is in the details.

Employers have significant flexibility to choose whether to advance commissions, to reconcile advances against future earnings, and to determine when commissions are “earned.” To do so, employers must ensure written commission agreements are clear. Courts and the Division of Labor Standards Enforcement will resolve ambiguities against the employer’s position.

A good commission agreement explains how commissions are calculated, when they are earned, and when payment will be made. The plan should also specify what sales are included and excluded, and how commissions will be allocated when circumstances, such as territories, change. A good agreement also addresses how commissions are earned and paid when employment ends. Earned wages must be paid at the time of termination. To avoid paying commissions to a former employee, employers may wish to ensure that salespersons concluding sales after the original salesperson’s departure earns the commission, or that earning a commission in part depends on service after the sale.

As always, it may pay to have commission agreements reviewed by competent employment law counsel.