The Importance of Clarity in Commission Agreements

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For both startups and established companies, commission-based compensation can be a powerful tool for aligning and incentivizing performance. However, without a written agreement providing clearly defined terms and conditions, commission arrangements can become a source of costly disputes with employees and transactional headaches with diligence partners. Given the patchwork of state wage payment laws and commission-specific statutes across the country, employers must pay careful attention to how commission terms are defined.

This article considers six critical areas every commission agreement should address in order to minimize the risk of disputes with employees and to avoid costly complications during transactional negotiations and due diligence.

1. Define When Commissions Are Earned

The single most important provision in any commission agreement is defining the triggering event that causes a commission to be “earned.” Does the salesperson earn their commission when a contract is signed? When is payment received from the customer? When goods are shipped or services rendered? How is a commission earned when multiple payments are provided over time for a single sale or service, or for ongoing services provided over a defined contract term or indefinitely, rather than just for a single sale and payment? Does the state law applicable to either the employee or employer mandate a particular time when a commission is earned? Ambiguity with respect to when a commission is “earned” is one of the most common sources of commission disputes. Employers should use precise language to identify the specific event that triggers the earning of a specific commission and confirm that the employee acknowledges understanding of that definition in writing.

2. Define When Commissions Are Payable

Even after a commission is earned, questions often arise about when payment must be made. Many states impose mandatory deadlines for wage payments (often including earned commissions) that apply regardless of what private agreements state. For example, some jurisdictions require payment on the next regular payday after the commission is earned or within a specified number of days following separation. Employers should review applicable state law and ensure their payment schedules comply with these requirements.

3. When Commissions Are Forfeited

Forfeiture clauses (provisions stating that unearned or unpaid commissions are not payable upon resignation or termination) are among the most litigated terms in commission agreements. Several states restrict or prohibit forfeiture of commissions that have already been earned. Even in states that permit forfeiture clauses, courts often construe ambiguous language against the employer. A well-drafted agreement should clearly distinguish between commissions that have been earned (and thus may not be forfeitable) and those that remain contingent on future events (such as with ongoing payment obligations for continuing services or standing orders).

4. Define How Draws Against Commissions Are Handled

Many employers provide draws (regular payments advanced against future commissions) to provide income stability for sales personnel. Draws may be recoverable (meaning the employer can recoup advances from future earnings) or non-recoverable (functioning as a guaranteed minimum). The agreement must clearly specify which structure applies. Failure to do so can result in disputes over whether the employee owes money back to the company upon a regular true-up period or upon separation, or whether the draw was intended as additional guaranteed compensation.

5. Define When Draws or Overpayments Must Be Repaid at Separation

If a salesperson separates from the company while in a deficit on a recoverable draw, can the employer recover the overpayment? The answer depends on state law and the language of the agreement. Some states prohibit deductions from final wages that would reduce pay below minimum wage, while others restrict recovery altogether absent a clear written agreement. Employers seeking to preserve recoupment rights should include explicit repayment terms and obtain the employee’s written acknowledgment. Moreover, employers must consider applicable law before seeking any remedies upon separation.

6. Define How Chargebacks for Canceled Orders or Warranty Allowances Are Handled

Chargebacks occur when a previously paid commission is reversed (typically because an order was canceled, a customer defaulted, or a warranty claim arose). Vague chargeback provisions or undefined true-up periods can expose employers to wage claims, particularly if the chargeback effectively reduces the employee’s wages below minimum wage or occurs long after the original sale. Agreements should define the specific circumstances permitting chargebacks, impose reasonable time limits, define when and how any true-ups may occur, and comply with state-specific restrictions on wage deductions.

One More Thought - Consider the Basic Structure - Commissions vs. Bonuses

Employers also should understand that commissions and bonuses are treated differently under the law. Commissions typically are tied to specific sales or transactions and once earned, are often considered wages subject to strict payment requirements. Bonuses, by contrast, may be discretionary or conditioned on broader performance metrics, offering employers more flexibility. When considering incentive-based compensation structures, careful consideration of which structure best fits overall business objectives and how each is treated under applicable state law can help employers design compensation plans that are both effective and legally compliant.

Conclusion

Although commission arrangements are not necessarily required to be written agreements, relying on verbal agreements and evidence of past practices and operational history often sets the stage for disputes and deprives the parties (and the courts) of a clear and concise statement of the true understanding of the parties.

A well-drafted commission agreement protects both the employer and the employee. It reduces litigation risk, demonstrates good-faith compliance with applicable wage and commission laws, and sets clear expectations from the outset. Taking the time on the front end to think through and define in writing all contingencies for the full life cycle of commission payments to employees is an investment that pays dividends both in dispute avoidance and operational and transactional efficiency.

For additional information about these topics, contact any member of Maynard Nexsen’s Employment and Labor Law Team.