One of your benefits as a MANA member is access to a list of attorneys who have been recommended to MANA as being experienced and knowledgeable about the manufacturers’ representative business and laws that govern rep-principal relationships, and an annual free half-hour consultation with one of those attorneys.
The purpose of this short consultation is to enable you to get a quick answer to a general legal question. It is not intended for you to get detailed legal advice or services such as a contract review or even a contract clause review.
The attorney with whom you speak will decide whether the consultation falls under the no-charge member benefit category or under a fee-for-service category. If the attorney believes the consultation does not fall under the no-charge member benefit category, he or she should notify you and allow you to decide whether or not to proceed. This notification should include the hourly rate and an estimate of the amount of time involved.
That list of attorneys follows. It is in no particular order – in fact MANA randomizes it regularly so that each firm spends some time in the beginning, the middle, and the end of this list. Visiting these attorneys’ web sites is a good way to narrow down the list and choose an attorney who seems best suited to your needs.
We ask that you limit your no-charge consultation to one attorney. If the attorney you call is unavailable or you feel that the attorney you called is not a good fit for your firm’s needs, you may of course try another on the list.
Representative law is a very specialized area of practice, so attorneys with that expertise are often called upon to work on cases outside their home state. Many practice in multiple jurisdictions or even nationwide. MANA members often report that their communications with their attorneys is almost exclusively by phone and email, so please do not be concerned if the attorney with whom you have the best rapport is not located in your state.
These attorneys are not under any agreement with MANA; each MANA member’s dealings with any of these attorneys is on an individual basis, arranged between the member and the attorney he or she selects.
MANA does not guarantee or warrant the services provided by these attorneys or their qualifications. You are responsible for performing your own due diligence before selecting any attorney. Although many of these attorneys will assist both representatives and principals to write a fair-and-balanced representative agreement, most will not represent a principal in a commission dispute.
MANA reserves the right to add or remove an attorney’s name from the list as it deems appropriate at its sole discretion.
*Entire US with court approval
**Arbitration – US and international
Negotiating Principal Agreements
Included in the agreement is the commission rate the manufacturer pays when the manufacturers’ representative gets them orders.
Manufacturers often ask MANA: “What commissions should we pay our manufacturers’ representatives?”
Based on a survey of 402 MANA members we found these common commission ranges based on customer type.
| CUSTOMER TYPE | HIGH | AVERAGE | LOW |
| OEM | 7% | 6% | 5% |
| Distributor | 9% | 7% | 5% |
| End-User | 14% | 11% | 7% |
These commission ranges get you into the ballpark. Ultimately, the uniqueness of each individual manufacturer/representative relationship will determine a commission rate that works for both parties. Under certain unique circumstances, rates may exceed these ranges.
Definitions
Customer Type: These are the customers that the manufacturers’ representatives sell to.
OEM (Original Equipment Manufacturer): These customers buy the components they use to assemble a finished product they then sell to their customers.
Resellers (Distributors, Wholesalers, Retailers, Etc.): These customers buy the products and resell them to others. They provide values by making these products available locally.
End-User: These customers buy the products and use them themselves. For example, capital equipment.
Commission Survey
“How much commission should I pay my reps?”
Those new to working with manufacturers’ rep ask this question frequently. The correct answer depends on a number of variables, such as:
- The product or service.
- The type of customer (OEM, Reseller or End User).
- How much business currently exists in the territory.
- What other services the principal requires of the rep (product training, etc.).
Ultimately, whatever commission rate the two parties agree on, it must work for both.
To provide some assistance in arriving at a fair rate, MANA surveyed its members. We asked them what rates the principals paid reps for different product classifications. We also differentiated the results by customer types.
The survey goal is not to provide a specific commission rate or set an industry standard. The intent rather is to set a reasonable range. The range provides room to compensate for the uniqueness of each relationship.
To help understand the results, we define customer types as follows:
End-User: These manufacturers’ reps sell to customers that use the product themselves. Typically, this refers to capital equipment, equipment used to manufacture or produce products.
Distributor: These manufacturers’ reps sell to customers that then stock the products and resell to others. Customers in this category are distributors, wholesalers, dealers, catalog stores and retailers.
OEM: These manufacturers’ reps sell components to product manufacturers. Typically, these include castings, forgings, plastic injection molded parts, anything a manufacturer uses when they assemble a product.
The commission rates the manufacturers pay their reps tend to stay stable over long periods of time. From the MANA profile survey, we learn that many rep-principal relationships last 20 years or more. During that time, it is doubtful the commission rates change.
We hope you find the survey helpful and it’s worth repeating, whatever rate you agree to, it must work for both of you.
Note: MANA surveyed the members in 1999, 2002 and 2005 to collect commission rate data. Participation in subsequent years dropped below an acceptable level. In analyzing data from the surveys with sufficient data, the commission rates appear to be stable over time. Given there is no other commission rate data available since 2005, please use the results accordingly.
Click here for Survey
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Also included in written agreements are special clauses.
Product Liability Protection For Reps — By The Numbers
The probability of a manufacturers’ representative being named in a product liability lawsuit is small. The probability of a judgment being rendered against a manufacturers’ representative in a product liability lawsuit is even smaller.
In a non-scientific survey done by MANA, less than eight percent of the respondents said they had ever been named in a product liability lawsuit, and less than half of those said they had been carried all the way through the suit. The survey was sent to all MANA regular members, so it is likely that the respondents were mainly those who had some concern about the issue. It is also likely that those that did not respond, for the most part, had never been named.
However, without proper planning, just being named in a lawsuit can be painfully expensive, and receiving a judgment can be financially disastrous. Many members have reported that they spent $5,000–$6,000 on attorney fees just to get to the point in the discovery process where it became clear that they were not responsible for damages and were dismissed from the suit.
So what should you do to protect your business and yourself? MANA is obviously not in a position to give direct legal advice, but we have summarized below the recommendations we have received over time from attorneys, insurance providers, accountants, other professionals, and members who have been involved in product liability lawsuits. Take a look at these, and then make your own informed decision after consulting with your legal advisor.
1. Indemnification
- Insist that the contract include a “hold harmless” clause (see Paragraph 9 of MANA Sales Agency/Principal Agreement Guidelines). The inclusion of this provision in the contract usually insures that your defense will be conducted by the principal’s attorney along with his own defense in case of a product liability lawsuit.
2. Co-Insurance
- Request that your principal name you as an additional insured in a Broad Form Vendor Endorsement on his product liability insurance policy. Also request that you receive an annual copy of your principal’s insurance certificate to verify continuation of your inclusion as a co-insured. This procedure usually does not affect your principal’s insurance rate, although it could affect the amount of insurance available to them. Co-insurance is not an option if the principal self-insures for product liability. Over one-third of MANA members now have this coverage from 100 percent of their principals and another large percentage has been co-insured by some of their principals.
3. Incorporation
- Pure Rep, Commission Sales Only — Protect your personal assets by organizing, and judiciously operating, your company as a limited liability entity, a C Corporation, an S Corporation, or a Limited Liability Company (LLC). (There may be other reasons to be a sole proprietorship or a partnership, so check with your accountant.)
- Buy-Sell or Stocking Rep — Consider establishing a second corporate identity for that portion of your business where you are involved in handling, modifying or packaging product, or servicing product, or training in its use. The probability of your company being dismissed from a product liability lawsuit is much lower under these conditions, or if you represent a foreign supplier with no assets in the U.S., so be sure you have adequate insurance coverage on the new corporate entity as well. This may require that you purchase your own product liability insurance on the new entity.
4. Insurance
- Purchase Product Liability Insurance — Product liability insurance may be impossible to get or prohibitively expensive, depending on the nature of your business. However, rates and availability are improving. Some members are purchasing product liability insurance for their rep firms at reasonable prices, particularly if they represent products that have low potential for injury to the user.
- Self-Insure — Consider the probability that you will be named in a product liability lawsuit and the expected result. Then compare those numbers with the cost of carrying product liability insurance. In the worst case, if you are not indemnified by your principal, and you are not co-insured by your principal, and you have handled, modified, packaged or serviced the product or trained in its use, but you are incorporated and have judiciously operated your business as a corporation, your loss could be limited to the physical assets of your business and your attorney fees (although your exposure could be greater, depending on conditions). The physical assets of most manufacturers’ representative firms are limited to a few computers, fax machines, phones and office furniture.
5. Accurate Representation
- No professional salesperson, rep or direct, would intentionally misrepresent a product or service. But one should be careful to never make a claim for a product that cannot be backed up by published data or written instructions from the supplier. Reps would also be well-served to be skeptical and question any performance recommendation that exceeds the supplier’s published data, proposal statements or similar information. If it seems too good to be true, question it. As mentioned above, if you function as a professional engineer, product or technical expert, technical advisor, or trainer, in addition to a commissioned rep, be sure to consider appropriate additional insurance (e.g., Errors and Omissions) and a separate corporate entity for that function.
- In the litigious society that we operate in today, everyone in the supply chain must be aware of the potential for a product liability lawsuit. When plaintiffs are injured and file suit, their attorneys often cast a very wide net to be sure that every business involved in the transaction that may be even partially responsible is named. The straight-commission rep that solicits orders on behalf of a principal, and nothing more, may be dismissed once the discovery process proceeds to the point where it is clear the rep did not design, engineer, manufacture, handle or modify the product. But the facts may not always be clear, and the rep could be in for a long ride. Evaluating the information presented above and making an informed decision is a critical part of being a complete businessperson in today’s business climate.
Extended Post-Termination Commission Clauses
006: First Visit To a New Lawyer: What Happens Before the Clock Starts
Some people can’t bring themselves to visit a dentist. Others struggle to get themselves into their accountant’s office at tax time. And for many, fear of the unknown keeps them from reaching out to a lawyer whose specialty is manufacturers’ representative law.
In this episode attorney Matthew Benson discusses the kind of conversation he and most MANA-associated attorneys have with MANA members before the clock on hourly billing starts to run, for example:
- What are my legal rights?
- How much will this cost?
- How do you evaluate my case?
- How long will this take?
- What disruptions may be incurred in my business?
With Matthew’s insights, we discover that launching a new relationship with a lawyer who specializes in rep law involves minimal cost and absolutely no Novocain.
Fotolia Minerva Studio
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Other Legal Issues
What to Do When a Principal Terminates an Agreement
Principal Agreement Terminations
By Jack Foster
© chayantorn | stock.adobe.com
MANA member attorney Scott M. Sanders identified three key areas to consider as he covered situations related to principal agreement terminations during a MANAcast:
- Key contract terms and the ability for reps to collect unpaid commissions.
- Potential ways around 30-day termination.
- A discussion of state laws favoring reps when they make a claim for unpaid commissions.
At the outset of his presentation, which was followed by a question-and-answer session, Sanders maintained that independent manufacturers’ representatives were what he considered “road warriors.” As such, “They often take a long time to build up a book of business with a particular principal. For all that work on the front end to build long-term sales, they should be protected ethically and legally on the back end. Unfortunately, most of the contracts that they enter into with principals don’t provide for that protection.”
Scott Sanders is one of 20 attorneys that MANA members can consult with as a part of their MANA membership.
Sanders is the senior partner of Sanders & Montalto, LLP, and lead counsel of the Sales Commission Enforcers, a team of attorneys and staff dedicated to protecting the legal rights of sales agents. Since 1989, he has a 98 percent success rate in settling or obtaining judgments in sales commission disputes. He is one of 20 attorneys that MANA members can consult with as a part of their MANA membership. A full list of those attorneys can be found further up this page.
The attorney continued, “The fact is that all contracts come to an end. Thirty days’ notice is pretty short, and sometimes, principals don’t give any notice at all. Sometimes principals will give more notice than is required by the contract. That is the best practice and one that we recommend. We prefer something like 60, 90 or even 180 days. It’s not unusual for me to receive a call from a rep informing me that their contract has been terminated and they’re not receiving their commissions that are due.” Hence, the need for the subject matter of the MANAcast — which may be accessed in the member area of the MANA website.
Among the many subjects pertaining to principal terminations of representation agreements covered by Sanders during the MANAcast were the following.
Venue
Sanders explained that venue means the place where a lawsuit or other form of dispute resolution will take place. Choice of venue may be the key in deciding whether or not to move ahead with a lawsuit. He emphasized how important it was for every agent to strive for a contract provision laying venue in their own state. As he stated in a previous article in Agency Sales: “If no venue provision is included in a contract, then any state that has a reasonable nexus to the dispute is probably a good place to file suit. That could be the agent’s home state or that of the key customer at issue, or where the agency performed the services. However, that is a technical legal question for which an attorney should first be consulted, on a case-by-case basis.”
Choice of Law
In a December 2013 article that appeared in Agency Sales, Sanders made the point that choice of law is the most misunderstood of the contract terms of importance to reps. “Most agents sign contracts making disputes over their contract subject to the laws of the principal’s state. They then assume that their own states’ Commission Protection Acts do not apply; and that they are thus limited in damages….”
In that article, he continued: “Neither a sales agent, nor a manufacturer can void state laws passed after many years of debate and legislation, just at their whim and the signing of a contract that claims the contract to be subject to a different state’s laws. Whether or not parties agree to make a particular state’s laws applicable in contract disputes does not conversely mean that another state’s laws do not also apply, though that does not mean cumulatively.”
Alternative Dispute Resolution (ADR)
An ADR is an alternative to a traditional civil lawsuit in deciding or resolving a dispute and can take the form of mediation, non-binding arbitration, or binding arbitration.
Mediation means that a neutral “mediator” (often a retired judge or an accomplished attorney practicing in the field) will try to procure a settlement between the opposing sides, something that all parties will agree to and sign.
Non-binding arbitration is a process where a neutral “arbitrator” will hear and decide a case in favor of one party or the other, after submission of evidence (and sometimes testimony of witnesses) in a more informal setting than a court room, and under less stringent procedure. The outcome may generally then be appealed by the losing party.
Although the same basic process as non-binding, binding arbitration results in a decision by the arbitrator that may not normally be appealed.
Of the three types of dispute resolution, Sanders stressed that in his opinion, “Mediation is the best.”
Among the questions posed towards the end of the MANAcast were the following:
Q: Sometimes when a rep makes a claim for unpaid commissions, the amount of the commissions is unknown. If that’s the case, what does the rep do?
A: According to Sanders, “Reps will come to me and simply don’t know what they’re owed. That occurs when they are not privy to purchase orders, invoices, etc. That causes the rep to enter the great unknown without knowing what they’re owed. If a rep is uncertain, and they can’t negotiate something with the principal, then reps have a cause of action called an Accounting. The court can order the principal to provide the needed [accounting] information. That can’t be done, however, unless the rep files suit. It’s then that discovery tools would apply to the rep’s action.”
Q: Why is the choice of venue so important?
A: “As an example, consider if a rep signed an agreement with a principal whose home state is Florida, and the rep is located in California. In that case, you must file an action in Florida and witnesses are in California. It’s going to be difficult to get witnesses/customers to travel for testimony unless they will voluntarily appear. Nothing is binding on them to do so.” He concluded by noting that if a rep cannot negotiate a venue provision in their home state, they can be in a difficult position.
Q: How can a rep learn which of the various state commission laws might provide them with the best protection?
A: According to Sanders, general contract law is pretty uniform throughout the United States. “But laws pertaining to reps and protection of their sales commissions do vary depending upon where the principal and the rep are located.” It was emphasized that a list of state laws pertaining to this subject may be found on the MANA website.
At the conclusion of the MANAcast, Sanders stressed how important it was for a rep faced with any questions about commissions they might be owed to speak with a rep-savvy attorney — a list of MANA attorneys can be found on the MANA website.
Disclaimer: This article is not legal advice. Consult your attorney whenever legal advice is needed.
A special report comparing European and United States laws relating to commercial or manufacturers’ agents and the principals for whom the agents act.
Prepared by MANA with the assistance of legal counsel from Europe and the United States.
This publication is intended to provide general information about aspects of the legal relationships between agents and principals and to compare the treatment of certain issues under the laws found in Europe to the laws found in the United States. This special report is not intended to provide legal advice. Those seeking counsel about specific laws and factual situations must discuss those issues with a qualified professional advisor. Courts and legislative bodies can modify, interpret or void laws. Consult with a qualified professional advisor to determine the appropriate law applicable to any specific situation.
Introduction
For many years, in both the United States and throughout Europe, suppliers of products and services have used agents to obtain orders from customers. In Europe, it is common to refer to such agents as “commercial agents.” In the United States, these agents are usually referred to as “manufacturers’ agents” or as “manufacturers’ representatives.” In this special report, we will use “commercial agents” when discussing European law and “reps” when discussing United States law.
In both Europe and the United States, the persons for whom commercial agents and reps obtain customer orders are commonly referred to as “principals.” However, many suppliers of products and services are not principals as that term is used in connection with commercial agents or reps. For example, in the United States, the laws applicable to the rep-principal relationship are not normally intended to apply to insurance agents or to those that sell door-to-door. There are many other particular state laws that apply to such activities. Similarly in Europe, the European Union (“EU”) has adopted Directive 86/653/EEC (“Directive”) with the purpose of harmonizing up to a certain minimum level the national laws of the Member States applicable to commercial agents and their principals. The Directive does not cover agents soliciting the sales of services, such as travel and insurance agents, who are covered by specific national laws of the Member States.
A brief comment on the use of the word “law” in this special report is in order. When discussing the law of the United States, law will generally mean statutes passed by state legislatures unless otherwise stated. In the United States, there are five main sources of law other than case law: (1) the Constitution of the United States; (2) International Treaties to which the U.S. is a party; (3) federal laws passed by the Congress of the United States; (4) state laws; and (5) the constitutions of the individual states. For the most part, there are few federal laws that directly apply to the rep-principal relationship, but over 30 states have enacted particular state laws that cover that relationship. Accordingly, in this special report, most often the “law” of the United States will refer to state laws.
The discussion of applicable European “law” in this special report shall generally mean the Directive unless otherwise stated. Even though the Member States implemented the general provisions of the Directive into national law, the specific national laws must be consulted in each case in view of the fact that important differences continue to exist.
The purpose of this special report is to compare how the laws of the United States and Europe address certain important general issues in the business relationship between reps and commercial agents and their principals. The intent is to provide a perspective on the treatment of some common significant issues within the United States and within Europe. The publishers and authors of this special report do not intend to provide legal advice or legal guidance for specific situations. Laws change and can be interpreted and voided by courts. Please consult with a qualified professional for advice on particular laws and factual issues.
1. Definition of Rep and Commercial Agent
United States
In the United States, the law usually defines a rep as someone who solicits customers and/or orders for the products of a principal. In other words, a rep seeks to influence customers to buy goods from a principal. Some laws broaden the definition to include reps that solicit the purchase of services provided by a principal.
The laws, however, may state that reps soliciting certain services are not covered by the law. For example, some laws expressly exclude insurance agents (although insurance agents and other agents in the United States are subject to many other state laws, which do not apply to the reps discussed in this special report). Other laws might apply only if the rep/principal contract is in writing and almost all apply only when wholesale orders are involved.
Reps under United States law are almost always independent contractors and are not employees or distributors. Most of those laws do not apply to employees or to those that either buy and resell or buy for their own account. In addition, the laws typically state that the rep must be paid in whole or in part by commission. Some of the laws state that they only apply to reps that solicit orders in the state that has enacted the law.
The laws do not describe what the rep can and cannot do within the business relationship. In the United States, the authority of the rep to act on behalf of the principal is left to the definition of it by the parties as expressed either in the written contract or in their conduct. Typically, and unlike under European law, the rep in the United States does not have authority to conclude the solicited purchase by accepting the order or to otherwise bind the principal.
Europe
The Directive defines “commercial agent” as a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of another person (his “principal”) or to negotiate and conclude such transactions on behalf of and in the name of that principal.
The Directive expressly excludes company officers, partners, receivers, liquidators and trustees in bankruptcy. It also excludes unpaid agents and those operating on commodity exchanges or in the commodity market or UK “Crown Agents.”
As the definition of commercial agent relates only to the sale or purchase of goods, agents in service industries such as travel and insurance agents, as well as musical, theatrical and sporting agents, are excluded. It should be noted however that many of the Member States, when implementing the Directive, have extended the scope of their national laws to also include agents in service industries.
Moreover, the Member States have the freedom when implementing the Directive to exclude those persons “whose activities as commercial agents are considered secondary by the law of the Member State.”
2. Rights and Obligations
United States
Most laws in the United States do not extensively detail rights and obligations (“duties”) of the rep and the principal except with regard to commission payments not timely paid under the contract or upon the termination of the relationship (discussed below in the “Remuneration” section). In the United States, the parties usually set forth their duties in a written contract. Parties have a great deal of freedom to determine what the respective duties will be.
The freedom is not unlimited. Here are some examples. For a rep to be recognized as an independent contractor in the United States by the Internal Revenue Service (“IRS”), the principal cannot exert control over the details of the methods by which the rep performs services for the principal or to otherwise usurp the independence of the rep to operate its business. If the principal exerts such control, the IRS will likely reclassify the rep as an employee of the principal and require the principal to pay withholding taxes, interest and penalties. This issue can create significant legal and financial problems and should be carefully discussed and documented before a rep begins to perform services in the United States.
The laws of a few states set forth some duties that must be in a written contract between the rep and the principal. Most often, the laws require the contract to describe how commissions are calculated and payable as well as to list any customers excluded by the principal from the solicitation efforts of the rep (“house accounts”).
Some of the laws are concerned with the details of the creation of the rep-principal relationship. A significant number of state laws require a written contract. Some enforce the payment of commissions due under verbal agreements. A minority of the state laws include a requirement that the principal provide a signed copy of the contract to the rep and even obtain a written receipt from the rep.
A variety of state laws or court decisions create other rights and obligations in the rep-principal relationship. Each party must keep confidential the trade secrets and proprietary business information of the other party. A small number of laws expressly either state that good faith is required in certain circumstances or state that certain acts or omissions create a presumption of bad faith. Most states have not passed laws that allow courts to imply good faith requirements in the rep-principal relationship, but some states have, through court decisions, recognized implied promises of good faith and fair dealing between reps and principals.
Under United States law, the parties are generally free to negotiate between themselves such matters as how much notice must be given and in what form before an action becomes effective. Similarly, they will usually state in the contract that the rep has no authority to change the terms of sale offered to the customer by the principal through the rep without the prior permission of the principal. The contract will prohibit the rep from accepting orders from the customer or otherwise binding the principal without prior authority.
The primary focus of the state laws concerns the duties of the principal to pay commissions upon the termination of the rep-principal relationship. This issue will be examined below in “Remuneration.”
Europe
The Directive addresses rights and obligations only in general terms. It provides a basic minimum and may not be derogated from by the parties.
The agent is obliged to “look after his principal’s interests and act dutifully and in good faith.” This includes making proper efforts, keeping his principal informed and obeying his reasonable instructions.
The principal is obliged to act dutifully and in good faith. This includes providing the agent with all necessary documentation and information. In particular, he should give reasonable notice to the agent if he expects a significantly lower volume of commercial transactions than the agent would normally have expected. The agent also has the right to be informed within a reasonable time of the outcome of transactions procured by him for his principal.
3. Remuneration
United States
No law in the United States mandates what the commission rate or other remuneration for a rep must be. The parties are free to negotiate such terms. As discussed in the prior section, some state laws require the parties to include the method of calculation of commissions in the written rep-principal contract.
The state laws set forth specific requirements for the payment of commissions during the relationship as well as upon the termination of the rep-principal business relationship. The laws differ, and it is beyond the scope of this special report to list the requirements in over 30 state laws. In general, the laws require that commissions must be paid within a fixed period of time. If commissions are not paid as required contractually or by law, the rep may sue the principal for the amount of the unpaid commissions and also seek additional exemplary damages (in some states, up to three times the amount of unpaid commissions) plus court costs and attorney fees. If the rep brings a frivolous lawsuit and the principal gets it dismissed, the laws often permit the court to award attorney fees to the principal.
These laws concerning commission payment requirements are often referred to as “commission protection acts” (“CPAs”). Some of the CPAs refer to paying commissions that are “due”; others refer to “accrued” commissions. The CPAs have varying other requirements that affect their interpretation and application. Both reps and principals should examine the applicable CPA with the assistance of a qualified professional advisor prior to making payments or other payment decisions at the end of the rep-principal relationship.
A few of the CPAs have provisions that may impact the payment of commissions upon termination in other ways. These laws contain provisions that arguably permit the rep to recover commissions if the rep can prove: (a) that the termination occurred after the principal had received and accepted an order from the rep’s territory; (b) that the order was shipped and paid for at some point; and (c) that the termination was motivated to avoid paying commissions to the rep.
Europe
Member States have the right to maintain or enact specific legislation concerning agents’ level of remuneration. In general the principal and the agent are free to agree on the payment. In the absence of an agreement, the agent is entitled to the customary local rate for the kind of goods he is selling or to a reasonable rate in the absence of any established custom.
The following rules laid down by the Directive apply exclusively to payment of commission and not to other forms of payment:
- Commission is payable during the contract period on all transactions concluded as a result of the agent’s action. If further business is done subsequently with a customer acquired by the agent for the same kind of business, the agent is entitled to commission on that subsequent business during the contract period. If the principal receives an order from such a customer during the agent’s contract period, then he must pay the agent commission on that contract.
- Even if the transaction is concluded within a reasonable period after the termination of the contract, the agent is entitled to commission if the transaction is mainly attributable to his efforts during the contract period.
The above rules could give rise to a situation in which both a current and a previous agent were entitled to commission. In this case the previous agent is entitled to the payment, “unless it is equitable because of the circumstances for the commission to be shared between the commercial agents.” It may also be provided that the agent is entrusted with or has the exclusive right to a specific geographical area or group of customers. In this case he is entitled to commission on all transactions with customers from that area or group. Under some of the national laws, exclusivity is assumed unless explicitly agreed otherwise.
The commission becomes due as soon as the transaction has or should have been executed by the principal according to the agreement made with the customer, or as soon as it has been executed by the customer. This protects the agent against non-performance or breach of contract by the principal. The commission shall be paid when the customer has executed his part or on the last day of the month following the quarter in which the commission became due, whichever occurs first.
4. Information
United States
The state laws have few requirements as to what information must be provided to either of the parties. A minority of state laws require that commission charge-backs for unpaid or returned orders and commission calculation information must be specifically addressed in the written contract or with the commission payment itself. The parties commonly negotiate the provision of information to each other and then include their agreement in the written contract.
In the event of a dispute as to orders, shipments, payments or similar information, in the United States an aggrieved party could file a lawsuit and then seek “discovery” within the lawsuit. In brief, there are rules of civil procedure which apply to business (and other) disputes. A number of these rules involve discovery, which is the specific procedure by which the attorneys for each party gather informationthat is relevant to the dispute by asking questions and requesting documents to examine and copy.
Europe
According to the Directive the agent is entitled to receive quarterly information relevant to the amounts and breakdown of his commission. If Member States have national rules which permit the agent to inspect the principal’s books, these rules are to take precedence over those found in the Directive.
5. Execution and Termination of Contracts Between Principals and Reps/Commercial Agents
United States
Some state laws require agreements between reps and principals to be in writing in a document signed by both parties. (There is no federal law that requires written contracts between the parties.) The state laws apply regardless of whether the principal is inside or outside the United States. Some of these laws also say that no provision of the state law can be waived either by express waiver or by an attempt to make the agreement subject to the laws of somewhere else.
Moreover, most states in the United States also have a state law generally known as the “Statute of Frauds.” This state statute requires certain contracts to be in writing. Typically, if performance of the contract will take longer than one year, the contract must be in writing. Since some contracts with reps in the United States will be for a fixed period of time, the applicable state statute of frauds may apply, and the contract should be in writing.
These laws do not prevent the parties from agreeing to a business relationship through a verbal or implied agreement. In addition, the rules of evidence in the United States may permit proof of the terms of an agreement through some writings that might not take the form of a traditional written and mutually signed contract. However, these rules and laws may also prohibit certain proof of a rep-principal relationship that was not embodied in a written contract.
If the parties continue to perform after the expiration of a contract for a fixed period of time, there may be an issue as to whether the contract as a whole was renewed by the actions of the parties or whether the agreement is now a new one for an indefinite period of time which can be terminated upon notice.
A minority of laws in the United States set forth the circumstances under which a party to a rep-principal contract may terminate it. Similarly, few laws state any required length of notice that must be given of termination or non-renewal. The parties are generally free to negotiate such terms. Termination or non-renewal may be with or without cause and upon such notice as agreed upon. “With cause” means there is a reason for the termination; “without cause” means that no particular reason is required. The reason for a “with cause” termination is usually the breach of the agreement by a party. Sometimes, the contract gives the party claimed to have breached the agreement the right to cure the alleged breach within a certain period of time after notice of the alleged breach. The parties may also agree to immediate termination in particular circumstances such as a “material” or major breach of the contract, an uncured breach or in the event of a significant change in ownership or participation in the selling effort (“key person” clause).
Europe
Each party has the right to receive a written document setting out the terms of the agency contract. The right to receive such a document cannot be waived. The contract of the agency itself can be concluded orally or tacitly, except the Member State has provided that an agency contract shall not be valid unless evidenced in writing.
The Agency contract may be concluded for a definite period. If such a contract continues to be performed after the expiration of the agreed period, the agreement is transformed automatically into an agreement for an indefinite period which can be terminated by notice. The period of notice cannot be shorter than one month for every expired contract year. With the beginning of the fourth year, the Member State can adopt longer periods of notice to a maximum of six months.
If longer periods of notice are adopted, these should be identical for both agent and principal. Fixed period agreements are also subject to the cumulative notice provisions described above.
The contract can also be immediately terminated by either party in certain cases, e.g., when one party fails to carry out its obligations or in “exceptional circumstances,” such as force majeure.
6. Indemnity and Compensation
United States
In the United States, these terms have different meanings from their European counterparts. In America, “indemnity” means a promise by one party (the “indemnifying party”) to protect and hold harmless the other party from financial liabilities arising from wrongful acts or omissions of the indemnifying party. The laws of the various states often have some indemnification provisions, but they may not be directly or clearly applicable to the rep-principal relationship.
Therefore, it is usually a matter of negotiation as to what indemnification provisions appear in the contract between the parties. The indemnification should be reciprocal so that each party is protected from loss due to wrongful acts of the other party. It is helpful to include specific indemnification for breach of the rep-principal contract and for court costs and attorney fees. In the United States, the general rule is that each party pays its own attorney fees unless a law or contract clause requires otherwise.
There are few state laws that provide post-termination compensation for reps that are terminated or non-renewed regardless of the length of service to the principal. Again, in the United States, such issues for the most part are left to the negotiation of the parties. If a rep fails to negotiate post-termination payments of either commissions or a severance payment, courts are often reluctant to impose an obligation on the former principal to make such a payment. Of course, egregious circumstances may permit assertion of claims for post-termination payments outside of the contract. For example, if the principal terminates the rep on the eve of accepting a large order which the rep has solicited for months or years, the rep may have a claim against the principal. There could be a number of other examples. The point, however, is that it is much better practice under United States law to anticipate, negotiate and document the post-termination compensation issue.
As discussed above in the Remuneration section, a few state laws permit a terminated rep to prove entitlement to post-termination commissions if it can be shown that, among other things, the reason for the termination was to deprive the rep of commissions.
Europe
Indemnity refers to payment in respect of business goodwill accumulated by the agent during the period of agency. If the indemnity option is chosen by the relevant Member State, then an agent is entitled to an indemnity if and to the extent that he has brought the principal new customers or has significantly increased the volume of business with existing customers and the principal continues to derive substantial benefits from the business with such customers, and the payment of this indemnity is equitable.
The articles in the Directive which deal with indemnification and compensation for agents bear the mark of political compromise. The principle of indemnification for agents at the termination or expiration of agency agreements was already applied in a number of Member States including Germany, Austria and the Benelux countries. The principle of compensation on the other hand was already applied in France. As these two positions had to be accommodated in the final text of the Directive, the Member States were given the option of implementing either the indemnity or the compensation principle. With the exception of France, The UK and Ireland, Member States have incorporated the indemnity option into their national law. The UK has permitted the parties to choose the indemnity option, but if they fail to do so, the agent will be entitled to compensation.
An agent must at least notify his principal that he intends to make a claim for indemnity or compensation within a limitation period of one year of the termination of the contract. Indemnity or compensation is payable even if the contract is terminated because of the death of the agent.
Indemnity or compensation is not payable if the principal has terminated the agency contract because of default attributable to the commercial agent which would justify immediate termination of the agency contract under national law, or where the commercial agent has terminated the agency contract, unless such termination is justified by circumstances attributable to the principal or on the grounds of age, infirmity or illness of the commercial agent in consequence of which he cannot reasonably be required to continue his activities, or where, with the agreement of the principal, the commercial agent assigns his rights and duties under the agency contract to another person.
The indemnification may not exceed an amount equivalent to the agent’s commissions for one year, calculated from the agent’s average annual commissions over the preceding five years or the period that the agreement has been in force, whichever period is the longer. However, if the agent thinks he suffers damages that exceed the indemnification as calculated above, he is entitled to claim additional compensation. It is not clearly indicated which damages are included, but it is generally assumed that it refers to damages caused by breach of contract.
Under the compensation system, the agent is entitled to compensation for the damage he suffers as a result of the termination of the contract. Such damage is deemed to occur particularly when the termination takes place in circumstances…
- …depriving the agent of the commission which proper performance of the agency contract would have procured him whilst providing the principal with substantial benefits linked to the agent’s activities;
- and/or which have not enabled the agent to amortize the costs and expenses he had incurred for the performance of the agency contract on the principal’s advice.
There is no maximum level of the compensation.
7. Post-Termination Restraint Clauses
United States
In the United States, some state laws expressly prohibit what are called “covenants not to compete” Others permit them. Such covenants are promises not to serve as a rep for a competing principal for a period of time and within a territory after the end of a rep-principal relationship.
If state law permits such covenants, the restrictions must be reasonable in three ways: (1) the length of the restraint must be reasonable; (2) the geography or territory within which the former rep cannot serve a competitor must be reasonable; and (3) the restriction must be generally reasonable in view of the interests sought to be protected by the principal and otherwise not unreasonably restrict the ability of the rep to earn a living. It is impossible to set forth what a particular court might find reasonable because the circumstances can vary so much. Suffice it to state that a principal seeking such a clause should draft it with professional advice and reasonable restraint.
Reps are free to negotiate such clauses and should consider seeking post-termination commission payments during the period of any agreed-upon restraint. If the clause is reasonable and permitted by state law, courts will likely enforce it.
Another clause to consider is an “anti-piracy” clause. Such a provision prohibits either party from seeking to employ or actually employing the employees or sub-agents of the other party for a period of time after the end of the rep-principal relationship. This clause will protect the respective organizations from predatory hiring efforts after the end of the working relationship.
Europe
A restraint clause is only valid if it is concluded in writing and it relates to areas, groups of customers and kinds of goods that were covered by the contract and the restraint lasts not longer than two years.
8. Conclusion
This special report can only highlight certain aspects of the rep-principal business relationship and some of the ways the laws of the United States and Europe deal with such issues. There are similarities and there are differences between the laws.
In Europe, the Directive and the harmonization efforts of the EU have led to more uniformity among the laws of the Member States concerning reps and principals. In the United States, there are over 30 state laws governing rep-principal relationships. These laws vary in some significant ways and often apply only in certain situations. Courts in both Europe and the United States regularly interpret applicable laws and also announce or clarify other legal issues that apply to reps and to principals.
Those interested in the legal aspects of the rep-principal business relationship in Europe or in the United States must become aware of the applicable law and of any court treatments of such laws prior to acting or to reaching conclusions.
by John H. Anderson, Esq.
“Information to Help Agents and Manufacturers Protect Their Interests Both Before and After Bankruptcy is Filed”
Why the Law Provides Protection to Bankrupt Entities
Congress has decided that, as a matter of public policy, society will benefit from granting relief to heavily burdened debtors. Congress’ goals are:
- To relieve the debtor from creditor pressure.
- To provide the debtor with a “fresh start.”
- To ensure that similarly situated creditors are treated equally.
Legal Bankruptcy
Where an individual, partnership, corporation, or municipality is insolvent or is otherwise unwilling to pay its debts, that entity may be ordered and adjudged to be “bankrupt.” This status will entitle the entity to the protection provided it by the federal bankruptcy laws. Note: The term “debtor” is used instead of “bankrupt” in the federal Bankruptcy Code.
Bankruptcy law is federal law, but the bankruptcy courts must apply state law to determine whether a claim is valid and whether a claim is exempt.
The Bankruptcy Code affects the rights of not only debtors, but also those of creditors, especially general and unsecured creditors. For example, even though a creditor collects a debt before the debtor files bankruptcy, the bankruptcy court may require the creditor to transfer that money to the bankruptcy estate for disbursement under the Bankruptcy Code.
As of 2005, many bankruptcy filers are required to get credit counseling before they can file a bankruptcy case — and additional counseling on budgeting and debt management before their debts can be wiped out.
All potential creditors should consider the effect the bankruptcy laws might have on their business before extending credit.
The Automatic Stay
The Bankruptcy Code provides that once the bankruptcy petition is filed, all actions intended to collect a pre-petition debt must stop. The idea behind this rule is to preserve the assets of the bankruptcy estate pending termination of the bankruptcy proceedings, and to relieve the debtor from creditor pressure.
Unless a creditor obtains relief from the stay by an order of the bankruptcy court, it will be bound by its provisions.
Any action taken by a creditor after the filing has no legal effect and is either void, voidable by the bankruptcy trustee, or voidable by the debtor. If the bankruptcy petition has been filed, a creditor may not even continue against the debtor a previously filed lawsuit for a pre-petition debt.
A creditor may be held civilly liable for any damages caused by a violation of the automatic stay.
Creditors are generally deemed by the court to know when the stay is in effect, even if they never actually learned that the bankruptcy petition was filed.
Extending Credit
Credit is the right granted by a creditor to a debtor to incur debt and defer its payment. Debts are often incurred when goods are sold, loans are made, and when services are rendered.
Before a creditor sells goods on credit, renders services on credit, or otherwise makes a loan, it should first evaluate the risk that the debtor will default (not pay what is owed). In making this evaluation, the credit history, net worth, and cash flow of the borrower should be considered.
If the debtor is a partnership, it is possible to make the partners themselves “jointly and severally liable” for the credit in a future court proceeding. If this is desired, a copy of the partnership agreement should be obtained by the potential creditor to determine the creditworthiness of each of the partners.
Whether a loan is “secured” is of utmost importance to any potential creditor, as more fully discussed below.
Once a debtor has filed a bankruptcy petition, an “automatic stay” of collection activities against the debtor is declared, and many creditor claims become subject to the power of the bankruptcy court’s decisions.
Before extending credit, creditors often want the debtor to fill out a detailed credit application including:
- All bank account information.
- A detailed balance sheet with a fair market value estimation for each category of assets.
- A list of accounts receivable, with addresses, because the creditor may decide to seek garnishments against third parties that owe the debtor money or are holding the debtor’s property.
- Copies of all other loan applications made by the debtor.
- Copies of any valuable contracts on which the debtor is working.
Insolvency
If an entity is unable to pay its debts as they become due, that entity is insolvent.
If an entity has liabilities greater than its assets, including the “good will” and “going concern” value of a business, then that entity is likewise insolvent.
Where creditors seek an involuntary bankruptcy (see definition below), a court is not likely to grant it if the debtor is able to pay its debts as they become due (regardless of whether its liabilities are greater than its assets.)
How the Issue of Bankruptcy Arises
Voluntary Bankruptcy:
Where an insolvent individual, partnership, corporation, or municipality initiates bankruptcy proceedings, the bankruptcy is termed “a voluntary bankruptcy.” A debtor must meet the requirements of the Bankruptcy Code to file voluntary bankruptcy. These requirements include petitioning the court for relief, filing a schedule with the court, and filing a statement of affairs with the court.
Involuntary Bankruptcy:
A bankruptcy is termed “an involuntary bankruptcy” where creditors either: a) seek to have the debtor’s remaining non-exempt assets distributed among themselves through straight bankruptcy (see definition below), thereby agreeing to discharge the debtor from any further obligation, or b) seek to restructure and reorganize the insolvent’s debt structure, thereby agreeing to look to the bankrupt’s future earnings to satisfy their claims.
If creditors wrongfully file an involuntary bankruptcy proceeding, and this wrongful action causes the debtor to suffer damages, then the debtor has a cause of action against the creditors.
Straight Bankruptcy (Chapter 7)
A straight bankruptcy proceeding is designed to liquidate the debtor’s non-exempt assets and distribute them among the creditors in accordance with the priority and distribution provisions of the Bankruptcy Code. This proceeding discharges the debtor from any further obligation to the creditors on the previously extended credit.
Before 2005, the bankruptcy rules allowed most filers to choose the type of bankruptcy which was best for them — and most chose Chapter 7. Since 2005, however, the law prohibits some filers with higher incomes from using Chapter 7 bankruptcy. Debtors wishing to file Chapter 7 must first measure one’s current monthly income against the median income for a household of similar size in the same state. If it is more than the median, the debtor must then pass a “means” test in order to file Chapter 7.
The purpose of the “means” test is to figure out whether the debtor has enough disposable income to make payments on a Chapter 13 plan. To determine whether one passes the means test, he should subtract certain allowed expense and debt payments from his current monthly income. If the income left over after these calculations is below a certain amount, the debtor can file Chapter 7.
The debtor is required to file schedules of assets and liabilities and a statement of affairs for the trustee to examine. The creditors may question the debtor concerning the schedules, and assist the trustee in discovering assets that the debtor failed to list.
In a straight bankruptcy proceeding, a creditor’s claim is subject to:
- The payment of expenses associated with the administration of the bankrupt estate.
- The payment of other claims and expenses which are deemed to take “priority” over that creditor’s claim.
- A pro-rata distribution.
The Bankruptcy Code allows the trustee to reverse pre-bankruptcy advantages (sometimes called “preferences”) that may have been gained by creditors through their collection efforts. The trustee is empowered to undo these transactions, and have previously collected money and/or assets transferred to the bankruptcy estate.
Unless the plan so provides, post-petition earnings do not become property of the bankruptcy estate.
Reorganization (Chapter 11)
If a debtor (such as a corporation, partnership, or individual) is facing insolvency, it may wish to keep its assets and/or continue to operate a business with the hope of becoming financially solvent. In such situations, the debtor may petition a bankruptcy court for reorganization under chapter 11 of Bankruptcy Code.
The court will not confirm the debtor’s proposed plan without the approval of a majority of the debtor’s creditors. The creditors may decide that they will benefit more by supporting a debtor’s plan (agreeing to a workout plan) than if they forced the debtor into straight bankruptcy. This is a business decision of the creditors.
A large number of Chapter 11 cases are eventually converted to Chapter 7 cases.
Under Chapter 11, a debtor business is generally permitted to continue its operations under court supervision, until some plan of reorganization is approved by more than half in number and more than two-thirds in amount of the creditors.
Sometimes no trustee is appointed. In such a case, the debtor remains in control of its estate assets and is called a “debtor-in-possession.” A debtor-in-possession holds the estate assets as a fiduciary for the benefit of its general creditors.
If the court is willing to grant permission, a creditor may settle its claim with the debtor after the debtor has filed Chapter 11.
If a corporation is insolvent at the time it files a petition for reorganization, a majority of the corporation’s owners (called shareholders) must also approve the plan. If an agreement cannot be reached, then the corporation’s assets will be liquidated and distributed in straight bankruptcy.
Unless the debtor’s plan so provides, post-petition earnings by the debtor do not become property of the estate. Therefore, before agreeing to a plan, the creditors may want to make sure that the plan provides that the debtor’s post-petition earnings become property of the estate.
Individuals with Regular Income (Chapter 13)
Under Chapter 13 of the Bankruptcy Code, any individual debtor (or husband and wife filing jointly; businesses cannot file Chapter 13) who is insolvent, and who is a wage earner (earns wages, salary or commissions) can formulate and file a plan with the court intended to provide the debtor with additional time to pay off his creditors.
A plan made in good faith and acceptable to the unsecured creditors will usually be confirmed by the court. Should the wage earner ultimately be unable to pay the debts, the bankruptcy may be converted to Chapter 7.
If the unsecured creditors do not accept the plan, or if the court decides that the creditors are not likely to receive at least as much as they would receive if the debtor’s assets were liquidated and dispersed in straight bankruptcy, then the court will reject the plan.
Unlike chapters 7 and 11, the debtor’s plan must provide (as opposed to “may provide”) that all property acquired by the debtor after the petition is filed, including post-petition earnings, becomes part of the estate (until the debts are satisfied).
The Law Regarding Promises to Pay Debts Discharged or Dischargeable in Bankruptcy
If a legal obligation is unenforceable, such as where a debt was discharged in bankruptcy under Chapter 7, a new written promise by the debtor to fulfill the unenforceable legal obligation is enforceable according to the terms of the new writing (not necessarily the terms of the original legal obligation).
Warning: During the time between when the bankruptcy petition is filed and when the debts are discharged in bankruptcy, the automatic stay prohibits a creditor from trying to collect a debt from the debtor. If a creditor decides to contact the debtor during this time, the creditor should proceed with caution. For example, creditors who have contacted the debtor directly, after the petition was filed and before the debt was discharged in bankruptcy seeking to obtain reaffirmation agreements without the knowledge of the debtor’s attorney, have been found liable for violating the automatic stay.
Example 1: Paul owes Alice $10,000. This debt is discharged in bankruptcy on February 1, 2013. After this date, Paul sees Alice at a cocktail party and says to her, “I feel bad that I never paid you. I will pay you $7,000 as soon as Bill pays me on a contract that I have with him.”
Discussion: Notwithstanding Paul’s statement to Alice, Paul continues to have no legal obligation to pay Alice anything, even if he gets paid on his contract with Bill. Paul’s new promise was not in writing and has no legal effect (assuming that there is no new consideration given in exchange for Paul’s promise).
Example 2: Paul owes Alice $10,000. Paul’s debts are discharged in bankruptcy on February 1, 2013. After this date, Paul, feeling guilty that the debt to Alice was never paid, writes Alice a letter which states, “I know I owe you $10,000. I will pay you $7,000 as soon as I get paid on my contract with Bill.”
Discussion: As soon as Paul gets paid on his contract with Bill, he will be liable to Alice for $7,000. If Alice sues Paul after Paul gets paid on his contract with Bill, she should win a judgment for $7,000 against Paul.
The Bankruptcy Estate
The bankruptcy estate should include all of the debtor’s legal and equitable interests in property as of the date the bankruptcy petition is filed, as well as all legal and equitable interests in property that must be transferred to it through the court’s reach-back power (such as “preferences” and fraudulent conveyances, discussed below).
A creditor is generally interested in making sure that all of the debtor’s property interests are disclosed to the court.
The Role of the Bankruptcy Trustee
The trustee is commissioned to investigate and “take control of” the debtor’s estate, and to administer it for the benefit of the unsecured creditors. For example, if a lien has not been properly created or perfected, the trustee may destroy it through its “strong arm powers.”
In Chapter 7 cases, the duty of the trustee is to collect and liquidate the debtor’s assets for the benefit of the unsecured creditors.
The trustee may initiate actions on behalf of the debtor’s estate, defend actions against the debtor’s estate, and set aside claim preferences.
If a Chapter 13 plan has been approved, the trustee acts largely as a collection and disbursing agent for the debtor’s plan payments to creditors.
The Secured Creditor
Secured creditors are generally favored over unsecured creditors in any bankruptcy proceeding.
If a secured creditor desires to receive a distribution through a confirmed Chapter 13 plan, or through a Chapter 7 liquidation, then the secured creditor needs to file a proof of claim (and thus become a claimant).
A secured creditor with an “unchallenged” lien may choose not to file a proof of claim because an unchallenged lien survives the discharge of a debtor in bankruptcy.
Secured Creditors with Voluntary Liens
As a condition to extending credit, a secured creditor receives collateral intended “to guaranty” the payment of the debt. This is accomplished:
- When the debtor gives the creditor physical possession of personal property for the creditor to hold.
- When the debtor grants a voluntary lien on personal property which is in the debtor’s possession by executing a security agreement, which is definite and certain in its terms.
- When the debtor grants a lien on real property by executing a promissory note secured by either a mortgage or a trust deed.
A creditor with a lien should promptly file or record the lien in the appropriate governmental office. If the creditor fails to do this, the creditor risks having the lien stripped from it by a future bankruptcy court action.
Also, a creditor with a lien should file or record the lien to serve as notice:
- To any and all future potential creditors of the debtor.
- To any future purchaser where the debtor is the seller. This is so because many states have adopted notice statutes that “protect” a bona fide purchaser of property who pays value for the property and does so without notice of prior unrecorded interests/claims. This may mean that a bona fide purchaser who pays value may successfully quiet title in its name through a court proceeding (an action to quiet title). Such a court proceeding would “cut off” the rights of the prior unrecorded interest holder and leave him without any property interest in the property.
If a “non-insider” secured creditor received the security on or within 90 days of the filing of the bankruptcy petition, that non-insider secured creditor may have no more rights than an unsecured creditor. If an “insider” secured creditor received the security between 90 and 365 days before the date the petition was filed, that insider secured creditor may have no more rights than an unsecured creditor (see “Insider Status and The Reach-Back Power of the Court,” below). Sometimes a debtor wishes to sell property which is encumbered by a creditor lien. Before granting permission to the debtor to do so, a creditor would be well advised to first obtain a court order giving that creditor a lien on the new property (the property gained by the sale, such as cash) as “adequate protection.” If a creditor gives the debtor permission to sell the encumbered property without first obtaining such a court order, the creditor may lose its security interest.
While it is true that a creditor will not lose the security interest simply by granting the debtor permission to sell the encumbered property, so long as the creditor can trace the new property (often cash) to the old property, tracing may become too difficult to accomplish where the debtor commingles the new property with other property of the debtor or otherwise fails to keep accurate records.
Secured Creditors with Involuntary Liens
Even where a debtor does not voluntarily give the creditor collateral, a creditor may sometimes take action against a debtor in a state court proceeding which gives the creditor a lien interest in the debtor’s property. While this is true, many involuntary liens are judicial liens, and, if they hurt a debtor’s exempt property interest, they may be successfully “taken away” or “pushed back” by the debtor through certain lien avoidance procedures.
The Unsecured Creditor
An unsecured creditor is a lender who extends credit without receiving collateral. If the debtor fails to pay the debt when it becomes due, an unsecured creditor may commence legal proceedings against the debtor. If the debtor files a bankruptcy petition, the unsecured creditor is generally at the end of the line when it comes to collection on the debt.
Note: Some court actions automatically give a judgment holder a lien against all real property owned by the debtor within a certain geographical boundary. If the debtor has equity in real property, this may convert the status of an unsecured creditor to that of a secured creditor.
The Oversecured Creditor
A creditor is “oversecured” when the value of his lien (or the value of the collateral being held, as the case may be) exceeds both:
- The amount of all claims prior to his.
- The full amount of his claim.
The Undersecured Creditor
A creditor is “undersecured” when the value of his lien (or the value of the collateral he is holding, if such is the case) does not exceed both:
- The amount of all claims prior to his.
- The full amount of his claim.
The portion of the debt which does not have sufficient lien value or collateral to cover it is treated as an unsecured claim. Creditors often attempt to show that the debtor’s total property value is greater than that of the debtor’s valuation, especially when the creditor is at risk of being partially unsecured. Creditors must be aware that the debtor has an economic interest in undervaluing an asset. The debtor is interested in having as many claims discharged as possible, and an unsecured claim is often discharged.
The Special Creditor
Some creditors enjoy rights superior to that of other creditors under the Bankruptcy Code. For example, parties to a contract that has not been fully performed on either side may proceed to enforce their rights pursuant to the contract free of the bankruptcy proceeding. These and other creditors, such as creditors who hold a lien secured only by the debtor’s personal residence, are known as special creditors.
Exempt Property
Under the Bankruptcy Code, the debtor is allowed to claim certain property as exempt which eliminates from the trustee the power to liquidate that property for the benefit of the creditors (usually the unsecured creditors are the most affected). Exemption categories are generally written with the idea of exempting property interest which the debtor “needs” to ensure his basic welfare and that of his family.
Each bankruptcy court has a list of the property interests which are exempt, and the list varies from state to state. This list will often include rights granted under state law.
For example, exempt property interests may include part or all of: a personal residence, a homestead, a burial plot, a motor vehicle, a “non-collector” firearm, a piece of household furnishing, an item of wearing apparel, a book, a tool of one’s trade, an unmatured life insurance policy, a contract right, a dividend interest, an interest or loan value in a life insurance policy, a health aid, a Social Security benefit, an unemployment compensation benefit, an assistance benefit, a veterans’ illness and/or disability benefit, an alimony and/or support right interest, a stock interest, a bonus interest, a pension interest, a profit-sharing interest, an annuity interest, a disability or other compensation plan interest, a wrongful death benefit, a life insurance proceed interest, a personal injury award, and/or a loss of future earning award.
Unsecured creditors often attach the debtor’s claimed exemptions in an effort to increase the dividend that they will eventually receive. A debtor must claim an exemption or it is lost. If the exemption is lost, the trustee is free to liquidate and distribute the property interest.
Where applicable, a creditor generally has only 30 days from the conclusion of “the meeting of creditors” to file a formal objection to a debtor’s claimed exemption. If a formal objection is not made on time, it is deemed “waived” and is permanently lost.
Deciding Not to Sue
Sometimes a creditor is better off not suing the debtor. For example, when the debtor is willing to transform the creditor’s claim from an unsecured claim to a secured claim, the creditor may end up being able to collect more money by not suing.
Even where settlement cannot be reached, a creditor may want to wait before instigating legal action. For example, if a note and trust deed were given to secure a loan, and monthly payments were required to be made every 30 days, and the debtor fails to pay on time, the creditor may be better off doing nothing until 91 days after the creditor’s trust deed was recorded. If the creditor sues too soon, the debtor may file bankruptcy and have the lien taken away as “a preference.” If the creditor waits, the creditor can get past the preference period and protect the lien from the possibility of being taken away by the court.
Bankruptcy Fraud
In the situations where bankruptcy results in the liquidation and distribution of the debtor’s then existing assets, as in a straight bankruptcy proceeding, the court is in charge of gathering all the debtor’s assets and distributing them according to the law.
Before a court will grant the debtor the protection provided by the bankruptcy laws, the debtor must declare to the court that no assets have been fraudulently transferred or concealed.
Sometimes a debtor, in anticipation of bankruptcy proceedings, will seek to perpetrate a fraud on some of its creditors. This is sometimes accomplished:
- Where the debtor allocates assets to creditors with “an uneven hand,” either before or after bankruptcy proceedings have begun (this is often called a preferential transfer).
- Where the debtor conceals its assets from the creditors by failing to declare assets which the debtor should have declared.
- Where the debtor fraudulently transfers assets to others (such as to the friends or relatives of the debtor) with the expectation of later receiving the beneficial use of those assets.
An Example of Debtor Fraud by the Uneven Treatment of Creditors:
A manufacturer-debtor is anticipating bankruptcy and wants to preserve a business relationship with one of its creditors.
Before bankruptcy proceedings have begun, this manufacturer ships out a large order of goods to the creditor at a discounted price. Under such circumstances, the recipient of the goods could be held liable to the other creditors (through the bankruptcy court) for the difference in value between the goods received and the value paid for them, as well as be held liable to the other creditors for any damages that they suffered as a result of the fraudulent transfer.
An Example of Fraud Through the Concealment of Assets:
An individual is anticipating bankruptcy but does not want to forfeit all of his assets. This individual:
- Fails to declare some of his assets to the court.
- Transfers some of his assets to “friends” or relatives with the idea of the later receiving the beneficial use of those assets.
A creditor may bring a cause of action against a debtor who thus perpetrates a bankruptcy fraud. Before bringing suit, the creditor should consider the sufficiency of the evidence, the anticipated cost of bringing suit, and the likelihood of collecting on a judgment.
Insider Status and the Reach-Back Power of the Court
The trustee may avoid (force the recipient to transfer the property to the bankruptcy estate) certain transfers that were made by the debtor. For example, the trustee may avoid certain transfers made by the debtor while the debtor was insolvent or when the debtor was close to filing bankruptcy (usually within 90 days for “non-insiders” and within 365 days for “insiders.”)
An “insider” is a person or entity with a certain close relationship to the debtor. Transactions between the debtor and insiders are more closely scrutinized than other transactions.
An insider may be a general partner, an affiliate of a general partner, a director or officer of a corporation, a relative, a managing agent, an affiliate of a managing agent, or another person with management responsibilities. Thus, an agent who participates in the management of a business is exposed to the risk of having to transfer to the bankruptcy estate assets transferred to it (or equal value) on or within 365 days before the date the petition was filed.
A bankruptcy court may decide that the debtor is not insolvent (and does not thus qualify for a discharge in bankruptcy) after recouping the assets previously transferred to insiders.
Willingness of the Bankruptcy Court to Disregard the Corporate Form of Business (“Piercing the Corporate Veil”)
Where it is necessary to prevent fraud or to enforce equity, the bankruptcy court will disregard a corporate entity and hold individuals liable for corporate obligations. These individuals may include the owners of the corporation (called shareholders), the corporation’s directors, and the corporation’s officers.
The corporate veil is often pierced:
- Where the corporation ignores corporate formalities such that it may be considered the “alter ego” of either the shareholders or another corporation (this situation can arise where shareholders treat corporate assets as their own or otherwise fail to observe corporate formalities and some basic injustice results therefrom).
- Where the corporation was undercapitalized at the time it was formed such that there was not enough unencumbered capital to reasonably cover prospective liabilities.
- Where necessary to prevent an individual shareholder from using the corporate form of business to avoid personal obligations which existed at the time the corporation was formed.
Tortious Interference With Business Relations
Sometimes an individual, partnership, corporation, or municipality will intentionally interfere with the business relationship or legal expectancy of another and induce a breach or termination of the relationship or expectancy.
To prevail against that individual, partnership, corporation, or municipality in civil court, a plaintiff must:
- Have had a valid contractual relationship with a third party (a party other than the defendant) of which the defendant was aware at the time the defendant induced a breach or termination of the relationship, or the plaintiff must have had a valid business expectancy of which the defendant was aware at the time the defendant induced a breach or termination of the expectancy.
- Show that the defendant intentionally interfered with the business relation and caused the plaintiff to suffer damages.
Example #1: Manufacturer and Independent Sales Representative have entered into a valid contract for Independent Sales Representative to represent the products produced by Manufacturer to potential buyers. X Corporation is interested in purchasing Manufacturer’s assets. If X Corporation induces Manufacturer to file bankruptcy promising Manufacturer’s management that they will be hired by X Corporation once X Corporation purchases Manufacturer’s assets from the bankruptcy court, then X Corporation can be held liable to Independent Sales Representative in a civil action brought by Independent Sales Representative against X Corporation for “Tortious Interference with Business Relations.” Independent Sales Representative should prevail in court if he can produce sufficient evidence.
Example #2: Buyer tells Seller that Buyer will enter into a contract with Seller to purchase goods from Seller, but will do so only if Seller breaches its agreement with its agent, Y. Perhaps Buyer does not want Y to receive such a large commission for bringing Buyer and Seller together. If Buyer has knowledge of the relationship between Seller and Seller’s Agent Y, or otherwise has knowledge of Y’s business expectancy, then Buyer can be held liable to Y for any damages suffered by Y as a result of the “Tortious Inference with Business Relations.”
Creditor Rights and the Uniform Commercial Code (the “UCC”)
Where a contract for the sale of goods is involved, the UCC governs and provides both buyer and seller certain rights and remedies. Where a contract is solely for the rendition of services, the UCC does not apply.
The seller may stop delivery of goods in the possession of a carrier or other bailee when the seller discovers that the buyer is insolvent. The seller may stop delivery of a carload, truckload, or larger shipments of goods when the buyer breaches the contract or when the seller has a right to withhold performance pending receipt of assurances.
When a seller (such as a manufacturer-seller) learns that a buyer has received delivery of goods on credit while that buyer was insolvent, the seller may reclaim the goods on demand made to the debtor/buyer:
- Before 10 days after receipt of such goods by the debtor/buyer.
- If the 10-day period expires after the debtor/buyer files bankruptcy, before 20 days after the debtor/buyer received the goods.
Creditor Rights and “Boilerplate” Bankruptcy Clauses
Except in situations where the contract is solely for the performance of personal services, or where the contract consists of a loan agreement, boilerplate bankruptcy clauses are generally unenforceable. This means that if the debtor uses language in a contract, purchase order, or invoice indicating that the agreement is terminated or otherwise modified in the event of bankruptcy, such language will not terminate or otherwise modify the agreement. Such clauses are often included in installment type contracts and leases.
Whether an agency agreement between a manufacturer and an independent sales representative is considered to be for “solely personal services” is determined by the arrangement between the manufacturer and the agent. Normally, if the agent is a corporation and the contract does not specify that the services are to be performed by specifically named individuals, then the contract will not be considered to be for “solely personal services.”
Keeping the Principal Informed
When a seller’s agent receives reliable information, from any source, that a buyer or potential buyer is or is about to become insolvent, or is otherwise having financial difficulty, the agent should immediately inform the seller of that fact.
The seller may be able to protect its interests, as well as the interests of the agent, by acting quickly. This can be accomplished, for example, by either stopping delivery of goods in transit or reclaiming goods already received by the buyer.
A Creditor’s Right to Receive Notice
The due process clause of the U.S. Constitution requires that creditors be given reasonable notice before their property rights can be adversely affected.
Collecting on a Creditor Claim
In order to share in the distribution of the debtor’s assets, a creditor must file a timely claim. A “claim” is a right to payment, whether or not reduced to judgment. A claim may be liquidated or unliquidated, fixed or contingent, matured or unmatured, disputed or undisputed, legal or equitable, and secured or unsecured.
When a debtor defaults on a loan, a secured creditor is more likely to collect than an unsecured creditor. Also, when the debtor files bankruptcy, a creditor is more likely to collect when his claim is a priority claim rather than a general claim.
Both the security, and whether a claim is a priority or general claim will often determine whether the creditor will be able to collect on the debt.
Agents should be aware that independent contractors have a right to file quasi-employee status for their commission claims. Many bankruptcy provisions read as if the priority preferences are limited to those who are employees rather than independent contractors. The term “wages” would seem to so indicate; however, the classification of an individual’s “employee status” by one branch of the government does not prohibit another branch of the government from classifying that same individual’s “employee status” differently. Therefore, an agent may be deemed to be an independent contractor for labor law purposes and “an employee” for bankruptcy purposes.
Filing a Proof of Claim
Creditors should file a proof of claim in all bankruptcy cases unless the debtor has no assets or the court has told the creditor not to file.
The proof of claim must be filed within 90 days after the first date set for the meeting of creditors (which may not be the same as 90 days from the date the meeting of creditors is actually conducted).
Priorities
Claims and expenses have priority as follows:
First: Domestic support obligations. These are claims for support that are to be given to the spouse, former spouse, child, or child’s representative.
Second: Expenses associated with the administration of the bankrupt estate.
Third: Where the bankruptcy is involuntary, a claim arising after the beginning of the case, but before the appointment of a trustee.
Fourth: Certain unsecured claims, but only to the extent of $10,950 for each individual (or corporation) if that individual (or corporation) earned the money within 180 days of the date the bankruptcy petition was filed, or the date of the cessation of the debtor’s business, whichever occurs first. This claim may be for wages, salaries, or commissions, including vacations, severance, and sick leave pay earned by the individual, or for sales commissions earned by an individual (or corporation, if that corporation has only one employee) acting as an independent contractor in the sale of goods or services for the debtor in the ordinary course of the debtor’s business if during the 12 months preceding that date, at least 75 percent of the amount that the individual (or corporation) earned by acting as an independent contractor in the sale of goods or services was earned from the debtor.
Fifth: Certain unsecured claims for contributions to an employee benefit plan arising from services rendered within 180 days before the date of the filing of the bankruptcy petition or the date of the cessation of the debtor’s business, whichever comes first.
Sixth: Certain claims related to:
- The production of grain.
- The production of “fish produce.”
Seventh: Certain unsecured claims of individuals, to the extent of $2,425 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services for the personal, family, or household use of such individuals, that were not delivered or provided.
Eighth: Certain claims by governmental units.
Ninth: Certain unsecured claims based on any commitment by the debtor to “a Federal depository institution’s regulatory agency” (or predecessor to such agency), to maintain the capital of an insured depository institution.
Tenth: Claims for death or personal injury from a motor vehicle that occurred while the debtor was driving intoxicated.
Final Thoughts
The following are appropriate items to consider for both manufacturers and independent agents:
- Consult your own attorney to determine the possibility of collecting your claim through bankruptcy court.
- If your claim is economically significant, you should hire an attorney who specializes in bankruptcy.
- Consider the possibility that your claim should be given preference.
- Consult with your bankruptcy specialist to see if you qualify for a priority claim.
- If your debtor files bankruptcy, commissions earned may qualify as a super priority claim.
- Ask your bankruptcy specialist if you have any right to a secured position.
- If you owe the debtor and the debtor likewise owes you, consider the possibility of offsetting claims.
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