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Does 30 Days Really Mean 30 Days?

The poison pill for any independent sales agent that relies on building up and establishing a territory, or booking business, is the dreaded 30-day at will termination provision. Unfortunately, such provisions are found in the great majority of sales agent contracts I see. Is the agent left with any leverage, legally speaking, when the principal complies with such a short termination notice provision? The answer, surprisingly, may be yes!

One doctrine that may override a poison pill provision in an agent’s contract is the Covenant of Good Faith and Fair Dealing. In its most generic form, this legal doctrine stands for the principle that one may not act in a way that deprives another of the benefits of the parties’ contract. More specifically, it stands for the rule that just because a party has an option available to them under a written contract (including an option to terminate on 30-days’ notice); they may not exercise that option in a way that is knowingly harmful to the other party, or their reasonable expectations under the contract at the time it was formed.

So, this doctrine may present a problem for manufacturers attempting to terminate a sales agent that has worked for many months or years to cultivate and establish a territory that at the time of termination is producing “pipeline sales.” Whereas, with the sales agent that has not built up any recurring sales, or one that is handed a sales producing territory, a claim for breach of the good faith covenant, for a short termination, would not likely be successful. However, under many of the scenarios presented by our clients, the typical solicitation to cultivation to sales period seems to be no less than six months; and in more technical industries, with engineered, designed in parts, this cycle can sometimes be up to two years.

Lengthy Cultivation Periods

If the parties both understand that there is a lengthy cultivation period involved in the sale of the principal’s products, and a lengthy cultivation period then actually ensues, followed by substantial recurring sales, then it could be said that the reasonable expectation of the sales agent is that it would not be terminated under a 30-day at will provision, without some compensation, once it invested substantial time and resources to develop the principal’s sales; or, put another way, that although the principal could terminate on 30-day notice, it could be liable for “back end” commissions for all the “front end” work. If, on the other hand, the principal has a legitimate business reason for the termination, then liability for breach of the covenant may not be so clear, or may not occur at all.

Sales agents, in a perfect world, would negotiate more protective contracts in those industries where a lengthy cultivation period is likely. There are many different provisions our firm uses to garner such protection, including length of service bonuses, contracts for a guaranteed duration, and/or life of customer or life of part commission provisions.

However, long-term protection is usually not demanded by sales agents, although they should; and unfortunately 30-day termination is often what occurs. As anyone in manufacturing and sales is aware, sales agents can oftentimes become expendable once they’ve created the relationships between their principals and customers, unless there is extensive, required, post-sale follow-up in a particular industry or transaction.

Courts, in many different jurisdictions, have long recognized the vulnerability of the sales agent in such a situation, and thus established a line of cases that uphold rights to post termination commissions, if the agent’s/employee’s services were responsible for the commission producing sales. If the principal pulled an opportunistic termination, seeking solely a windfall on the sales commissions it would save, post termination commissions could be awarded for a breach of the good faith covenant. Again, if there is business legitimacy to the termination, which can be proven by the defendant, and not just a desire to avoid paying commissions, then breach of the covenant is probably not available as a damage theory.

The following is a non-comprehensive survey of some of the key case law on this topic.

In Illinois

In Gordon v. Matthew Bender & Company, Inc., 562 F.Supp.1286, at p. 1297 (1983) Gordon worked for Matthew Bender, a legal publisher, as one of its law book sales reps. The employment agreement contained no explicit duration clause.

After many years of service under the contract, Gordon was informed that his territory would be reduced. He was later told that he would be terminated if he failed to achieve, in his new territory, the same sales levels which had been set for the former territory. Thus, strangely enough, although Gordon’s territory had been greatly diminished, his sales quotas remained the same. Not surprisingly, he did not meet the quotas and was fired. Due to the termination, Matthew Bender avoided paying him a pension that would have vested a mere seven months after his firing.

In allowing plaintiff’s damage claim for the unpaid pension, the U.S. District Court, Northern District of Illinois noted:

“The law seems fairly clear that an employee at will may not be deprived of commissions (in large part ‘earned’ prior to separating from the employer) by a discharge made in bad faith and intended to deprive the employee of the commissions….The existence of an at will employment does not preclude this count. In fact, it would seem to be an essential component of this cause of action under the case law.” [Emphasis added by author]

Although Gordon was classified as an employee, he was paid on a straight commission basis, thus making that case more synonymous with a sales agent’s commission dispute; and, whether it’s a pension or sales commission at issue it is still compensation denied, and the same principles should prevail.

In Jordan v. Duff and Phelps, Inc., 815 F.2d 429, at p. 438 (7th Cir.1987) the Federal Court of Appeals, for the Seventh Circuit, validating the ruling in Gordon, stated:

“No one…doubts that an avowedly opportunistic discharge is a breach of contract, although the employment is at-will.” [emphasis added]

Some 26 years later, in Wilson v. Career Education Corporation; 729 F.3d 665 (7th Cir. 2013) the same Seventh Circuit Court of Appeals decided a case based on this principle and held that:

“CEC’s discretion to terminate the Plan and refuse to pay unearned bonuses was limited by the reasonable expectations of the parties.

“…When one party’s contractual obligation is ‘contingent upon a condition particularly within the power of that party’ [such as the right to terminate on short notice] the controlling party’s discretion in bringing about the condition is limited by the implied covenant of good faith.

“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.” [Emphasis added]

This language makes it clear that a defendant may not technically breach the contract but could still be liable for a breach of the good faith covenant. Illinois is not the only jurisdiction where this doctrine is recognized.

In California

California Courts have likewise long recognized that although a party may have the advantage of a contractual option, including an option to terminate a contract, it may not exercise that option in a manner detrimental to the other party, if that would deny the reasonable expectations of the other party; lest they violate the covenant of good faith and fair dealing.

In Cleary v. American Airlines, Inc., 111 Cal.App.3d 443, at p. 445 (1980) the California Court of Appeals noted this rule, and held:

“…There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement…On occasion, it may [thus] be incumbent upon an employer to demonstrate good faith in terminating an employee…” [citation omitted] [emphasis added]”

There is no logical reason why the same principle would not apply to sales agents.

In Carma Developers… v. Marathon Development California, Inc., 2 Cal.4th 342, at pp. 372-373 (1992) the Supreme Court of California, stated:

“…The covenant of good faith finds particular application in situations where one party is invested with a discretionary power affecting the rights of another. Such power must be exercised in good faith.” [citations omitted] [emphasis added]

Putting some flesh on the bones of this rule, wouldn’t it be reasonable for a sales agent to expect they would be paid commissions for the sales they put into place, at least after a lengthy cultivation period, coupled with a territory where few if any existing sales had taken place, prior to the inception of the agent’s contract? That notwithstanding what about the fact that the principal could terminate them on 30-days’ notice? If those expectations are not reasonable, then any manufacturer could use and abuse its sales agents by gaining the benefits of all their work, firing them, and then not compensating them for recurring, pipeline sales at or after termination, without a legitimate business purpose, other than to increase their margins.

That’s where the covenant of good faith and fair dealing comes into play. It should not allow such an inequitable reading of the contract!

In Massachusetts

In Joyal v. Hasbro Inc. d/b/a Hasbro Games, 380 F.3d 14, at p. 20-21 (1st Cir, 2004) the United States Court of Appeals, First Circuit, ruled:

“Under Massachusetts law, an employee who would be entitled to a bonus or commission based on his past performance and who is deprived of it by a discharge without ‘good cause’ may recover the sum already ‘earned’ even though contingent on a condition not fulfilled. The theory is that even in a contract for employment at will, there is an implied obligation of good faith and fair dealing. Recovery is only for this already accrued, albeit contingent, compensation.

“One might think from its origin and some of the case law language that liability under this line of cases would arise only for ‘bad faith’ discharges, such as a deliberate attempt to deprive the employee of his bonus or compensation. But Massachusetts decisions hold that even without a malign motive, a discharge without ‘good cause’ is enough to make the defendant liable for contingently due bonuses….”

Much earlier, in Fortune v. National Cash Register Company, 373 Mass. 96, at pp. 101-102 (1977) Orville Fortune, a former salesman of the defendant (NCR), brought suit to recover sales commissions allegedly due, including claimed bonus payments, under the parties’ written contract.

Fortune argued that, in spite of the literal wording of the contract (a 30-day at will termination provision) he was nonetheless entitled to a jury determination on NCR’s motives in terminating his services under the contract and in finally discharging him. The Court agreed, and stated:

“We hold that NCR’s written contract contains an implied covenant of good faith and fair dealing, and a termination not made in good faith constitutes a breach of the contract.” [emphasis added]

“…we believe that where, as here, commissions are to be paid for work performed by the employee, the employer’s decision to terminate its at will employee should be made in good faith. NCR’s right to make decisions in its own interest is not, in our view, unduly hampered by a requirement of adherence to this standard.”

“The requirement of good faith was reaffirmed in RLM Assocs. v. Carter Mfg. Corp. [citation omitted]. In that case the plaintiff…, a manufacturer’s representative of the defendant…, was entitled to a commission on all sales within a specified territory. Either party could terminate on thirty days’ notice. The principal cancelled the agreement shortly before being awarded a contract [procured by the plaintiff sales rep]. Because ‘[t]he evidence permitted the conclusion that [the principal’s] termination of the arrangement was in part based upon a desire to avoid paying a commission to RLM,’ we held that the question of bad faith was properly placed before the jury….”

In New Hampshire

In Monge v. Beebe Rubber Co., 114 N.H. 130, 316 A.2d 549, at p. 133 (1974), which noted and followed the decision by the court in Fortune, cited above, the court allowed an at will employee to sue for breach of contract, under a breach of good faith covenant theory. The court held:

“…termination motivated by bad faith or malice is not in the public interest and constitutes a breach of the employment contract. [citation omitted]. See Fortune v. National Cash Register Co., [citation omitted] (employment contract, even at will, includes an implied covenant of good faith; employee has a cause of action when employer dismissed him to avoid paying a bonus)…”

Terminating an Agent

So what does this all mean? It means that although an agent can be terminated on 30 days’ notice, if that’s what their written contract provides, many states could hold the principal liable for commissions on at least some, if not all sales “in the pipeline,” but only if a violation of the good faith covenant is found to have occurred (meaning no legitimate business purpose). A lengthy golden parachute may thus result, as well it should, in most cases.

Considering the language repeated over and over in these cases, in the context of an agency sales contract, where it often takes months or even years to earn one’s commission compensation, the exercise of an option to terminate the contract must not be undertaken by a principal to deprive a sales agent of recurring earned commissions, at least not without offering compensation. Otherwise, the reasonable expectations of the sales agent would not be met. Simply speaking, a “buy out” or “termination bonus” should be offered in such a situation.

If such compensation is not offered, a quasi breach of contract claim, for violation of the implied covenant of good faith and fair dealing, can be made, even though a manufacturer might have conformed to the specific notice provisions regarding 30-day, at will termination, and may not have technically breached the contract. However, that analysis should be made on a case-by-case basis, depending on the specific written contract and criteria of the jurisdiction. For simplicity’s sake, however, the answer is: 30-days termination may not mean 30-days termination, without compensation.