Negotiating Sales Representation Agreements
Mark T. Butler
A professional and effective sales staff is crucial to the success of any manufacturing or distribution business. Perhaps more than any one else in the organization, with the exception of the business owner, a sales representative — particularly one compensated solely by commissions — has a personal stake in the fortunes of the company he represents. If the company does poorly, so too does the sales representative. On the other hand, it is not uncommon for a successful sales representative to be compensated at a level approaching that of upper management.
Because of the risk inherent in the commission system, a sales representative is thought to be in a position of vulnerability. For example, after the representative is induced to invest his time and energy creating product recognition and developing prospects, an unscrupulous principal may then terminate the relationship just when those efforts begin to result in sales. In such a case, the company may reap the benefits of the representative’s work without paying compensation.
In response to intense lobbying from sales representative trade associations, numerous state legislatures have enacted statutes governing the relationship between a company and its sales staff. More than 30 states have adopted sales representative commission acts, establishing deadlines for a company to pay earned commissions providing harsh penalties in the event it fails to do so. These penalties commonly include treble damages plus costs and attorney fees, and may apply even where a legitimate dispute exists as to whether commissions are owed. Predictably, the enactment of these statutes has led to a marked increase in litigation between sales representatives and their former principals.
The sales representation agreement
In light of the severe consequences of failing to pay commissions in a timely fashion, such litigation can have a devastating effect on a business. Thus, it is essential that a company negotiate a complete and effective written contract with its sales representatives at the inception of their relationship, before any disputes arise. The following is a brief description of various topics that should be addressed in the sales representation agreement.
1. In-house versus independent sales representatives
Initially, the terms of a sales representation contract will vary depending on whether the business employs an in-house sales staff or an independent agency. As company employees, in-house sales staff members are generally subject to the same personnel policies as the rest of the company’s work force. Consequently, the commission agreement should be drafted with those policies in mind. Typically, this means that the agreement will focus predominantly on the sales function and commission arrangement, with a provision incorporating the employer’s other personnel policies.
Independent sales representatives, on the other hand, are not employees of company and thus are not subject to its standard personnel policies or many other duties implied by law. For example, while an employee typically has a common law duty to maintain the confidentiality of the employer’s proprietary information, an independent sales representative may not. Accordingly, a contract with an independent sales agency must be comprehensive, addressing all significant aspects of the relationship between the parties.
2. “Sales procurement” versus “customer procurement”
The sales representation agreement must specify whether the agent is expected to procure sales, customers, or both. Under a sales procurement arrangement, the representative will typically be entitled to commissions only on those sales in which he is actively involved. On the other hand, where an agent is hired to procure customers, he directs his efforts toward finding willing buyers for the company’s products, and is generally entitled to commissions on all sales to such buyers, whether he is personally involved in those sales or not.
3. Geographic territory/product lines
Typically, a sales representative is assigned to sell designated products in a specific geographic territory. It is imperative that the sales representation agreement adequately describe both the products and the territory. Any vagaries in the agreement could result in disputes between representatives or, under certain circumstances, expose the company to liability for multiple commissions on the same sale.
Similarly, the agreement should identify any existing customers which are considered “house” accounts. The assigned representative will receive compensation while actively working on these accounts, but will not be considered to have procured these customers and typically will not be entitled to commissions on sales made after his termination or transfer.
4. Servicing and maintenance of accounts
Often, the sales representative’s job is complete at the point a sale is consummated. In many industries, however, sales representatives are responsible for the ongoing servicing of accounts, even after the original sale has been made. The sales representation agreement should describe the representative’s post-sale obligations and condition his right to continuing commissions on the performance of those duties.
This is particularly important when sales representatives are terminated or transferred. A sales representative assuming the responsibility for an existing account will rightly expect to be compensated for his efforts. At the same time, if the sales representation agreement has not conditioned the right to ongoing commissions on the servicing and maintenance of accounts, the company may find itself obligated to pay commissions to both the current and former representatives. Such a result could have a devastating effect on the company’s profitability.
5. Commission rates
Perhaps the most fundamental term of the sales representation agreement is the commission rate to be paid to the sales representative. The agreement should not only specify the basic rate to be paid, but should also detail exactly how that rate is to be calculated. If commissions are to be split between two or more representatives, that division should be agreed upon in advance as well.
Commonly, commissions are calculated as a percentage of the net proceeds realized on a particular sale. In such a case, the agreement must detail the specific factors which go into calculating that net figure. Any job costs which are to be deducted from the “commissionable” portion of the sales price should be agreed upon by the parties in advance. This is particularly important with respect to costs which are not specific to a particular sale or job, such as general overhead or entertainment expenses. Failure to reach accord on this issue at the outset could result in a later dispute over whether the full amount of earned commissions has been paid.
6. Payment terms
The sales representation agreement controls when the right to commissions accrues and how they are to be paid. The company will often insist that commissions on a particular sale are not payable unless and until payment is received from the customer.
Where appropriate, the agreement should also be coordinated with the terms of sale between the company and its customer. Thus, if the customer is permitted to return products for a credit within a specified time, the sale representation agreement should acknowledge that fact, and include a mechanism for charging back the commissionable portion of the refund.
7. Standards of conduct
The sales representative is often the most visible point of contact between a company and its customers. Because the company’s reputation with its customers depends so heavily on the representative’s actions, it is appropriate to set forth basic standards of conduct in the sales representation agreement. The agreement should permit the immediate termination of any representative who fails to abide by these standards.
8. Representation of competing products
In exchange for its agreement to pay commissions, the company is entitled to expect that its sales representatives will dedicate their efforts to selling its products, and not those of its competitors. Thus, the sales representation agreement may preclude the representative from selling competing products in the same market or from selling any other products to the company’s customers. In order to ensure that the parties are compatible, the company may request a list of an outside sales agency’s existing companies and products prior to entering into the representation agreement.
9. Termination of employment/representation
At the time they negotiate a sales representation agreement, the parties usually anticipate a long-term, mutually profitable relationship. Notwithstanding this natural optimism, however, it is critical for the company to take the necessary steps to protect its interests when the relationship ends, amicably or otherwise.
In this regard, the most significant issue is the representative’s right to post-termination commissions. If the contract does not sufficiently describe the parties’ rights on termination, the law may impose an ongoing duty to pay post-termination commissions on sales procured by the representative during the term of the agreement. In such a case, the amount of post-termination commissions owed could be staggering, particularly if the company is also required to pay compensation to the representatives taking over the accounts at issue.
The agreement may also address a variety of other post-termination issues, such as the return of product samples and other company property; maintaining the confidentiality of trade secrets, customer lists and other proprietary materials; a reasonable restriction on the agent’s right to represent competing companies or sell to his former customers; and a mutual agreement by each party to refrain from disparaging the other.
The ultimate success of any manufacturer or distributor depends in large part on those responsible for selling its products. An effective sales staff — either in-house or independent — can create markets for a company’s products and open doors that might otherwise be closed.
At the same time, however, it is imperative that the company take steps to protect its interests at the inception of the relationship between the parties. In light of the problems that may arise following the termination of that relationship, including the harsh penalties set forth in the sales representative commissions acts adopted by several states, the failure to negotiate a complete and effective sales representation agreement can have dire consequences.