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ADVANCE AT YOUR OWN RISK:

How to structure commission advances so they can be lawfully charged back in California

By Robert S. Nelson, Esq.

Nelson Law Group

Score another victory for California employers in the ongoing battle over whether they can charge back advances against future commissions. In the recent case of Koehl v. Verio, Inc., a California appellate court reaffirmed employers' right to charge back commission advances, and provided helpful guidelines about the circumstances under which charge-backs will be upheld.

The case is good news for all employers who pay commissions generated from sales involving multiple steps spanning extended periods of time. Many employers do not consider sales to be complete (and therefore commissionable) until they have been booked, the products or services have been delivered, and/or the customers have actually paid for their orders. This process often takes weeks (or even months) to complete. Employers generally do not want to pay commissions from multi-step sales until all the steps have been completed, especially customer payment. However, employees generally want to receive payment as soon in the sale process as possible. As a compromise, many employers advance some portion of commissions soon after sale bookings, on the understanding that the advances can later be "charged back" if the subsequent conditions to the sale do not occur. If not done right, however, charge-backs can violate California's strict rules against unlawful wage deductions.

There is little doubt that properly structured charge-backs are legal, and have been for many years. The issue in Koehl and most other recent charge-back cases has been whether the advances being recovered were already earned and vested at the time of recovery, or whether they were still conditioned on the occurrence of some subsequent event(s). If the amounts were already been earned and vested, they are considered to be wages and cannot lawfully be charged back without violating California law. If, however, the amounts were not yet been fully earned, then they will not be considered wages and can be lawfully charged back.

Koehl explained in detail when commission advances will and will not be considered wages. The case involved salespeople who sold Internet access and web hosting services to large companies. As with many other products, sales of Internet access are not instantaneous. Rather, they involve an ongoing series of steps ranging from initial sale booking to arrangement of installation to eventual installation of the product itself. In most cases, this process can take weeks or even months to complete. Customers pay for the service in monthly installments. Customers generally have to retain (and continue paying for) the service for several months before the company can recoup its costs and begin making a profit.

The salespeople in Koehl were compensated though a combination of base salary and commissions; the commission terms and calculations were carefully detailed in written pay plans. The plans were designed to prevent the employer from having to pay vested commissions before any profit was actually generated from the sales. To that end, the pay plans stated that employees generally would be paid half of their "eligible commission" upon booking of a sale, but that those payments could be charged back if the sales were canceled within a proscribed period of time (usually three months after installation). The charge-back system was implemented in order to motivate salespeople to follow up with customers after initial bookings to ensure that the customers were happy. Salespeople therefore had to do significant customer service work post-booking. The pay plans clearly stated that commissions would not actually be earned until customers had paid for orders for at least three months. However, the plans did not use the term "advance" when describing the payments that salespeople received immediately after booking orders.

The salespeople argued that the payments they received after bookings were non-deductible wages because: (1) the pay plans did not expressly refer to the payments as advances against commissions; (2) it was unfair for them (and not the company) to bear the risk that customers would cancel orders; (3) the charge backs amounted to surprise "kickbacks" to the employer; and (4) the pay plans were unconscionable. The Court rejected every argument, ruling that the pay plans were so clear and unambiguous that the salespeople could not renege on the charge-back deals after previously agreeing to abide by them. As evidence that the pay plans were not subject to interpretation, the Court pointed to the clear language saying that commissions were not earned until three months after booking. The Court also noted that salespeople were required to do significant customer service work post-booking, thus illustrating that booking was not the only thing employees had to do to earn their commissions. Because the pay plans were so clear, it did not matter that they did not specifically use the term "advance," nor were they in any way unconscionable. There was "nothing surprising about the commission plans, and nothing oppressive," the Court reasoned, hence the salespeople could lawfully be bound by their terms, including the charge-back provisions.

In the wake of the Koehl case, employers in California should do the following before attempting to charge-back commission advances:

  • Draft pay plans that clearly and unequivocally explain that commissions will not be earned until the occurrence of a specific event (e.g., customer payment or retention of a product order);
  • Articulate in the pay plans that any monies paid prior to the earning of commissions are advances against commissions that can be subject to charge-back;
  • Clearly explain the terms and conditions of charge-backs (e.g., order returned after a month are subject to a 100 percent charge-back, orders returned after two months are subject to a 50 percent charge-back, etc.); and
  • Require employees to perform ongoing work up to the vesting of a commission to illustrate that they have to do something other than simply booking orders to earn their commissions (e.g., require employees to perform customer service duties after booking orders).

For questions regarding employment agreements or pay plans for commissioned employees, please contact the Nelson Law Group at (415) 689-6590, or rnelson@nelsonlawgroup.net.