Better termination provisions for sales reps (and why you need them)

An electronics sales rep contacted our office and said he had been terminated after taking 2 years, and tens of visits with purchasers and engineers, to gain a lucrative design win from a new customer. Based on the rep’s prior dealings with this customer (on behalf of other principals) the rep was able to procure the key design win which had produced no sales as of the termination but would result in long term substantial sales after the termination. The win was clearly attributable to the rep, as evidenced by an attaboy email from the regional sales manager stating: “great design win.”

The rep didn’t think we could help him since the contract allowed termination on 30 days’ notice without any post-termination compensation. He was told by several non-MANA law firms that the 30 day notice provision barred him from recovering further commissions. That turned out to be false!

The sales rep retained my firm and within months we recovered a six-figure settlement. The leverage we possessed to settle this matter was based NOT on a Breach of Contract but instead on a claim for Bad Faith (technically referred to as a Breach of the Implied Covenant of Good Faith and Fair Dealing). And the facts were damning for the principal.

In prior issues of MANA’s Agency Sales magazine (see Jan. and Feb. 2018 issues) I wrote about Bad Faith and Procuring Cause as doctrines that can potentially allow a sales rep to avoid losing earned commissions after a 30 day termination.

Bad faith may apply when a party to a contract, even though that party has not breached an explicit contract provision, acts in an unreasonable, arbitrary, or capricious manner that deprives the other party of their reasonably expected benefits under the contract.

In a Bad Faith case my firm litigated, major infrastructure expenditures were required of a small agency by a potential new principal, when the sales agency evolved from a two person to a six person sales team. The agency was required to invest in expensive software to monitor customer contact, service and sales; as well as leasing a fleet of vehicles and two regional offices.

The agency was successful and set up long-term sales through several key distributors after just six months, earning substantial sales commissions for several months, UNTIL the principal decided to terminate the contract based on a 30 day termination provision, after only eight months under contract. It was clear the only reason for the termination was to avoid payment of the long term commissions, since the email between the two sides showed only the principal’s admiration and appreciation for the reps’ efforts.

The case went to mediation (a settlement conference usually with a retired judge) and the mediator pressured the defendant to settle by agreeing to pay commissions on the subject sales through the distributors for a period of one year after termination. The mediator reasoned that our client would not have invested in the software, the fleet of vehicles, and the office leases if it had any notion that there was a chance of termination after only eight months of excellent service.

Interpretation and application of Bad Faith vary from State to State. Illinois for example requires an actual breach of express contract terms to allow such a claim. However, statements of decision from Illinois Federal Courts have left open the possibility of a valid Illinois claim for Bad Faith termination, even though no explicit contract term was breached.1

Other states, including California, Massachusetts, New Jersey, and New York recognize a separate cause of action for Bad Faith that is not dependent on the breach of an express contract provision.2

Procuring Cause may apply when a principal offers a sales rep commission compensation without providing a written contract. Or when a written contract does not specify what the sales rep’s rights to further commission are upon termination, or (in some jurisdictions) when a commission becomes earned. In these instances, a sales rep is allowed to make a claim for commissions on any post-termination sales for which they are the Procuring Cause.

In one Procuring Cause case we had, the principal verbally offered its sales rep a commission for transactions through a distributor located outside the geographic territory assigned in the parties’ written contract, for products not included in the written contract, at a higher commission percentage. The principal knew that the sales rep had a long-term history with this distributor (via other principals) and might be able to set up long-term sales through them; but that it would likely take a long time because the distributor would need to first become an approved vendor by the U.S. Department of Defense.

The sales rep procured this key distribution agreement for the principal after nearly three years of effort, resulting in a contract that would go on to produce sales over several years in the low eight figure range. The principal then terminated the sales rep two months after he received his first ever six-figure commission check (the majority of which was for sales to the out-of-territory customer), and attempted to cease paying any further commissions on the long-term sales.

The principal was eventually held liable for commissions on sales for several years, based on Procuring Cause. The Judge found there was no contractual provision limiting the right to commission on the sales to the distributor after any specified amount of time. Defense counsel tried to argue that the addition of the distributor as a commissionable account was simply a modification of the original contract, which did have a strict limitation on commissions for post-termination sales, and which could have been interpreted to apply to the sales to the distributor. But the judge would have none of that argument since the sales contemplated in the original written contract did not require long-term efforts to set up a distribution agreement, and were more in the nature of solicitations resulting in individual purchase orders from end users.

Obviously, it is best to garner more protective commission rights contractually, especially when sales may take a long time to develop. We utilize several tools to draft and negotiate such terms, including: 1) minimum duration with buyout rights for early termination; 2) adjustment of commission structure, with time added to the contract upon hitting certain sales targets or length of service; 3) right of refusal on principals taking house accounts and/or lowering commission percentages, resulting in a liquidated buyout of the contract; 4) long term commission protection on virgin accounts.

The key to a successful Sales Representation Agreement is to negotiate such terms in advance. We have strategies to assist with your negotiations. If you are required to rely on claims of Bad Faith or Procuring Cause, these doctrines normally require the plaintiff to raise them initially in their pleadings or potentially waive them. Consequently, a consultation with legal counsel should always ensue when a party is given notice of termination.

  1. See e.g. Wilson v. Career Education Corporation, 729 F.3d 665, at pages 673-675 (2013): “It bears emphasizing that CEC can breach the implied covenant of good faith even though the Plan gave CEC the unambiguous discretion to terminate the Plan and not pay unearned bonuses.” And, Barwin v. Village of Oak Park, 54 F.4th 443, at pages 454-455: A duty of good faith and fair dealing is implied into every Illinois contract… As relevant here, that obligation precludes an employer from making an “avowedly opportunistic” decision to discharge an at-will employee…” ↩︎
  2. Although the criteria required for a valid Bad Faith claim vary from State to State. ↩︎