Commission disputes are all too common in California. The threshold question in most of these cases is do the commissions at issue constitute earned wages under the California Labor Code?
What is a “Commission”?
In order to answer this question, let’s first look at what counts as a “commission” under California law. Section 204.1 of the California Labor Code states, “Commission wages are 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 2751 specifies that “commissions” do not include the following:
“(1) Short-term productivity bonuses such as are paid to retail clerks.
(2) Temporary, variable incentive payments that increase, but do not decrease, payment under the written contract.
(3) Bonus and profit-sharing plans, unless there has been an offer by the employer to pay a fixed percentage of sales or profits as compensation for work to be performed.”
When is a Commission “Earned”?
Determining when a commission is earned is often critical for executives who have left their employer with outstanding commissions. If the commission is deemed earned at the time they leave the company, they most likely have the legal right to the commission. If the commission was not earned at the time of their departure then they will forfeit the payment.
According to California law, classifying a commission as “earned” is a matter of contract between employer and employee. In Koehl v. Verio, the court held, “A commission is ‘earned’ when the employee has perfected the right to payment; that is, when all of the legal conditions precedent have been met. Such conditions precedent are a matter of contract between the employer and the employee…” Likewise, Sciborski v. Pacific Bell Directory states clearly that once the contractual obligations are fulfilled, the commission is considered a wage: “[O]nce the express contractual conditions are satisfied, the commission is considered a wage.” The courts have traditionally deferred to the language of the contract in determining when a commission is “earned” – for example, courts have held that employers are legally allowed to require customers to submit payment before a salesperson “earns” the commission in question.
Thus, once employees fulfill their contractual obligations, their commissions are typically deemed “earned.” And once commissions are “earned,” they are protected by the California Labor Code. In fact, California courts have held that section 221 of the Labor Code prohibits an employer “from collecting or receiving wages that have already been earned by performance of agreed-upon requirements.” Thus, once an employee fulfills all its contractual requirements, thereby earning the commission, an employer is required to pay the commission to the employee.
Retroactive Commission Changes
Some companies attempt to alter an employee’s commission after a deal has been closed. This normally occurs after a commissioned sales employee closes an unusually large transaction. Is it legal to lower the commission after the employee has done the work? The answer is not always clear.
While courts generally give deference to the language of the contract, courts have also refused to allow employers to apply changes to commission plans retroactively. In Mathews v. Orion Healthcorp Inc., the court for the northern district of California held that “Although the commission plans contained a clause reserving to Defendant the right to unilaterally change the plans, such a clause is contrary to California law if applied retroactively.”
To come to its conclusion, Matthews cited a previous case that dealt with changes to a commission plan, Asmus v. Pacific Bell. In Asmus, the court relied on contract theory, specifically the notion of a contract as “illusory,” to arrive at its ruling. The Asmus court held that “an unqualified right to modify or terminate the contract is not enforceable. But the fact that one party reserves the implied power to terminate or modify a unilateral contract is not fatal to its enforcement if the exercise of power is subject to limitations, such as fairness and reasonable notice.” Citing this section from Asmus, the Mathews court held that “Defendant’s reserved right to modify the commission plan could not extend to past earned commissions under California law, and there is no dispute of fact that Plaintiff satisfied the conditions precedent to qualify for the commissions due to be paid.” The point here is that the terms of a commission plan will govern unless the agreement gives the company the unfettered right to make retroactive unilateral changes.
Pfeister and Vinson: Are Commissions Plans Enforceable Contracts?
As the rulings in Asmus and Mathews demonstrate, the courts have generally refused to allow employers to modify commissions plans retroactively. In order to deny employers this right, the courts started from the position that the incentive commission plans it dealt with were enforceable contracts. However, there has been a thread of subsequent cases pushing back on this conception of incentive plans. In such cases, courts have interpreted commission plans between employer and employee not as a matter of enforceable contract at all. Therefore, employers in these cases were not required to pay employees commissions according to the terms of the incentive plans.
In Pfeister v. Int’l Bus Machs. Corp, Plaintiff worked for IBM and had a dispute over Q4 commissions earnings. IBM originally set Plaintiff’s Q4 signings quota to approximately $2.8 million. IBM then increased this quota to $10 million in February of the following quarter. When applied to Plaintiff’s Q4 sales, this retroactive change had the effect of reducing his commissions by nearly $400,000. In this case, the court denied Plaintiff’s claim for breach of contract on the grounds that the incentive plan was not an enforceable contract. To reach this position, the court discussed two principles characterizing an enforceable contract: (1) Mutual assent or consent of the parties to enter into a contract; and (2) sufficiently definite terms.
Regarding (1) mutual consent of the parties, the Pfeister court held that, because the incentive plan stated it “does not constitute an express or implied contract or a promise by IBM to make any distributions under it,” IBM did not consent to form a contract with Plaintiff. Likewise, regarding (2) sufficiently definite terms, the court stated that, because the incentive plan granted IBM the right “in its sole discretion to change sales performance objectives…[and] the right of IBM in its sole discretion to adjust the incentive payment,” the incentive plan did not contain sufficiently definite terms. Because the incentive plan contained neither (1) mutual consent of the parties or (2) sufficiently definite terms, the court did not recognize the incentive plan as an enforceable contract.
In refusing to recognize Plaintiff’s incentive plan as an enforceable contract, the Pfeister court dismissed Pfeister’s breach of contract claim. In Vinson v. Int’l Bus Machs. Corp, a 2019 commission dispute again involving IBM, the court similarly sided with IBM. Like Pfeister, the Vinson court again held that the incentive plan in place did not constitute an enforceable contract, because IBM reserved the right to change the plan’s features and modify or cancel the plan.
As discussed previously, once a commission is considered “earned,” this triggers wage protections under California law. As cases like Koehl and Sciborski demonstrate, determining when a commission is “earned” is typically a matter of contract between employee and employer. While the courts generally defer to the language of the contract in deciding when a commission is earned, the Mathews court offered some protection to employees. Mathews relied on contract law principles cited in Asmus to deny employers the unrestricted right to apply changes to commission plans retroactively.
But some commission plans, such as the ones used by IBM in the Pfeister and Vinson cases, were not even contracts because they did not make any firm promises and they even stated that they were not contracts or a promise. These agreements had clauses that state the plan “does not constitute an express or implied contract or a promise” and that the plan grants the employer “sole discretion” to make changes to it. The courts refused to recognize the incentive plans in their respective cases as enforceable contracts, effectively allowing IBM to change commissions retroactively in these instances. In doing so, Pfeister and Vinson highlight the importance of addressing the specific language used in an incentive plan on a case-by-case basis, as well as the intricate role that contract theory plays in commissions disputes.
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Will Ward, a legal intern at our office, assisted in drafting this article.