Townsend: Can employers withhold, claw back bonuses, commissions?

By Nancy J. Townsend

Employers offer extra pay to entice employees to sign on, produce more or continue employment. They naturally hope to withhold incentives from employees who miss the targets. Employers must know the type of payments that can legally be withheld or pulled back, recognize that payments may become so vested that they are beyond retrieval, and understand lawful techniques to withhold or recoup funds when warranted.

Earned wages untouchable

Assuming wage and hour standards for minimum wage and overtime are not implicated, the ability to withhold or claw back promised payments depends on whether the incentive payments are considered earned wages under state law.

“Wages” must be paid within 10 days after they are earned and cannot be waived, forfeited or repaid by the employee. An employer who withholds or attempts to claw back earned “wages” can be liable for the wages, plus double damages and attorney fees under the Indiana Wage Payment Statute. Ind. Code § 22-2-5-2.

“Wages” mean pay for the employee’s labor or service, as contrasted with other payments that depend on contingencies such as customer payments, profitability or productivity of the company or one of its departments, employee attendance or tenure with the company, or commemoration of a holiday or company anniversary. Ind. Code §22-2-9-1(b); Highhouse, 807 N.E.2d at 740; Brown v. Bucher and Christian Consulting, Inc., 87 N.E.3d 22 (2017). Indiana courts offer critical factors to define “wages” that are subject to the Wage Payment Statute and cannot generally be withheld:

• “Wages” are not generally linked to a contingency or factor outside the employee’s control because those payments cannot feasibly be determined or paid within 10 days and do not lend themselves to the strictures of the Wage Payment Statute.

• “Wages” generally relate directly to the employee’s work or the amount of work produced by the employee, as distinct from payments based on length of employment or financial success of the company.

• “Wages” are generally paid on “a regular periodic basis for regular work done by the employee,” as distinguished from irregular payments or an annual bonus.

If the compensation is the only form of pay to the employee, it is probably “wages.”

Vacation pay

Indiana employers can refuse to offer vacation pay and can enforce their written policy against paying for unused vacation upon termination of employment. They can also specify in a written policy that employees who quit, are fired “for cause” or fail to give two weeks’ notice will receive no payout for unused vacation. In this way, the vacation pay can itself be used to incentivize desired conduct. But if the employer has no written policy against payouts for unused vacation, then unused vacation pay is “wages” that must be paid on the next regular payday after a termination of employment. Ind. Code §§ 22-2-5-1 and 22-2-9-1. Withholding pay for unused vacation could render an employer liable for the vacation pay, double damages and attorney fees under the Indiana Wage Payment Statute. Ind. Code § 22-2-5-2.

Employment contracts, policies

Employers can control non-wage payments through employment contracts or policies. For incentive payments that are not earned wages, the prudent employer can impose conditions to reserve the right to retrieve payments from employees who don’t keep their end of the bargain. A policy stating that the bonus or commission is earned and paid after the employee achieves the goal is safest and easiest to administer. For example, an employer that pays a retention bonus after the retention period does not risk the employee accepting the retention bonus at the beginning of the retention period, leaving before the end of that period and failing to repay the bonus. Delaying the payment avoids the unpleasant and uncertain task of clawing back the compensation, possibly from an employee who is long gone or lacks the financial resources to repay it. It also avoids an argument as to whether the money already paid should be deemed earned when paid.

But in some cases, a policy that delays payment does not effectively incentivize. A signing bonus, for example, sets the company apart from others to attract highly competitive employees, best and brightest students, or specialized talent. Delaying the payment dilutes its power to attract employees who may need the cash to buffer the risk of a job change or transition from school into the work world. Employers who choose to pay the bonus or commission up front might consider options to reduce their financial risk:

• Make payments subject to a vesting schedule, by which payments vest and are paid incrementally as benchmarks occur.

• Pay half of the signing bonus at the time of employment and the other half after a year’s employment.

• Require that the employee sign a promissory note for the upfront bonus with the stipulation that the bonus be repaid if the employee fails to meet the required conditions or with an agreement that the promissory note will be forgiven incrementally while the employee continues employment. These payment structures may have tax consequences for both the employer and the employee but may streamline collection from the wayward employee.

Draft policies carefully

Any bonus or commission policy should be communicated to employees through a written handbook, an employment contract or a stand-alone bonus or commission agreement. To manage employee expectations and minimize the risk of future disputes, the written policy should:

• Use clear, plain and precise language so that employees (and perhaps judges) can readily understand and apply it.

• Identify when the payment is earned, specify all conditions that must be satisfied to earn the payment, and state directly that an employee who terminates before all conditions are met does not earn the commissions.

• State whether the bonus is discretionary with the employer and, if so, identify any guidelines for the exercise of that discretion. If fully discretionary, state expressly that the employer has “sole discretion” to determine whether, when and in what amount a bonus will be paid, if at all.

• Provide formulas and examples for calculating nondiscretionary bonuses and commissions. If calculated from “net” income, detail all expenses that are deducted before calculating commissions or bonuses.

• State whether the advance bonus or commission is forfeited upon termination of employment. If forfeited, state directly the amount that must be repaid if employment ends before that term expires, the timing for repayment, interest on unpaid funds and recovery of legal expenses of collection.

Employer takeaways

Withholding earned wages can have painful consequences — pay wages within 10 days after they’re earned or with the next regular paycheck after termination of employment.

For non-wage compensation, understand the company’s objective for the incentives and, if feasible, create a policy that pays after the goal is achieved.

If the lure requires upfront payment, consider a creative or compromise payment structure that preserves the appeal for the employee but reduces risk to the employer.

In all cases, draft and publish a clear, simple and comprehensive policy, provide examples to show how it works, reserve the intended discretion to the employer, and spell out methods for recapturing unearned incentive payments.•

• Nancy J. Townsend is of counsel at Krieg DeVault LLP. Opinions expressed are those of the author.