Since the Fair Labor Standards Act (29 USC 206 et seq.) defines your consultants (“counselors,” “account executives,” “senior vice-presidents in charge of anything you say,” etc.) as employees, federal and state labor laws apply. This means you must fully adhere to the minimum wage and overtime pay laws in the identical manner as for clerical employees. Consultants are “non-exempt” employees — not exempt from the minimum wage laws. Call them “independent contractors,” and send your 1099 “audit invitation” to the IRS. But don’t call us when you’re audited. We can’t help you. Besides, you won’t have enough left to pay for groceries (let alone legal fees).
Still, the only reasonable way to compensate a consultant is on a commission basis, based upon actual production. No place, no commish. Kapish?
A fixed salary is an automatic office door-closer. A cushy, comfortable couch that you’re buying on credit. Any consultant sharp enough to negotiate a deal not based on “cash-in” deserves it. If you let yourself get talked into it, they should be your boss (and is). You’re working for them.
I wasn’t the first person to figure this out. Our industry wouldn’t be an industry if the “draw against commission” system didn’t work. It complies with the wage and hour laws while building in the incentive that only a commission provides. In fact, it’s the only way to follow the law and human nature.
What is a draw, and how do you get it back? That depends on the answers to three other questions. Here they are:
1. ISN’T A DRAW A LOAN?
Yes, at least partially. A draw is similar to a loan while the employee (consultant) is on the payroll. The commissions are used to “repay” the loan, thereby reducing the “red figure” — the indebtedness owed.
However, a draw is a hybrid between a loan and a fixed salary. It’s like a salary because all payroll deductions must be taken out of every draw check. As with any salary, a draw is considered wages. This means it must be paid every pay period and vests upon the employee terminating (voluntarily or involuntarily).
So you can’t “recapture” the draw by enforcing repayment of the “loan” when the employee leaves. Legally, it would be like suing an hourly employee for wages paid. If you overpaid — even by mistake — that “loan” on a payroll check becomes a gift.
2. ARE THERE WAYS TO RECOVER AN EXCESS DRAW AFTER A CONSULTANT LEAVES?
Yes. However, you must do three things:
First, you must have an agreement in writing with the consultant allowing you to do so. To be enforceable, an employment agreement must appear bilateral — fair to both parties. That’s because you have unequal bargaining power. If the consultant doesn’t sign, they’re not hired (or is fired). It makes no difference whether you say this, believe it, or deny it.
Therefore, I suggest you carefully word a written compensation policy. Here’s a start:
Consultants shall receive wages every pay period as a draw to be deducted from commissions from a percentage of placement fees attributable to their individual effort. All mandatory payroll deductions shall be withheld from said draws and commissions. Commissions shall be due after receipt of fees, the expiration of any guarantee period, the performance of any conditions by (name of your organization), and shall be less actual expenses incurred for collection.
In the event consultants wish to negotiate a non-interest bearing personal loan, the terms will be arranged individually. During the time the consultant is employed by (name of your organization), loan repayment shall be solely through payroll deductions from net commissions, if any.
Second, you must reduce the draw (but not below minimum wage) and separately issue a “loan” check for the “non-wage.” The loan check should not include payroll deductions, because they contradict your claim that the payment isn’t wages.
Why a separate check? Because:
a. State labor departments and courts presume that “compensation” to an employee is wages.
b. The IRS and state taxing authorities look past your creative bookkeeping and consider it a payroll tax-avoidance device.
c. The employee says he had no choice, or just assumed it was all wages.
“Mixing” is called commingling in the law. The way to “unmingle” a mingled, mangled mess is to trace the source of the funds. In this case, the source of the check “draw” and “loan” portions is undoubtedly the identical “cash-in.” So you can call the payments anything you like: One check with some deductions means wages. Two checks at least give you something to argue about. Two checks at different times give you even more. (The draw checks on regular paydays, and the loan checks whenever you like.)
Third, you must furnish a statement in writing at regular intervals, just as any prudent lender would do. That means at least once a month. The failure by the employee to object to the “loan balance” on the statement can easily be considered a waiver of their claim that it was wages.
Then, repayment of the loan is taken out of the next commission due, less (in order):
a. The gross amount of the draw paid (since payroll deductions were already taken).
b. Payroll deductions for the balance (since the commission is wages).
If this confuses you, just reason it through logically: A draw and a commission are wages. Therefore all deductions are taken. A loan isn’t wages. Therefore no deductions are taken.
3. CAN I HAVE THE CONSULTANT SIGN A PROMISSORY NOTE TO REPAY THE LOAN?
Yes, and unlike an employment agreement, it’s usually enforceable. It doesn’t endear consultants to you though, so think about it.
If you really want to look like a banker, here’s what it should say:
In consideration of the sum of $________, receipt of which is hereby acknowledged, (name of consultant) hereby promises to repay (name of your organization), its assigns or order, the principal sum of $_______. This amount shall be due on or before _______, 20__, and shall not bear interest.
Executed on ______, ___ at (city), (state).
(name of your organization)
(name of consultant)
There’s nothing wrong with charging interest on the loan, or providing for attorney’s fees and litigation costs if you need to enforce it. However, both of these terms are unnecessary since you’re controlling the amount and it should be low enough to be repaid by the net commissions. Otherwise, you’re reducing the incentive for the consultant to place, and also your ability to collect it.
If you get carried away with legalistic loan terms, you run the risk that some judge or jury will find you were coercing the employee to sign “or else.” This will negate the terms, and possibly subject you to some very painful liability.
That’s a draw. A loan. And that’s how you get it back when a consultant leaves.