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Sales Commissions Case: Court Holds No Breach of Contract

A recent breach of contract case decided by the Court of Appeals of Tennessee drives home two lessons.  One lesson is for sales representatives who earn their living by commissions: The other is for Tennessee lawyers who handle breach of contract cases.  The lesson for sales representatives is that, if they don’t obtain adequate protection for themselves in the written contract they sign before they start to work, they should not be surprised if they are not paid commissions for sales which they generated and should not be surprised if they cannot be helped by a court.  The lesson for lawyers who handle sales commission cases is that the duty of good faith, which is implied in every contract in Tennessee, cannot rescue a sales representative, even one who has been treated unfairly, from a bad bargain which they made on the front end.

In Schwartz v. Diagnostix Network Alliance, LLC (Tenn. Ct. App. 2014), Mr. Schwartz, a sales representative, signed an agreement with Diagnostix Network Alliance (“Diagnostix”) pursuant  to which he was to be paid commissions for each medical test which he sold.  That agreement (“Commission Agreement”) provided for the payment to Schwartz of commissions, but also stated that either party could terminate it “with or without cause” and could do so “immediately” upon providing notice.   Another clause in the Commission Agreement provided that Schwartz, the sales representative, had no rights to commissions once he was terminated.

For eight months after the Commission Agreement was signed, Schwartz traveled extensively and, the opinion seems to indicate, worked pretty hard and diligently to sell the medical tests offered by Diagnostix.   Schwartz made pitches to one particular organization which had a big network and which could potentially result in many sales.  Then, Diagnostix and that organization bypassed Schwartz by entering into an agreement for the purchase of the tests.  Then, Diagnostix terminated the Commission Agreement with Schwartz.  Although Diagnostix claimed that it had to terminate the agreement because the organization in question complained about Schwartz’s aggressive sales tactics, it is reasonable to assume that Diagnostix’s stated reason for terminating the agreement with Schwartz was pretextual and that it terminated him to avoid paying him commissions.

Schwartz filed a breach of contract lawsuit against Diagnostix.  He alleged that Diagnostix had breached its duty of good faith by terminating him to avoid paying him commissions.  Diagnostix filed a motion for summary judgment asking the court to dismiss Schwartz’s claim of breach of the duty of good faith.  The trial court, the Davidson County Circuit Court, granted Diagnostix’s motion.  Schwartz appealed.

Before we discuss what happened on appeal, let’s review the concept of the duty of good faith.  In every contract in Tennessee, courts imply a duty of good faith in performance.  This means that every party to a Tennessee contract must act in good faith in performing his, her or its obligations.  What is the duty of good faith?  It varies from case to case, and is determined based on the particular facts of each case.  The simplest example of a breach of the duty of good faith which I can think of is this:

Seller agrees to sell Buyer a product. Seller agrees to deliver the product to Buyer as soon as Buyer wires the purchase money to Seller’s account.  Buyer asks Seller to give it the information for Buyer to wire the payment.  Seller refuses relying on the fact that there is no term in the written contract requiring it to give Buyer that information.   Seller refuses to deliver the product because it never receives the payment. Buyer sues Seller.  Seller claims that it did not breach because it never received the payment.  In such a case, a Tennessee court would surely hold that Seller breached the duty of good faith by failing to provide the information necessary for Buyer to wire the payment.

The facts of the Schwartz case are not similar to the above example, and the court of appeals agreed with the trial court that Diagnostix was entitled to a summary judgment on the breach of the duty of good faith claim.   The court of appeals pointed out that Schwartz had expressly agreed that he could be terminated without cause, and, that, if he was, he was not entitled to any commissions.  What Diagnostix did to Schwartz was unfair, but Schwartz had expressly agreed that it could do just that.  So, the Court of Appeals of Tennessee concluded, as it must have, that Diagnostix did not act in bad faith, or, to put it another way, did not breach its duty to perform the contract in good faith.  The Schwartz case teaches us that the duty of good faith cannot be used to throw out agreed upon contract terms even if those contract terms do not comport with what a court would consider good faith (in the absence of those terms) and even if those terms are harsh.

What Schwartz should have seen at the outset was that the contract which he was asked to sign with Diagnostix allowed Diagnostix to terminate the agreement and to pay him no commissions even if he had worked for months to generate sales.  There were many ways Schwartz could have tried to protect himself in the written contract.  For example, Schwartz could have included a provision that required him to be paid for all commissions generated from sales to customers to whom he introduced to Diagnostix for a certain period of time, say one year, after he was terminated.

To be fair to Mr. Schwartz, he may have tried to negotiate more favorable terms, but have not been able to do so.  If so, another lesson might be taken from the fact that Mr. Schwartz might well have been better off walking from the deal rather than betting that Diagnostix would not use the tremendous leverage which it had by virtue of the one-sided contract terms.