Why Manufacturer Representatives Should Have Termination Clauses In their Contracts

Termination clauses are among the most important aspects of any independent sales representation agreement.  Without a strong termination clause, an independent manufacturing representative is left without little legal protection should the principle decide it no longer needs its services.

The recent Tax Court case Potter v Commissioner, T.C.M. 2018-153 (T.C. Sep. 17, 2018)   provides a great example of the type of protection that a termination clause can provide to a manufacturing representative.  In that case, Jeff Potter worked as an independent contractor for a company called Green Country, which was in the business of selling garden soil and other related products.  Mr. Potter was well represented when drafting his sales representative contract and was protected by a strong termination clause.  The clause stipulated that if his compensation agreement was terminated, he would be owed a termination payout equal to 150% of his commissions from the previous year.  When his agreement was terminated, the company compensated in accordance with this clause.  The lawsuit that followed did not contest this payment, the dispute was merely over the federal income tax implications of the termination payment.

As we see in Potter, one approach to contracting for compensation in the event the sales representation contract is terminated is to structure it as a payout equal to a percentage of commissions paid over the previous year, or some other period of time.  This is of course not the only way to structure a termination clause pay out. Another popular approach is to structure it in terms of a percentage of sales made on accounts that the independent sales representative generated.  This, in effect, would allow the sales representative to continue earning a commission on sales that were properly attributable to their own work efforts. In order to provide real protection, termination clauses must be negotiated as a part of the initial contract. As a result, some sales representatives may prefer to structure the clause in terms of a flat rate, like a liquidated damages clause.

In addition to compensation, strong termination clauses can also provide manufacturing representatives protections that their governing state law may not be ale to provide them.  First, the prospect of paying the termination compensation outlined in the contract could serve as a deterrent for the principle for a variety of reasons.  It could make financial sense for the company to continue paying commissions periodically rather than paying out a large lump sum. Additionally, the termination clause can include other provisions separate and apart from severance pay. For example, the termination clause can contain limitations on how and for what reasons the sales representation contract can be terminated.  For example, the contract can provide that it may only be terminated for certain causes, either grouped generally under a “good cause” definition or specifically articulated in a list of permissible causes for termination.  While “good cause” termination clauses are typically not beneficial to a manufacturing representative, if force to have one, it is important that it provides limitations on how the termination can occur, notice be given in advance of termination, and a period of time within which to cure the deficiencies in their performance under the contract. The termination clause can also address future competition between the representative and the principle, carving out permissible and impermissible activities.

State laws rarely provide more statutory protections to manufacturing representatives that what can be negotiated by the parties at the beginning or during their sales relationship.  Minnesota is an exception to the general rule. In Minnesota, independent sales representatives have substantial protections afforded to them in the event of termination.  Minnesota Statute § 325E.37 “Termination of Sales Representatives” establishes: (1) that sales representatives in Minnesota may only be terminated for good cause; (2) that written notice setting forth the reasons for termination be provided at least 90 days in advance of termination; and (3) that a sales representative be given 60 days within which to correct those stated reasons. Regardless of the language of the sales representative contract, these protections are afforded to sales representatives in Minnesota.

The strong protections provided by this statute created an interesting outcome in a case decided last year.  In Apex Technology Sales, Inc. v. Leviton Manufacturing, Inc., CV-17-2019 (D. Minn. June 26, 2017), a principle attempted to terminate its relationship with the plaintiff independent sales representative without adhering to the notice requirements of Minn. Stat. § 325E.37.  The plaintiff moved for an injunction, mandating that the principle continue to perform under the contract during the pendency of the breach of contract lawsuit.  The District Court granted the injunction, finding both that plaintiff had a likelihood of succeeding on the merits of the breach of contract claim, and that money alone would be insufficient to remedy the potential harm to the plaintiff’s goodwill in the industry.

This case provides a great example for the difference that strong termination clause language can provide and a framework for how manufacturing representatives outside of Minnesota could negotiate their own termination clause in contract.  Not every sales representative will be protected by this type of statute, in fact most will not be, but that does not mean that they can’t all obtain this level of protection through savvy draftsmanship.  This underscores just how important it is that an independent sales representative be well represented during the contract negotiation.

If you are a manufacturing representative in need of advice and counsel in connection with drafting and negotiating a sales agreement, please feel free to contact our Sales Representative lawyer to discuss your legal issue.