A Sales Rep’s Options if Their Principal Breaches the Contract and How to Prevent It

Part Two

Author’s note: When our firm is contacted by a rep whose contract has been breached, overwhelmingly the principal in question is not a MANA manufacturer member.

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Option 1: Trying to get the principal to retract a commission reduction or sign a more protective contract

This may be useful in situations where the principal could be liable for the payment of long-term sales commissions, based on either the Procuring Cause Doctrine, a violation of the Covenant of Good Faith and Fair Dealing; or, for punitive damages under state laws that apply when commissions are not timely paid. See my articles in Agency Sales magazine from January and February 2018 for a discussion of whether either the Procuring Cause Doctrine or a violation of the Covenant of Good Faith and Fair Dealing may apply, potentially providing a right to long-term commissions. If the principal has long-term liability for sales commissions, often a retraction of the commission reduction or a new contract with better protection can be negotiated.

Option 2: Giving notice of breach and a chance for the principal to cure

Giving the principal notice and a chance to cure the breach is required if the contract says it is. Otherwise, if a party fails to comply with this provision they will likely be barred from bringing up the claims for which they failed to give notice. One can also seek to tie the failure to cure a material breach to the rep’s right to terminate the contract and be paid a buyout.

Option 3: Protesting a breach by the principal, but continuing to receive other contract benefits

Protesting a breach by the principal, while continuing to receive other commissions under the contract and reserving one’s right to sue later, can make sense when there are substantial commissions at stake other than the ones that have been taken away. However, this option has the most potential pitfalls for a plaintiff. One has to be very careful to not only dispute the reduced commission payment, or taking of a house account, when they first become aware of such a breach; they need to regularly notify their principal of same, with the payment of each deficient commission check. If the record indicates that the rep continued to accept a lower commission rate without any further dissent/protest/notice of breach, they can be found to have waived their right to collect the balance! A simple email notifying the principal of the deficiency, upon receipt of each such deficient commission payment can remedy this potential problem.

Also, whenever there is a dispute over a commission payment, the commission check may bear an endorsement by the principal, stating “full and final payment….” or words to that effect, as to a given sale, customer or program. One must be very careful to closely inspect commission checks to be sure they do not bear that endorsement. If they do include such an endorsement, under California law (and the laws of some other states) one may strike a line through the endorsement language and initial, while still negotiating the check. This reflects that they did not agree to the endorsement. Consult legal counsel if using this tactic.

As to the issue of potentially waiving the right to collect further commissions, after accepting a lower rate, there are many important cases in California applying this principle to business breach of contract matters. Here is a relatively new and a relatively old one:

• “A party to an agreement who believes it has been breached may elect to continue to perform the agreement rather than terminate it, and later sue for breach; this is true, however, only where notice of the breach has been given to the other side.” Roling v. E-Trade Securities, 860 F.Supp.2d 1035 (2012).
• In a much earlier California Court of Appeals decision, the court stated: “plaintiff waived such alleged breaches of contract by continued performance on its part without any claim of breach….” ABC Distributing Co. v. Distillers Distribution. Corp., 316 P. 2d 71 (1957).

Consequently, it is imperative that any rep who wants to continue earning other commissions under a contract, after it’s been breached in certain regards by the principal, must continue to communicate its disagreement with and non-acceptance of the reduction by specifically noting the breach of contract to the principal.

Option 4: Terminate the contract based on a material breach and sue

Obviously, nobody wants to terminate a previously productive agreement and sue their principal for breach of contract. However, sometimes there’s really no choice. In one of our recent cases, a sales agency who had an ongoing 18-year relationship with its principal and whose sales were large ran into problems. Another instance of a sales agency that became too successful.

The first thing that happened was the principal took one customer, accounting for the largest portion of the agency’s sales and commissions, as a house account. Goodbye 50 percent of sales commission income! Not very nice treatment after 18 years of service! When my client complained of that action, which was technically authorized by the contract, it was unceremoniously terminated. This occurred right after new, voluminous business was initiated by our client (via a spinoff product envisioned, conceived and suggested by our client) resulting in a long-term sales program to a large agency of the state of California, which was expected to produce mammoth business for at least five years.

Although the written contract technically allowed for both of the above actions by the principal, we based the lawsuit on a theory that the Covenant of Good Faith and Fair Dealing had been breached by the taking of the largest account and a termination at the most opportunistic time to avoid the payment of substantial long-term commissions. What does a violation of the Covenant of Good Faith and Fair Dealing mean? A less cumbersome way of referring to it is simply: bad faith. Many states, including California, have a long line of case law establishing that even though an employment or representation agreement allows for certain “options” (including termination) in favor of the principal, the principal can be guilty of bad faith, if it exercises one of those options in a way that will knowingly harm the reasonable expectations of its contracting partner (the rep) while giving the principal a windfall.

So, in certain cases, courts place liability on employers for terminating employment or sales representation agreements without paying further compensation, even though the agreement allows for termination. What some courts refer to as opportunistic terminations are those that are meant to deprive a sales rep of commissions that would otherwise be payable, where there is no other basis for the termination other than the desire to increase profit margin. In the case just mentioned, we sued the principal for bad faith, litigated the case for slightly over one year and were then in a position to push the lawsuit to mediation, whereupon a structured settlement was reached, resulting in our client being paid a large sum of money — the same income it would have been paid, had it not been terminated, over a period of three years after the termination.

Conclusions

1. The best protection against an opportunistic termination or a devastating commission reduction is to be sure to include protective language in the contract at the inception of the relationship with a principal: buyout provisions; automatic renewals; right of refusal to commission reductions.
2. If those protections cannot be obtained and a rep’s contract is breached, they should evaluate the situation to see if a breach of the Covenant of Good Faith and Fair Dealing might have occurred, or if application of the Procuring Cause Doctrine might be possible, or if certain state commission protection laws may have been violated resulting in punitive damages. If so, the rep may have leverage to get the principal to rectify the breach and/or provide a contract with more protections.
3. If the contract has notice and cure provisions, the rep should give notice of the breach according to the contract provisions and see if the principal will rectify it. That is, unless they want to continue under the contract without disrupting the relationship.
4. If a rep is willing to continue under contract, after a breach by the principal, to obtain other commissions under the contract, but they want to reserve their right to sue for the breach that has occurred, regular written communications must be made disputing the commission reduction, taking of an account, etc., and specifying that such actions are a breach of contract. Otherwise, one might be waiving their right to seek further commissions for such sales. Of course, the principal may get tired of receiving those communications and simply decide to terminate — which is why protective contract provisions from the inception are the key.

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