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Calculating Payouts to Employees Upon Termination of Employment

In today’s economic climate, employment terminations and layoffs are an unfortunate fact of life.

Questions often arise as to whether the company must pay commissions or bonuses that are only partially earned or accrued as of the termination date, and whether the company can withhold from the employee’s final paycheck amounts owed by the employee to the company. Most employers know that final paychecks must be issued in a timely fashion, but many employers do not understand the laws regarding accrued vacation time, calculating bonuses, commissions or incentive compensation, or withholding employee loan amounts or the value of unreturned company equipment.

The Maryland Wage Payment Act

The Maryland Wage Payment Act requires that employers pay all wages due to an employee at the conclusion of employment. Payment must be made on or before the day on which the employee would have been paid the wages if employment had not been terminated. An employer violating these requirements may be subject to fines and may be sued for damages by the Labor Commissioner or the former employee. If a court finds that an employer withheld wages — not as a result of a bona fide dispute — the court may award the employee up to three times the unpaid wage amount, and may also require the employer to pay the employee’s attorneys fees and court costs.

The question of whether wages were withheld — as a result of a bona fide dispute — often becomes the crux of these disputes. Although an employer that improperly withholds wages is always subject to entry of a legal judgment in favor of the former employee for the amount of the wages, the employer may be saddled with a treble damages or attorneys’ fees award only if the wages were withheld when no bona fide dispute existed.

Given the risk of treble damages, and of having to pay all of the former employee’s attorneys fees and court costs, not to mention possible criminal fines, employers are well-advised to promptly pay all earned wages at the end of employment regardless of any perceived dispute with the former employee. Having stated this general principle, however, there remains room for confusion when the law is applied:

Must an employer pay a former employee for bonuses or commissions at the end of employment?

Most employers under the obligation to promptly pay earned salary or hourly wages upon termination, but things can become confusing when other benefits such as bonuses or commissions are added to the mix. Companies sometimes have policies or bonus plans that limit payment of sales commissions or bonuses only to persons who remain employed at the conclusion of the commission or bonus measurement period. Sometimes an employee performs a significant amount of work necessary to bring one or more new customers to the company prior to termination, but the new customers actually sign contracts (or the commissions otherwise vest) after the employee leaves the company. Do earned (or partially earned) bonuses or commissions have to be paid by the employer?

The Wage Payment Act includes a broad definition of what constitute wages that must be promptly paid at termination. The Act states that wages include all compensation that is due to an employee for employment. It then goes on to provide the following non-exclusive list of compensation categories that are included within the definition of wages: (1) bonuses, (2) commissions, (3) fringe benefit, and (4) any other remuneration promised for service. Earned bonuses and commissions are clearly within the scope of the law — but when are bonuses and commissions earned?

An employer may not refuse to pay commissions that have been earned solely because the employee no longer works for the company, even if the company’s policies or bonus plan specifically states that a person must still be an employee on the date of bonus or commission calculation in order to be due the bonus or commission. Once a bonus, commission, or fringe benefit has been promised as part of the compensation for service, the employee is entitled to its enforcement as wages once the employee does everything required to earn the wages.

The question of whether particular bonuses or commissions have been sufficiently “earned” requires a detailed review of the employer’s bonus or commission plan in order to determine the contractual terms of the compensation plan. Overlaying these contractual obligations is case law applying the Wage Payment Act, which may require payment of commissions or bonuses even if the bonus or commission plan provides otherwise. When an employee leaves a company after engaging in work that may have given rise to a bonus or commission had the employee remained with the company, it is important to consult with legal counsel to analyze the particulars in conjunction with an up-to-date review of the law. Equally important, companies should have counsel closely review their written incentive or bonus plans to ensure they provide clarity to employees and to the employer, consistent with Maryland law.

Must an employer pay a former employee for accrued but unused vacation time at the end of employment?

The Maryland courts and Legislature have struggled with the question of whether accrued but unused vacation leave is a “wage” that must be paid out as monetary compensation upon termination. In recent years, Maryland court decisions have moved in the direction of requiring that accrued but unused vacation be paid out as wages at the end of employment. In reaction to this trend, legislation was enacted in 2008 which provides:

An employer is not required to pay accrued leave to an employee if:

(1) the employer has a written policy that limits the compensation of accrued leave to employees;

(2) the employer notified the employee of the employer’s leave benefits in accordance with 3-504(a)(1) of [the Wage Payment Act statute]; and

(3) the employee is not entitled to payment for accrued leave at termination under the terms of the employer’s written policy.

Therefore, the question of whether accrued vacation leave must be paid out at the end of employment now depends on whether or not the employer has a clear written policy stating that unused vacation leave expires upon termination of employment, and is not an accrued benefit that is to be paid out at the end of employment. To be effective, any such policy must be communicated to employees, and the employer must be able to show that it has been adequately communicated to employees.

Employers should review their employee handbooks and policies to ensure that they clearly and accurately state the employer’s intent with regard to payment for accrued but unused vacation at the end of employment. It is good practice for employers to obtain, and maintain in human resources files, written acknowledgements signed by each employee affirming receipt of the company’s handbook or policies. If a company changes its handbook or policies in material ways (for example, by stating that employees are not entitled to payment for accrued leave at termination), it is good practice for the employer to obtain new signed acknowledgments from each employee acknowledging receipt of the revised policy or handbook.

This underscores the absolute necessity for employers to create and maintain a well written and up-to-date employee handbook. Employee handbooks offer significant protections to employers. They can have significant legal consequences, so it is important that they be written by competent counsel for the particular company’s circumstances, and not purchased “off the shelf” or downloaded from the internet. Among other things, it is important that the handbook include language that the handbook does not create a legally binding contract of employment and that it can be amended or terminated at any time by the employer. Once an employee handbook is in place, the employer must ensure that policies stated therein are followed (including, for example, any policy regarding whether accrued vacation time is or is not a wage benefit payable to employees upon termination).

May an employer withhold funds from a final paycheck if the former employee has failed to return company property?

Employers should not withhold funds from a final paycheck if an employee fails to return company property. Although there may be some room to argue the merits of doing so under the law, the clearly stated policies behind the Wage Payment Act, and the penalties available under the Act, make offset of wages for un-returned property highly inadvisable (and possibly illegal). Instead, employers should promptly pay all wages owed at the conclusion of employment, and then seek return of, or compensation for, unreturned company property through separate legal action. The return of tangible property may be pursued through a replevin action, and money owed to the employer under a written agreement may be pursued in a breach of contract action. Rights to company property are also something that should be clearly stated in a company handbook, and employers need to keep accurate records and receipts of checked-out company property.

The question sometimes arises whether a dispute with a former employee regarding return of company property can constitute a bona fide dispute insulating the employer from treble damages and from an attorneys fees award, should the employer withhold wages at the end of employment. The answer to this question is unclear under existing precedent interpreting the Wage Payment Act. An employer is well-advised not to tempt fate by offsetting accrued but unpaid wages against any claim for un-returned company property, however. As noted earlier, whether a bona fide dispute exists is relevant only to whether treble damages or attorneys fees may be awarded against the employer. An employer will always be held responsible for the actual amount of wages that are wrongfully withheld upon termination of employment.

May an employer withhold funds from a final paycheck if the former employee has violated a non-compete obligation?

Maryland courts have also struggled in recent years with the interplay of the Wage Payment Act with contractual severance agreements, and with non-compete obligations that are often incorporated within severance agreements. Severance payments sometimes are made contingent upon the former employee agreeing not to compete against the employer for a period of time, and this obligation can be supported by a contractual setoff against severance payments if the former employee violates the non-compete obligation.

The legal precedent in this area is very fact-specific, and a detailed review of relevant case law is beyond the scope of this article. Contractual severance payments may or may not constitute wages protected by the Wage Payment Act, depending on whether the payments are deferred compensation for labor provided during employment, or ongoing compensation for continued adherence to post-employment non-competition obligations. Application of the law to the facts of a particular employment arrangement will require a detailed review of relevant contracts, and of recent case law in this evolving area of law.

The enforceability of covenants not to compete under Maryland law is another topic beyond the scope of this article. Generally speaking, Maryland law will enforce covenants not to complete only if they are reasonable in geographic scope and duration, and only where the employee provides unique services, or to prevent the future misuse of trade secrets, routes, client lists, or the solicitation of customers. An employer wishing to include non-compete obligations in an employee contract should consult with counsel in drafting the employment agreement.

May an employee withhold funds from a final paycheck to repay a loan made to the employee?

The Wage Payment Act states that an employer may not make a deduction from an employee’s wages unless the deduction is expressly authorized in writing by the employee, or is ordered by a court, allowed by the Labor Commissioner, or otherwise made in accordance with government rule or regulation. An employer may not withhold loan repayments from an employee’s paycheck (either during employment or after the end of employment), unless one of these conditions is present.

Employee loans must be very carefully documented and be signed by the employee prior to any deductions being taken. Other than in the case of court orders (such as child support orders or wage garnishments), employers should never withhold funds from an employee paycheck without first having an attorney review the proposed written agreement between employer and employee.