Sales & Marketing: The Perils of Restructuring Sales Commissions for EKRA

For many years, it was fairly common practice for labs to pay their sales representatives variable compensation based on the volume and value of the tests they generated. But those arrangements became problematic under the new Eliminating Kickbacks in Recovery Act of 2018 (EKRA) law. (For more on EKRA, see EKRA: More Than a Year Out). To avoid the risk of criminal penalties under EKRA, labs had to eliminate these commissions and bonuses from contracts with sales and marketing staff. A recent federal case is an illustration of the kind of complications and backlash this restructuring has the potential to engender.

What Happened

In addition to a monthly base salary, a Hawaii lab paid its senior account reps commissions related to the revenues they and their team supervised brought in. But when EKRA took effect, the lab felt it had no choice but to pay the reps a fixed annual salary and a discretionary bonus determined by the CEO each quarter. Although the result was lower annual compensation, the lab felt like the new salary-based structure was a fair arrangement since it would now bear the financial risk of a rep’s poor performance. Unfortunately, many of the senior reps were less than happy about losing their revenue-based commissions, not to mention the fact that the deal also required them to sign a new non-compete.

Most dissatisfied of all was Darren, the senior rep serving as the lab’s Chief Business Development Officer. The bad blood had been brewing a while. Darren felt he was instrumental in the lab’s commercial success and that his contributions weren’t appreciated. The resentment grew when the lab rejected his quest for an equity stake. The new salary arrangement was the last straw.

The CEO soon learned that Darren was talking to competitors about leaving; worse, he was trying to persuade key colleagues to come along with him. She was also convinced that Darrin was disclosing secrets about the lab’s sales methods to competitors, poaching lab clients and making sexually demeaning remarks about her. Soon major clients began to leave, including those for which Darren was responsible. And why the CEO didn’t know why, she suspected that Darren was behind the client exodus.

The lab suspended Darren, apparently wanting to keep him employed to avoid the massive severance payment he’d be due if he was terminated. During the disciplinary proceeding, things got ugly with insults exchanged and Darren threatening to take all of the lab’s clients and drive it out of business. The next stage in the escalation was litigation. The lab accused Darren of breach of contract and unlawful disclosure of trade secrets. It also asked for a preliminary injunction barring Darren from competing with the lab until the case was resolved.

The Ruling

The federal court refused to issue the preliminary injunction.

The Reasoning

Courts are reluctant to issue injunctions before a lawsuit and will do it only if the person seeking the injunction can prove that, among other things, it would suffer “irreparable harm” without one. Darren’s threat to put the lab out of business was the irreparable harm, the lab contended. The problem, as even the lab acknowledged, was that nothing had actually happened yet. Darren was still on suspension and the court wasn’t willing to issue the injunction as a “prophylactic” measure so it could “get ahead of the problem.”

It doesn’t work that way, the court explained. While threatening to put someone out of business can be the basis for an injunction, the threat has to induce reasonable and realistic fear of imminent and irreparable loss. In this case, there was no reasonable basis to believe that Darren would and could make good on his threat:

• He was still employed by the lab;
• His attempts to persuade the other senior reps not to sign the new sales compensation contract had failed;
• There was no proof that he was responsible for the loss of the lab’s clients; and
• There was no proof that the lab incurred any losses as a result of his alleged disclosure of proprietary information to competitors.

S&G Labs Haw., LLC v. Graves, 2019 U.S. Dist. LEXIS 204058, 2019 WL 6311356

Takeaway: Losing a preliminary injunction doesn’t mean losing the entire case. The lab still has the chance to prove its claims at trial. And if it does, it may be entitled to an injunction as well as monetary damages. But what it can’t do is keep Darren from going about his business unless and until it does prevail in court.

 The larger significance of the Graves case is in illustrating how compliance-driven changes to sales and marketing compensation arrangements can engender bad feelings, disputes and even litigation with affected staff members. So, it’s critically important to ensure that:

•  The reps are aware of what EKRA is and why it may be necessary to alter their bonus and commissions arrangements to comply; and
• The reps get fair consideration for giving up their opportunity to earn volume- and/or value-based bonuses and commissions.