You’ve incorporated properly. You have great business partners. Funding, with a little room to spare, is in your business account. All licenses are accounted for. The warehouse is brimming with new products you designed and the patents are pending. Today, after years of training, education, sleepless nights, drawing boards, and good old fashioned hard work, you are ready to sell your product. Just one problem: you’re not a salesperson.
But you have that angle covered. A group of candidates are walking into your office starting at 9 a.m. sharp to discuss what they might bring to your company. The agreements you reach with these near-future employees will control countless items, including your profitability, their willingness to be retained long-term, precedents with respect to pay and equitable compensation, incentives to go the extra mile, and so much more. The deals you make today will also dictate your legal liabilities in the future. And after all those years of work, it would be a shame to face down a door-closing class action lawsuit from your salespeople just because the deal you made was a “bad deal.”
How do we make good deals that control legal liabilities? Follow this step-by-step guide.
Step One: Know the Law or Get Help
Before we decide what we would like to put in our deal, we need to know what must be included. Generally speaking, federal statutes do not address what must be included in a commission agreement, nor do the statutes of many states. However, some states, like California, have specific statutory provisions related to commission agreements and what must be included in them. No matter how good your deal may be with respect to your other objectives, such as profitability and incentivization, if you do not follow the legal requirements in your jurisdiction, it will be a bad deal.
Aside from states like California in which specific statutes control what must be included, the common law of contracts dictates how our deals are interpreted and, as a result, what is strategically desirable. Take for instance the issue of what happens with a contract, like a commission agreement, when it expires, i.e., after its explicit end date, and no new contract is executed but work continues. Does the expired contract still control? If so, what is the practical effect of an “end date” at all? Does it control for another year, or a month? Is the employee still subject to other contractual provisions, or does he or she become an “at-will” employee?
The common law of contracts is not statutory and relies on interpretations, primarily, of state courts. This means that state courts have vastly different answers to the seemingly simple questions above. Your results may vary greatly. Not knowing how your deal will be treated by the state in which it is implemented is a substantial legal risk.
Step Two: Secure Your Future
At some point, one of your enthusiastic new salespersons will leave for what they consider greener pastures. Or you may be forced to show them the door. What happens afterward? Very likely, their best prospects will be in your industry and perhaps even in your target markets. If you have a flashy bestseller, you can bet your competitors will want to know what you’re doing right. Emulation may be the highest form of compliment, but it is undesirable when you wish to exploit your hard work to its fullest potential.
Three words will guide you here: noncompetition, non-solicitation, and confidentiality. As with all things “contracts,” state law will determine what you may or may not do in this arena.
First, noncompetition agreements range from prohibited (e.g., California), to restricted (e.g., Colorado), to unregulated. Do not implement a noncompetition agreement where it is prohibited. In states where such agreements are regulated, i.e., only allowed given certain circumstances, ensure that you meet the terms of any regulation or law and spell out why your noncompetition agreement is acceptable in the document itself. The penalty for noncompliance in this area could be that your suit to enforce the agreement morphs into a countersuit for an unfair employment practice.
Non-solicitation agreements are generally less complex to implement than noncompetition agreements, primarily because prohibiting a former employee from stealing your customers is usually considered an important objective, whereas stopping that employee from pursuing his or her livelihood in your market altogether has a substantial impact on that person’s right to pursue gainful employment.
This does not mean, however, that non-solicitation agreements are without their considerations. In some states, non-solicitation agreements must be tailored in such a way that they do not prohibit contact with any of your customers at all, but only contact with customers with whom the former employee worked or of whom they had reason to become aware. The penalty for getting it wrong here is that you may find yourself with an altogether unenforceable non-solicitation provision and little recourse as your customers are lured away to a competitor. Careful drafting of just one or two sentences makes all the difference here.
Attention to detail is critical with these provisions. The good news is that there are no states that prohibit confidentiality provisions. The bad news is that these provisions are only as good as you make them and there may be special rules involved. For instance, you may be inclined to rely on your state’s version of the Uniform Trade Secrets Act and broadly protect all “trade secrets” without further specificity. However, some states, e.g., Colorado, have authoritative cases that require a “trade secret” to be an actual “secret.” In others, merely protecting an item as a “secret” may grant it protection on par with a “trade secret,” even if the so-called “secret” is technically discoverable by means other than infringing upon your confidences. Again, know the law. But in any circumstance, consider carefully which items are most important to keep confidential and then refer to them specifically in your agreement or confidentiality provisions. Don’t forget the magic words: “This provision applies both during and after employment,” especially if it is to be found exclusively in your employee handbook or other standard operating procedures.
Step Three: Prepare for Eventualities
There are too many possibilities to discuss in the parameters of this article; indeed, a tome would be insufficient to cover all our bases. Start with the basics. For instance, what happens with the agreement when an employee leaves?
For many deals, the provisions may only make sense during employment. With others, such as commission agreements, it may remain an open question whether commission payments terminate at the end of employment, or continue for a certain timeframe, or continue until all the accounts on which the employee worked during his or her tenure are closed. Too often, our deals are silent on this topic. In fact, the uncertainty related to end-of-employment issues typically draws in plaintiff’s employment attorneys and may also result in wage claims. When it is unclear what happens to contractual payments when an employee leaves your company, you may end up paying far more than what would otherwise have been owed just for closure. Don’t fall into this trap. Be clear about end-of-employment mechanisms in your deal.
Another eventuality may be inconsistent information disseminated to an employee, whether verbally, in writing, or both, during employment. Unfortunately, we cannot always trust our managers and supervisors to accurately convey information to their employees. Sometimes, in the struggle and desire to meet and exceed goals, promises are made that we would rather not fulfill. Yet through the concept of respondeat superior, sometimes referred to as vicarious liability, your organization is liable for such representations made by your supervisors, even without your authorization. This creates significant risk as we can never be certain how a court or a jury will interpret the conflicting evidence until we have reached the end of a trial. These issues should not be left to chance and circumstance. A simple provision that the agreement controls and that no other documentation outside of the agreement may override it, sometimes called an “integration” provision, will work wonders in containing liability on this basis.
Step Four: Take the Time for Proper Execution
Your golf swing is useless without proper follow-through. Your product won’t sell as well if you don’t provide support after it has left your warehouse. So, too, will your deal be lacking if you do not follow through with proper execution. First, for any agreement to be enforceable, it must be signed by the party to be charged. In our case, we want to potentially “charge” the employee with abiding by the agreement, so the employee should sign it. Often, a deal is set forth in an unsigned offer letter. When other documentation is used by an employee to challenge the terms of the offer letter, one unsigned document seems as good as the next. Take the time to obtain a signature and, if the employee refuses to sign the agreement, either renegotiate or reconsider your hiring decision. Second, if you include an end date in the agreement, ensure that you follow up with a new agreement when the old one expires. Keep copies of the agreement, several of them, in various safe places, including in electronic and paper formats. While a paperless operation may save you on costs, finding yourself enforcing an agreement that you cannot produce in court has its significant difficulties. Make sure your supervisors and managers understand the importance of maintaining the integrity of the agreement as well, to avoid situations like in “Step Three” where conflicting information is provided that compromises your ability to manage your deal.
Step Five: Don’t Forget Wage and Hour Law!
In “Step One,” we shrugged off federal law and focused on states. Now, we look to federal, state, and even local law, in limited circumstances, for other obligations. Sometimes, we want to look exclusively within the four corners of our deal to determine the parameters of a person’s employment, including their rate, frequency, and manner of pay. We may also want to define other incentives in our deal, like bonus programs, or a draw on commission arrangement.
While our deal may spell out these items, the law imposes additional obligations on us when we offer them. For instance, consider the threshold question of whether your deal describes an exempt or nonexempt employee. If the employee is exempt, as may be the case with an outside salesperson, it means we do not have to pay for overtime. But if the employee is nonexempt, overtime is unavoidable. How does this factor into the profitability of the deal for your organization? Did you know that bonuses spelled out in your deal are likely to be included in the employee’s regular rate of pay and may result in even more overtime premiums? Did you know that sometimes the way you phrase the parameters of an incentive, such as a bonus program, may dictate whether it results in additional overtime obligations?
Sometimes, we dispense with the exempt-or-nonexempt didactic altogether and classify the subject of our deal as an independent contractor. Stop right there! Independent contractor misclassification is one of the riskiest and most expensive threshold liabilities you can face as an organization. It may seem like an easy answer now, and one that is also desirable from a profitability perspective, but independent contractor rules are strict, vary on a state-by-state basis, have significant federal and state labor and tax components (i.e., you’ll fight and pay both the Department of Labor and Internal Revenue Service, and/or their state components, if you get it wrong), and are aggressively enforced through a variety of different audit and investigative processes.
Both federal and state law often weigh in on these additional obligations that are usually not made part of a deal. Regardless, you must still account for them, which brings us full circle and back to “Step One.”
The “Take Away”
It’s as “simple” as one, two, three, four, and five. Know the law (or get legal help), protect your future, prepare for eventualities, take the time for proper execution, and don’t forget wage and hour law! Employers Council attorneys specialize in these areas. Call us to get you started or to make sure you’re off to a great start, no matter how long your dream business has been a reality.