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.