Bonuses and commissions are useful and common compensation tools for employers. If implemented properly, they can incentivize hard work, generate sales, increase productivity, help to recruit and retain talent, promote fairness and objectivity, and allocate uncertainty from the business to the employee. But what is the difference between a “bonus” and a “commission”? In one Minnesota case, a professional placement recruiter who had been ordered to pay 30% of his monthly net “commissions” to his ex-wife for child support but was paid “bonuses based on collection” was unable to explain “the difference between bonus and commission.” The court held that his bonus was actually a commission. In re the Marriage of Hlavka v. Hlavka, No. C4-00-2001, 2001 WL 741538 (Minn. Ct. App. 2001). So there is no precise distinction under Minnesota law between a bonus and a commission. Although the terms are sometimes used interchangeably, there are certain characteristics more typical of each.
One of the definitions of “bonus” according to Black’s Law Dictionary is an “addition to salary or wages normally paid for extraordinary work” or “an inducement to employees to procure efficient and faithful service.” A bonus is often paid for meeting certain performance requirements, goals, or other criteria. It can be based on performance of the company, a unit, team, or division, or the individual. A bonus could be paid monthly, quarterly, annually, or upon achievement of the goal. Bonuses are sometimes paid merely for staying employed for a certain period time (retention or stay bonus) or even at the beginning of employment (signing bonus). A bonus is usually a set sum, not a percentage of a variable amount. An unanticipated, discretionary bonus can be more akin to a gift. But promises of a bonus can form an enforceable contract. A bonus can more easily be waived or forfeited than a commission. Finally, bonuses are always offered in addition to regular base pay or other compensation, not as the sole means of compensation.
Black’s defines “commission” as the “recompense, compensation or reward of an agent, salesman, executor, trustee, receiver, factor, broker or bailee when the same is calculated as percentage on the amount of his transactions or on the profit to the principal.” An alternative definition is a “fee paid to an agent or employee for transacting a piece of business or performing a service.” Commissions are usually subject to an objective, mathematical calculation. Commissions are very often based on a percentage of total dollars of sales of goods, services, or real property.
Unlike bonuses, commissions can be the only or primary form of compensation for an employee. A commission plan may provide for a draw or advance against the commission. An independent contractor or agent could be compensated with a commission, but it would not be typical for an independent contractor or agent to receive a bonus. Commissions are not as discretionary as bonuses. An employer may be obligated to pay commissions to the salesperson who has been the “procuring cause” of a sale, even if the employee leaves or terminated for cause. Although a bonus can be “earned” it can be waived if, for example, the employee does not stick around until to the payout date. An “override” commission is the term used to describe that amount paid to a sales manager based on the commissions earned by the salespeople reporting to him or based on the performance of the entire sales team.
Drafting Commission Plans
All commission arrangements and many bonus arrangements are contracts, whether they are or are not in writing. A “plan” is a usually a contract between the employer and two or more employees. A bonus or commission agreement applicable only to a single employee might also be called a “plan” however. Properly drafted written contracts prevent misunderstandings, miscalculations, and legal disputes. It is therefore important to confirm that the terms were distributed to participating employees. Employers should obtain confirmation of the employee’s understanding with a signature. Employees should get the employer’s commitment in writing.
Drafting a bonus or commission plan is not difficult. Start with plain English and bare bones – what will the employee earn and what must occur for them to earn it? Then, define key terms used in the agreement. What is a “sale?” How do we know what is “your sale” or someone else’s sale?
After you are finished with a first draft, including definitions, challenge the terms with different factual scenarios to see if the agreement clearly addresses what happens with each one. For example, what happens if the employee does well, does poorly, leaves mid-year, or is fired mid-year? Then revise as necessary.
The purpose of a commission agreement is both to explain how the commission is calculated and when and how it is considered “earned.” Objective terms are better than subjective language. Use metrics you can measure such as sales, revenue, profit, placements, or billable hours. Define assigned accounts to avoid disputes between salespeople. Create a mechanism to track the metrics, that is accessible to the employee, so there are no surprises or misunderstandings. Consider complicated situations such as collaborative efforts, split commissions, and so-called “house” accounts.
“Caps” on bonuses or commissions are usually enforceable if clearly stated up front in the contract. These are dispiriting to the employee who makes the sale of a lifetime or vastly exceeds expectations. The employer might see the cap as necessary to avoid a windfall to the employee but consider that if the plan is otherwise sound the employer should be receiving an even greater windfall.
The Pipeline Problem
The number one cause of commission disputes arises from sales that are still in the pipeline when the employee leaves or is terminated. In other words, both parties may agree that the employee is entitled to a commission on sales, but a “sale” has many iterations. Is the commission payable upon obtaining a signed contract or purchase order? Upon the shipment of goods? The receipt of goods? The completion of a project? When payment received by the company? Or finally, is the commission due only after payment received plus time for adjustments? Adjustments can include charge-backs, cancellations, adjustments, rebates, returns, credits, non-payments and discounts, among other factors. Careful drafting is the only way to avoid confusion as to these questions.
Issues Related to Bonuses
Many states, including Minnesota, uphold provisions that require an employee to be employed on a certain date in order to be eligible for a bonus. For annual bonuses, the payout is often January or February of the next calendar year. Most disputes regarding payment of bonuses arise from whether the bonus is truly discretionary and secondarily how it is determined. Many executive contracts state that the employee is “eligible” for a bonus “up to” some percentage of their base salary. That is difficult language to enforce as a matter of contract. If there are some objective goals or metrics agreed upon, however, and the employee works throughout an entire calendar year in expectation of receiving the bonus but receives nothing, they may have an equitable if not a contract claim, as discussed further below. In the movie Christmas Vacation, the character of Clark Griswold played by Chevy Chase was expecting a hefty bonus check but received a membership in the Jelly-of-the-Month Club instead. Depending on the language of his contract, he may or may not have had a legal claim. Many bonus plans state that whether to award any bonus is completely “discretionary” or up to the “discretion” of the board of directors. Whether a court will enforce a discretion clause depends on the facts and equities of the case.
Changes to Bonus or Commission Plans
Changes to commission or bonus plans can usually be made at any time prospectively. In other words, if the employer informs an employee that it is lowering a commission rate from ten percent to five percent starting with any sales made the following Monday, the employee receiving notice will probably be deemed to have accepted the new arrangement, unless they resign. Commissions cannot be changed as to sales already completed, however, because the employee has already performed in reliance upon on the original agreement. Under Minnesota law, new, more favorable bonus or commission opportunities might serve as consideration for a non-compete or other type of restrictive covenant.
What if an Employee is Over-Paid?
Minnesota’s law prohibiting deductions from wages without express written permission is quite strict and may preclude an employer who accidentally paid an employee more for a bonus or commission than they were entitled to from simply deducting it from their next paycheck. See Minn. Stat. § 181.79 and Erdman v. Life Time Fitness, Inc., 788 N.W.2d 50 (Minn. 2010). Some commission plans may allow for adjustment or true ups, however.
Wage and Hour Compliance
Employers should remember that “nondiscretionary” bonuses are considered part of an employee’s “regular rate of pay” for calculation of overtime under the Fair Labor Standards Act. Where the employer offers a bonus on a regular basis and an employee has come to expect it, the bonus will likely be considered nondiscretionary. The employer will need to determine whether the bonus should be spread out over a week, a pay-period, a month or a year. Employers should also remember that salespeople who are employees on a pure commission bases must receive at least a minimum wage, even if they do not make any sales.
Potential Statutory Claims
There are several Minnesota statutes that govern the penalty to an employer for not paying commissions:
- Minn. Stat. § 181.03 states that “an employer or a person, firm, corporation, or association may not alter the method of payment, timing of payment, or procedures for payment of commissions earned through the last day of employment after the employee has resigned or been terminated if the result is to delay or reduce the amount of payment.”
- Minn. Stat. 181.101 states that commissions earned by an employee must be paid at least once every three months.
- Minn. Stat. § 181.13 applies to claims for earned and unpaid wages “and commissions” by discharged employees.
- Minn. Stat. § 181.14 applies to claims for earned and unpaid wages “and commissions” by employees who resign.
- Minn. Stat. § 181.145 applies to claims for commissions by salespeople who are independent contractors and not employees.
All of these statutes refer to “commissions” not bonuses, but as noted above this distinction can be fluid. All of these statutes provide that an employee may recover penalties and attorney’s fees if they are forced to bring a lawsuit to recover earned but unpaid commissions. None of these statutes explain how or when commissions are considered “earned” however, so the language of the plan or agreement is still very important. Executives should know their rights when faced with unpaid wages or commissions. Employers should be wary of ignoring these types of claims. The longer the litigation goes on, the more attorneys’ fees the other side may be entitled to. Minnesota has recently re-emphasized its commitment to preventing so-called “wage theft” and the penalties can be significant. Other than the language of the contract, one of the few defenses to a claim for unpaid wages or commissions is that the employee was breaching their duty of loyalty to their employer during the time the commissions were earned.
Common Law Claims
In addition to a claim for breach of contract and statutory penalties, employees who worked in reliance on a promise of a bonus or commission, or were the procuring cause of a sale, may also assert equitable claims arguing that it is not fair that they were not paid even where there is no clear contract. These claims include promissory estoppel, unjust enrichment, and quantum meruit.
Bonus and commission claims can be expensive to litigate. Careful drafting up front can avoid problems. If you have questions about bonuses or commissions under Minnesota law, contact the Minnesota employment law attorneys at Trepanier MacGillis Battina P.A.
About the Author:
This article is based on a presentation by the author to the American Payroll Association in 2018.