Pay Plan Pitfalls

California recently joined New York in requiring that all sales commission pay plans be in writing. This may seem like common sense since many dealers realize that from a legal and practical standpoint, all commission agreements should be in writing whether it’s required or not.

Even if you already utilize written pay plans, the questions are how well are they drafted and do they offer the dealership adequate protection? Verbal commission payment agreements or poorly drafted pay plans can lead to legal trouble and employee dissatisfaction. Complaints from commissioned employees often include the dealership failing to disclose the proper cost of the vehicles and various products sold, failing to reveal the method and manner in which the pay is calculated, failing to properly justify chargebacks, and failing to comply with pay plans.

Not surprisingly, aggressive plaintiff’s attorneys smell blood in the water and actively encourage lawsuits by employees (and former employees) who claim that they were improperly compensated or charged back. These lawsuits allege dealers are intentionally violating pay plans to reduce commissions paid to the employees.

A number of recent cases involve claims that the terms of the pay plans were unclear and manipulated by dealers to cheat employees. Since judges typically have little understanding of the auto industry, they may feel that the agreement is ambiguous and find for the plaintiff. For instance, a pay plan that simply states that the salesperson will be paid "25% of front-end gross" or which fails to itemize each of the items that are not included in the commission calculation can be a ticket to disaster. It’s likely that a judge’s opinion of what constitutes commissionable gross profit will differ greatly from the dealer’s. Without proper disclosures, he or she may decide that “gross profit” simply means the difference between the sale price and the price originally paid for the vehicle.

The absence of written pay plans, or poorly-written plans that create confusion or ambiguity, makes it extremely difficult for a dealer to defend against legal challenges. To avoid these issues, it’s vital that your pay plans explain exactly how commissions are calculated, when they are “earned”, and how they can be charged back.

Best Practices for Bulletproof Pay Plans

Clearly Define Commissionable Amounts - Comprehensive pay plans are important for every commissioned employee in every department of the dealership, but for illustration purposes I’ll use a vehicle salesperson’s pay plan as an example. When a commission agreement provides compensation based on a percentage of profit, the formula for calculating the cost of the vehicle for commission purposes should be clearly defined and any costs or adjustments that may be added to the original cost of the vehicle should be carefully itemized. These items may include:

• Reconditioning (at retail rates, not dealer cost)
• Lot damage
• Dealer trade fees
• Transportation fees
• Lender fees
• CPO fees
• Trade-in over-allowances
• Goodwill adjustments
• Pack (non-commissionable reserve)
• Uncollected fees or payments from the customer
• Market condition adjustments

In addition, it should be clearly stated if items like holdback or dealer cash are included in the commission calculation.

Chargebacks - Laws in many states prohibit employers from taking back any portion of an employee’s wages previously paid to the employee. In order for chargebacks to be allowable, a commission agreement may need to delay the time when a commission is “earned” to allow for cancellations or refund requests. In this case, commissions paid to employees are an "advance" and are not actually earned until a deal is complete and a specified time period expires. The pay plan should define clearly when the deal is closed and when the employee is deemed to have earned the commission.

Pay Plan Development - In many industries, commission calculations are very straightforward. For instance, a commission that is simply a percentage of the selling price of a product or service is easy to define and calculate.  Of course, dealership pay plans tend to be much more complicated than that. Ideally, commissioned pay plans should be drafted, or at least reviewed, by qualified labor law attorneys familiar with the auto industry. Input from the dealership staff is vital in order to ensure that the attorneys are aware of all of the elements involved in the commission and chargeback calculations.

Distribution - A system should be put in place to ensure proper distribution and updates of pay plans. The pay plans should be signed by the employee and the dealership.

Language - Pay plans should be drafted in plain language and be as easy to understand as possible. If an employee is confused by it, chances are a judge or juror will be too. Management should take the time to carefully explain all elements of the agreement to employees and answer any questions completely and honestly.

Transparency - Full transparency is essential to avoid employee concerns and misunderstandings. Managers should not avoid questions about how pay is calculated or chargebacks determined. If a staff member questions a commission calculation or chargeback, management should share any and all documentation. The worst thing that can happen is that the information is not shared until a plaintiff’s attorney subpoenas it.

Terminated Employees - Be sure to carefully determine and promptly pay any commissions due to terminated employees. Plaintiff’s attorneys love disgruntled former employees and frequently try to springboard their complaints into class action lawsuits.