Can the Covenant of Good Faith Trump a 30 Day Termination
Case Study
The owner of a sales agency contacted us because her agency’s contract with a principal had been terminated while there was impressive distribution continuing to take place; distribution that resulted from our client’s efforts over the prior 2 years working closely and continuously with one customer in particular.
Our client had been paid significant commissions in the 3 months prior to the termination (some of the largest commissions it had ever earned from this principal), all related to the monumental long-term distribution the agency had set up to one key customer. It was then unceremoniously terminated in a cold notice stating its “services would no longer be required.”
This kind of scenario, unfortunately, is presented to us on a somewhat regular basis. Everything is great until the big orders on a long-term program start coming in and then the bean counters catch wind of all of the commissions on the books, and then heads roll!
There were no problems in the working relationship, no personality disputes or anything else that would have disrupted a prosperous relationship other than a desire by this corporation to save the 3% commission it had promised to pay our client, on sales which would occur over the next 5 years after termination (estimated at $10 million-$12 million).
The Angle by the Principal
By virtue of the timing of the termination, our client feared it would be losing out on 95% of the commissions it had earned on this long-term distribution arrangement. After all, our client had agreed to a standard 30-day termination provision. If terminated, the contract provided that the sales agency would then receive commissions only on orders which were shipped and paid for in the 30 days following termination. A somewhat standard (but bad) contract provision; especially when only the first 3 months of shipments had occurred on the expected distribution period of 5 years.
Smart move by the principal, right?
After all it had a right to terminate on 30 day notice, and followed the termination provisions precisely. Under the laws of many States, the sales agency would have had no recourse. What the principal was unaware of, however, was that the laws that would pertain would bar them from taking such a windfall.
The Response by the Sales Agency
Even though our client was a California sales agency, the laws of New York would have been applied to any dispute between the parties because that was what they had agreed to in the contract; and New York has some of the best case law in the country concerning terminations that are undertaken in bad faith to avoid the payment of commissions already earned. We cited the provisions of these cases to opposing counsel, which was very effective in bringing this dispute to a settlement.
The Leverage Under New York Law
Under New York law, a principal can still be held liable for the payment of commissions on future sales, occurring after the termination, even though a 30 day termination provision was complied with and limited the right to commissions on post-termination sales.
Damages are not recoverable for a breach of contract, because there was no breach of contract, if the principal complied with the termination notice provisions.However, the implied covenant of good faith and fair dealing, the violation of which we refer to less formally as Bad Faith, would offer protection, as a quasi-contract remedy.
That covenant prohibits either party from doing anything that (although not prohibited by the contract) harms the other party’s reasonable expectations of their benefits under the contract. Such as imposing a 30 day termination provision while knowing it would deprive the sales rep of high six-figure commissions it had already earned by its 2 years of prior work.
That is precisely what occurred here.
The Outcome
Luckily for our client, New York has some of the strongest case law applying the Bad Faith doctrine in situations such as occurred here. The following is one strong example:
even if [the at will termination provision] is still in effect, we believe it cannot be read to enable the defendant to terminate an employee for the purpose of avoiding the payment of commissions…
We cited such cases to opposing counsel; and eventually, after 5 months of intense negotiations, we settled the dispute by leveraging the principal to agree to pay commissions on sales which occurred for two years after the termination.
Without a lawsuit, without any depositions. Simply based on the strong state of bad faith law in New York.
The take away
A 30 day termination provision is not always fatal to a sales rep being paid commissions on sales after the termination occurs. An analysis of both the Bad Faith and Procuring Cause doctrines, under the particular State law at issue, must be undertaken so that the sales rep can better understand if they have leverage in negotiations after a wrongful termination.