Sales representatives and principles sometimes enter into relationships in which the principle recognizes that for whatever reason, the future sales by a sales representative may be sporadic or unpredictable. In order to alleviate the cash flow concerns sales representatives encounter, the principle agrees to pay a set bi-weekly or monthly stream of income, otherwise known as a draw. There are several critical legal issues of which salespersons should be aware when accepting a draw. It may or may not be a friendly arrangement.
Types of Draws
Some arrangements allow for a permanent draw; meaning, the money paid to the salesperson is similar to a salary. The parties will then negotiate different commission percentages for sales made against the draw. In this arrangement there is no concern that the salesperson will ever be expected to pay back any of the monies earned as a draw. It is understood that the draw is for the sales person to keep forever and ever.
Other arrangements are more complex and provide for the sales representative to maintain a certain level of sales, usually monthly. Such sales quotas are then compared to the draw and the sales representative may have to pay the company back, from future or even past draws, for any shortfall in sales quotas. As such, the monies paid as a draw are not necessarily for the sales person to keep on a permanent basis and there is no future expectation of payment on a continued draw basis, should the sales person fail to maintain the necessary level of sales.
Draw as Borrowed Money
This was the case in a recent Kentucky case, Bowman v. Builder’s Cabinet Supply, Co., 2006 U.S. Dist. LEXIS 62712 (E.D. Ky. Aug. 23, 2006). In Bowman, the company established a payment schedule in which the sales person’s draw was against any commission such that if the monthly sales were below her sales goal of $ 42,000, she would become indebted to the company for any deficiency. Sure enough, the sales person couldn’t maintain her monthly sales quota. The company then began deducting commission deficiencies from her draw, until at some point it stopped paying her completely, despite that the same sales person continued to make sales.
The Federal District Court held in favor of the company and against the plaintiff’s claim for unpaid commissions. It reasoned that the parties understood that the draw was not a guaranteed salary and that the sales person understood the implications of in effect, borrowing from the monies she was paid.
Claim for Overtime
Another very important concern with respect to this arrangement, involved the sales person’s claim for overtime under the Federal Labor Standards Act, (“F.L.S.A.”). Under that act, an employer must pay employees overtime at time and a half unless the employee or company meets one of the recognized federal exceptions. Section 13(a)(1) of the FLSA provides an exemption from both minimum wage and overtime pay for "any employee employed in a bona fide executive, administrative, or professional capacity ... or in the capacity of outside salesman ...." 29 U.S.C. 213(a)(1).
The specific requirements to meet the “professional capacity” exception necessitate that any employee:
- Must be compensated on a salary or fee basis at a rate of not less than $ 455 per week (or $ 380 per week, if employed in American Samoa by employers other than the Federal Government), exclusive of board, lodging, or other facilities; and (d/n include draws that can be lost);
- Must have a primary duty involving the performance of work:
- Requiring knowledge of an advanced type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction; or
- Requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor.
The Kentucky Federal Court ruled that a draw in which the sales person must potentially return the money back to the company is not called compensation as per the professional capacity exception. Thus, it rejected the company’s argument that the sales person was not covered under the F.L.S.A.
The company attempted a second argument for an F.L.S.A. exception known as the “retail or service establishment” exemption. This exemption has three requirements: First, an establishment must have at least 75 per centum of whose annual dollar volume of sales of goods or services (or of both) is not for resale and is recognized as retail sales or services in the particular industry. Macy’s, for example, or any retail store generally fits this definition. Second, the employee's regular rate of pay must be more than one and one-half times the minimum wage rate. Third, more than half of the employee's compensation for a representative period must represent commissions on goods or services.
This argument also failed because the company couldn’t establish, without a trial at least, the actual rate of pay for the sales representative because the company conceded that the employee/sales person, whatever they called her, had numerous duties in addition to her sales responsibilities.
The bottom line with draws is that sales representatives should be fully aware of the arrangement he or she has with the employer. Written incentive plans or employment agreements should contain a detailed provision regarding the draw and sales quotas. To prevent owing the company money, a sales person or company may want to set up an escrow account, much like an attorney, and keep the draws’ funds separate from other income. In this way, the sales person won’t have to worry about owing the company money he or she can’t pay back.
Also the scope of duties for sales principles should also be carefully defined to prevent confusion regarding things like overtime. Written agreements can in many cases prevent these types of disputes.