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My sales representative client and his principal are beginning a relationship and are having a hard time agreeing on a commission rate for new business.

My clients often ask me for advice regarding a reasonable commission rate. I generally tell them that the commission rate is an economic issue that is part of the bargaining process. I am a firm believer that commission dollars are more important than commission rates. Both parties need to have a good understanding regarding the potential size of the programs that will be quoted. Often the principal will push for language that the parties will agree upon the commission rate for a new program at the time the business is quoted.

The Problem

Having an agreement that the parties will agree upon the commission rate on a job-by-job basis may seem reasonable at first glance. That way, the parties can have a higher commission rate if the margins are higher (almost never happens) and a lower commission rate if the margins are lower (much more likely). The reality is that an agreement to agree is not an agreement at all. The best illustration of this is in the answer to the following question: “What happens if the parties are unable to agree on the commission rate?” The answer is that the sales representative may get no commission.

My firm arbitrated a case recently where the attorney for the principal terminated a good contract and submitted a bad contract in its place for my client to sign. See the article I wrote, “Don’t Trade a Brand New Cadillac for a Used Yugo” (May 2016, Agency Sales). The attorney who wrote the new/bad sales rep agreement included the following language in the proposed new agreement:

“Commission for New Business. Commissions will be paid to Representative on projects for which Representative was the procuring cause. The amount of each commission and its individual terms shall be memorialized in a written addendum to this Agreement, or they shall not be due and owing. If an addendum is not negotiated and arrived upon, it shall be concluded that Representative and Principal were unable to arrive at an agreed upon commission and Representative will not be entitled to payment.”

All that the principal would have to do would be to stretch out the negotiating process for the commission rate until after the purchase order is awarded. The principal can then offer a very low commission rate and tell the sales representative to either take it or leave it and get nothing.

A quote from the famous Prussian General Baron Carl von Clausewitz (1780-1831) is apropos here: “Prepare not for what you think your enemy will do but for what your enemy can do.” Don’t fall into the trap of believing that your principal would never refuse to pay you for new business you procured. Keep in mind that the person calling the shots today (your close friend/owner of the company) will not necessarily be the person calling the shots down the road (an accountant working for the private equity company who purchased your principal). Please see the article I wrote entitled “Beware of the New Owner” (April 2021, Agency Sales). A high percentage of the lawsuits we handle involve principals that have been purchased by private equity companies.

Shortly after we received the letter terminating the good sales rep agreement, we filed a lawsuit for the commissions due under the good sales rep agreement. Ultimately after almost three years, we arbitrated the case. The Arbitration Award included the following language:

“The proposed agreement contains many significant variances from the original Representative Agreement…. By way of example, the new draft agreement gives Respondent the ability to adjust commissions on any orders in place if their production profitability is impaired at any time. Additionally, under Section III.B., Respondent has the ability to say that if an agreement is not reached on a sales commission for a project Claimant has procured and reduced to writing, no commission will be due on that work. No reasonable agent would enter into an agreement of this nature since it is onerous to the rights of the agent to collect their commissions on sales they procured. Instead of negotiating a new agreement, Claimant elected to commence litigation to enforce the terms of the original Sales Representative Agreement, Exhibit 1.”

The arbitration award required commissions to be paid pursuant to the original sales rep agreement. The total commissions owed will be approximately $2.7 million for the life of the part. Under the new sales rep agreement, the amount would have been nominal.

The Solution

It is possible to have an agreement that commissions on new programs can be agreed upon on a job-by-job basis but there is a proviso. The proviso is that there needs to be a default commission rate that will apply if the parties are not able to agree upon the commission for a particular job. For example, “The parties will attempt to agree upon a commission rate on a job-by-job basis. If the parties are unable to agree, then the commission rate will be five percent.”

It is important to keep in mind that the principal and the sales representative are both motivated to try to reach an agreement on the commission rate. The customer will not generally appreciate a response that the principal will not be able to submit a quote because the sales rep and the principal were unable to reach an agreement on the commission rate. Sometimes it is better to take less on one order and stay in the ball game for the next opportunity.

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