© Mark Stay | stock.adobe.com

Disclaimer — This article is based on my thoughts and my experiences in litigating sales commission disputes for more than 40 years, primarily in the automotive industry. Some of my comments regarding accountants and private equity firms may be somewhat over-generalized. I apologize in advance in case any reader is an accountant/consultant or owner of a private equity firm.

The Problem

I’ve had several cases recently where principals, primarily automotive suppliers represented by independent manufacturers’ representatives, have been purchased in whole or in part by private equity firms. This often occurs when the primary owner, often one person, decides to cash out his investment and retire or do something else with a fair amount of cash.

In each of these instances the book of current business that made the principal an attractive target for the private equity firms was primarily obtained by my clients. My clients are independent
manufacturers’ representatives.

One of the key factors private equity firms look at when considering the purchase of a manufacturing company is the amount of commissions being paid to independent manufacturers’ representatives. Private equity firms are generally run by accountants or consultants who happen to be accountants. Pretty much everything is a numbers game for them. The typical plan seems to be to replace the independent reps with employee salespeople. Generally, the line of thinking for the accountants seems to be that they can get an in-house employee cheaper than the commissions being paid to the independent manufacturers’ reps. The commission savings would then go directly to the bottom line. This makes sense if you are an accountant. My experience in handling sales commission cases for more than 40 years, however, is that very few accountants have a good understanding of the automotive sales business.

I will say there is a difference between manufacturers that sell commodity type products and those that sell highly engineered products. Cost is a more significant factor in commodity type products. Although cost is a major factor in the automotive industry, so is the importance of personal relationships with the customers’ purchasing personnel and engineering personnel. Trust is also a major factor. Automotive customers rely heavily upon the principal’s sales personnel and the relationships are typically long-term. Terminating the independent sales reps can cause a significant disruption in the relationship.

There are almost always problems in any relationship between an automotive supplier and its customers. These can include quality and delivery issues as well as pricing issues. The added stress in the relationship resulting from the termination of the sales reps can significantly increase the overall stress in the relationship. This will not normally affect business already in production, but it can impact the ability of the supplier to obtain new programs. The accountants running private equity firms often wonder why they are not getting the new programs or replacement programs down the road after they terminate the independent manufacturers’ representatives. By the time they figure out what the problem is, it is often too late.

I’ve had two cases recently where companies that were acquired by private equity companies terminated their manufacturers’ reps and refused to compensate the reps for the business they brought in. In one case, the principal unilaterally reduced the sales commission rates to an amount the accountants wanted to pay. My client tried to work it out until the representative of the new owner said that since there was no written contract, they did not have to pay anything. Unfortunately for the new owner, an agreement to pay sales commissions is not required to be in writing under Michigan law. My client had a life-of-part sales commission claim under Michigan’s procuring cause doctrine. We filed suit and reached a rather quick seven‑­figure resolution.

In the second instance, the manufacturer decided to terminate the independent manufacturers’ reps and transition to an all in-house sales staff. The reps were offered jobs as employees with an at-will agreement, no post-termination sales commissions, no asset sale protection, and a post-termination non-compete agreement. As far as I know, none of the independent reps agreed to this arrangement. So far, we have three cases in progress against the principal for life-of-part sales commissions and violation of the Michigan Sales Representative Commission Act. I expect there will be a few more.

The Solution

The best way to deal with this problem is to have a written sales representative agreement with the payment of post-termination sales commissions for the life-of-part and asset sale protection. One of the reps in my last example had a written agreement with life-of-part commissions. The other agreements were not in writing. All three of the reps have good cases but the rep with the written contract for life-of-part commissions has the best case. It is always recommendable to consult with an attorney experienced in drafting and litigating sales commission disputes when forming a relationship with a new principal or whenever there are any other issues regarding the payment of your commissions. The MANA list of recommended attorneys is an excellent resource.

If you find yourself in a situation like that described in this article and you do not have a written contract, then do not agree to anything or sign anything until you obtain legal advice as described above.

A Common Strategic Error by the Accountants

Private equity firms often purchase companies in the hope that they can quickly improve the financial performance of the purchased company and then sell the company in a few years at a significant profit. A strategic error committed by many private equity firms is assuming that in-house sales representatives paid on salary/bonus will perform as well as independent manufacturers’ representatives who are paid commissions based on their performance. It has been my experience that the accountants working for the companies I have sued do not fully understand the psychological and motivational aspects of sales representatives getting paid for performance vs. in-house employees getting paid a salary. Commissioned salespeople motivate themselves by always keeping in mind the commissions they will earn if they are successful in obtaining new business. The result of this dynamic is that the commissioned salespeople work harder and more hours to be successful than the typical 9-to-5 in-house employee.

In my opinion, the proper course of action for the new private equity owners would be to sit down with the manufacturers’ reps and actually talk to them before acquiring the automotive supplier. Topics of conversation should include the reps’ thoughts on what could be done to improve performance and to get more new business. There should also be a discussion about the mutual goals and objectives of both the private equity firm and the manufacturers’ representatives. One goal should be to maximize current sales and make sure that future business is obtained to replace current business. Otherwise, the target company may end up dying a slow death. In the instances described above, the private equity firms never really had a conversation with the manufacturers’ representatives to get their input on anything. Instead, they chose to play hardball and terminated the manufacturers’ representatives with no post-termination commissions, essentially daring the reps to file suit.

The way to increase the likelihood that new business would be obtained in the future with minimal disruption would have been to make a deal with the manufacturers’ reps to pay them on the existing business and incentivize the reps to get new business. About the only way to incentivize the reps to get new business would be to guarantee the sales reps that they will be paid on current business and on the new business even if the company is sold. One way to do that is for the private equity firm to agree to cash out the sales reps when the company gets sold with a fair payment to compensate the sales reps for the existing business for the life of the part, as well as for the new business. That way everybody wins. There is no incentive for the rep to obtain new business if he or she knows that once the company is sold all commissions will stop.

The problem is that most private equity firms are very protective of the profit they will receive when the company is sold. In my experience, there seems to be little inclination to share those profits with the manufacturers’ reps, or anyone else for that matter. The result of this is the high likelihood of litigation when the sales reps are terminated. This causes disruption in the business of the principal and can often result in customers getting subpoenas for documents and for depositions. This can also result in significant attorney fees for the principal. About the only thing accountants dislike more than paying sales commissions is paying large amounts of attorney fees defending lawsuits. Litigation can also result in penalty damages under the Sales Commission Act, as well liability for the sales rep’s attorney fees in addition to their own attorney fees.

The Moral

If you are a private equity firm and you want to increase the likelihood that the company you are looking to either purchase or invest in will continue to have good sales performance, I would recommend that you sit down and have a conversation with the manufacturers’ reps early in the process. A little respect can go a long way. Frankly, it makes good financial sense.

Conclusion

As I tell my clients, most sales commission disputes are the result of great success rather than great failure. Most successful independent manufacturers’ sales representatives will experience a termination and a fight over commissions at least once in their career. Frankly, there is not much you can do other than to have a good sales representation agreement with good post-termination sales commissions for business obtained before termination and asset sale protection. It is better to have that type of agreement in place at the commencement of the relationship because it is very difficult to get these provisions added after you have become successful.

MANA welcomes your comments on this article. Write to us at [email protected].