How to Avoid Potential Pitfalls for Companies Starting and Ending Relationships with Commissioned Sales Representatives
October 12, 2022
In a perfect world, every company that enters into a contract with an outside sales representative hires an attorney to draft a legally enforceable agreement that protects the company’s interests. In reality, contracts with sales representatives are often drafted by the parties (without legal counsel) or consist merely of a handful of exchanged emails stating what the parties believe are the key terms. In the interest of saving money on lawyers, the company exposes itself to a potentially enormous amount of liability when the sales representative relationship ends (and let’s be honest, these relationships always end at some point).
What does the company need to know?
There are laws in some states, including Illinois, specifically designed to protect sales representatives because of their weaker bargaining position when entering into contracts with companies to sell products for a commission. The Illinois Sales Representative Act (820 ILCS 120/1 et seq.) controls the relationship between a company and an outside sales representative. The Act requires that a sales representative be paid all commissions due within 13 days of when they are earned, or the company can be liable for the sales representative’s attorneys’ fees and three times its past-due commission in damages.
The Sales Representative Act only applies in certain circumstances. First, it does not apply to employees. That relationship is governed by the Illinois Wage Payment and Collection Act (820 ILCS 115/1 et seq.), after which the Sales Representative Act was modeled. The public policy for both acts is the same: protecting sales representatives who have weaker bargaining power. Whereas employers may have an HR manager or department well-versed in employment law and the requirements an employer should follow upon hire, during employment, and upon termination, the same rules do not apply to the contractual relationship with a sales representative. Where a company sells its products primarily through outside sales representatives, it is crucial that the company follow the letter of the Sales Representative Act to protect the company’s profitability.
Second, the Sales Representative Act in Illinois does not apply to sales representatives who sell services; it only governs those who sell products.
However, the Sales Representative Act applies whether a company contracts with an individual to act as its outside sales representative or a distinct corporation or LLC. While a company may believe that it is entering into an arms-length transaction with another company and that ordinary contract law would apply, Illinois law affords sales representative companies the same protections as it does to individuals and applies the same public policy concerns as it does in the employment setting.
How can a company protect itself?
At the Beginning of the Relationship:
- Execute a formal agreement
- Allow for changes in commission structure in the agreement
- Include provisions for duration/renewal (without one, it is terminable at will, so avoid that battle at the outset)
- Include provisions regarding cause for termination, including:
- Expressly providing for when commissions will be paid (e.g., a sales representative is only entitled to commissions for sales made during the duration of the agreement)
- Expressly providing that sales representatives shall not be entitled to commissions on any sales made post-termination, no further fee shall be due to the contractor post-termination, and the contractor shall have no further rights to receive any other compensation after termination.
- Including objective language to determine when a sale occurs (e.g., when the company receives a purchase order)
- Include dispute resolution provisions such as:
- A specific method for dispute resolution regarding alleged underpayment of commissions
- A time frame for the representative to communicate the dispute (otherwise, they are deemed to have accepted the amount of commission, as appropriate)
- Provisions stating that the calculation of fees, including whether a sale was realized, will be determined by the company in its good faith discretion
- Include provisions regarding reorders, such as:
- An express discussion of how reorders will be treated (does the rep get commission? For how long?)
Disputes regarding reorders can often occur without specific language in the contract, especially if there’s a custom and practice of paying someone on reorders of products they have sold. As a result, you may end up fighting about what occurred in the course of dealings over many years, which is a very fact-intensive and expensive fight. Most often, it is appropriate to specify that the contractor will be entitled to commission on reorders (but limit it to solely during the period of the agreement, not post-termination) or expressly state that the representative is not entitled to commissions on reorders.
During the Course of the Sales Representative Relationship:
In addition to following all of the above recommendations, companies should:
- Provide consideration for modifications to the agreement, particularly for changes in commission percentage, which is one of the most significant reasons for damages (plus attorneys’ fees and triple damages)
- Give commission reports regularly to sales representatives (e.g., monthly, with every commission payment)
- Keep an accounting on purchase orders, records of sales/commissions generated, dates commissions were earned, dates of payment, etc.
At the End of the Sales Representative Relationship:
Companies should determine the following before terminating a sales representative:
- What is the duration of the agreement? If none, it is terminable at will.
- When must commissions be paid after termination? In Illinois, the Sales Representative Act requires commissions to be paid within 13 days of termination.
- Provide commissions as soon as possible and reiterate the vehicle for disputing the amount owed within a set period of time and language from the contract stating that no further commission is due.
What if a company already has an inadequate contract in place?
If you have a sales representative agreement that does not include these considerations, you should consider doing the following:
- Terminate the agreement if no duration is specified.
- Provide a small bonus for the execution of a new contract to formalize the relationship under a new and enforceable contract.
- If neither of the above is an option and you’re stuck with the incomplete contract, be sure to follow the guidance above under “During the Course of the Sales Representative Relationship” to avoid issues at termination.
- Consider mediation or a declaratory judgment action to resolve any commission disputes.
LP has significant experience advising clients about relationships with outside sales representatives. If you have any questions, please contact us.
For additional information, see the following:
Put Your Commission Agreements in Writing: 10 Things to Include in Sales Representative Agreements
What to Know about Renegotiating Sales Commission Agreements