What is a Referral Agreement?
Referral agreements take place between two entities that don’t have a prior relationship but each party believes the other has potential clients that can be brought to the party. In some cases, such agreements may exist between two or more parties even where there is a working relationship, such as between a professional and an intermediary. The intermediary may know of other clients who are in need of the person’s product or service and the professional receives a fee for the referral.
[Attorney] XXX, the referrer, and [Entity A], the company being referred to in this referral agreement, may not have any previous business relations, or it may be a simple client introduction, where [Attorney] XXX introduces [Entity A] as a potential service provider for [Entity B] . To put it another way, the referral agreement serves to outline who agrees to send clients to whom based on the other party’s established relationships with clients.
By executing a referral agreement, both parties have the opportunity to benefit from the services of the other by recommending that their clients work with the other party’s business. For example, if [Attorney] XXX is approached by a client seeking the services offered by [Entity A], then he may choose to send that client to [Entity A]. Typically, the agreement will specify the number and type of clients whose referrals will result in payment for the referring party.
By entering into this agreement, [Attorney] XXX will be able to translate existing contacts into additional compensation.
Elements of a Referral Agreement
Typically, the key components of a referral agreement are a description of the referral fees owed to the referrer, the commissions owed to the partner for referrals that lead to sales resulting from direct introductions or other leads, and a confidentiality clause prohibiting the referrer from disclosing the relationship.
Some referral agreements contain very detailed provisions addressing the relationship, including who can make referrals, whether rebates can be paid, whether the referrer is the business’s sole or exclusive referrer, whether the business maintains a list of other referrers and what happens if the agreement terminates, whether the referral fee can be transferred, whether the business can terminate the agreement for convenience, whether the referral fee is payable for terminated referrers, whether the referral fee is the only fee payable to the referrer in connection with the referral, the method of paying referral fees and the time periods in which the referral fee is payable, the frequency of reporting obligations by the business and referrer regarding sales and referral fees, audit rights of the referrer for commission payments, and any representations or warranties by the parties.
Types of Referral Agreements
Referral Agreements come in a variety of types with each serving a different purpose and designed to work in the context of different marketing strategies. This section breaks down some of the main types of Referral Agreements into three sub-sections that cover specific agreement points that are commonly included within each type.
While some Referral Agreements are handshakes between two parties, most will include some of the following specific agreement points in their terms.
A one-time lump sum is the simplest type of Referral Agreement and often used for high-ticket items with a lower frequency of sales. A one-time payment referral agreement may take the following form: Party 1 ("Referring Party") agrees to pay Party 2 ("Referral Partner") 10% of the gross amount collected by the Referring Party as a result of the referral by Referral Partner. The referral fee shall be paid by the Referring Party to the Referral Partner within thirty (30) days of the date when the Referring Party receives payment from the referred party. No payments shall be made for any amounts that are refunded, charged back, recouped or returned to the Referred Party by the Referral Partner or referrer of the business.
Similar to a one-time lump sum payment, percentage of sales may be negotiated into the Referral Agreement and paid out as a commission for business referrals or leads. A percentage of sales referral agreement may take the following form: Party 1 agrees to pay Party 2 10% of the net amount collected by Party 1 for the referred services as a result of the referral and successful collection of debt, if any. The referral fee may also be negotiated into a performance-based fee and reflected as a flat percentage of sales made based upon the referral.
A recurring revenue referral agreement may be appropriate for affiliate marketers who regularly promote other’s products or services through their unique website links and then receive a monthly share of sales or leads generated. With a recurring revenue referral agreement, a company may even pay its referral partners the monthly installments from those referred customers over the contract period. A recurring revenue referral agreement may take the following form: Party 1 ("Company") compensates Party 2 ("Referral Partner") up to 10% of the monthly gross profit generated through sales made by customers referred by Referral Partner through referral links or codes provided by the Company. Such payments will be made in the first week of each month for the previous month’s sales. Each Customer referred to the Company shall be accounted for separately and shall not be under any obligation to make payment hereunder.
Most Referral Agreements will provide for a confidentiality clause, but it may also prove beneficial to include a non-compete clause where the Referral Partner agrees not to serve as a referral agent or partner for a competitor under the same circumstances. Some Referral Agreements may also have an "expiration of right" clause providing for the termination of the referral relationship at certain intervals, e.g., annual revenue targets, minimum sales generated, customer sign-ups, and so forth.
How to Prepare a Referral Agreement
Even with the above considerations, referral agreements are often a simple thing where both parties just agree to split the fees from new clients who were referred from one party to another. The agreement should identify the parties, describe the referral arrangement in as clear detail as possible (including the territory and duration) and describe how the fees will be shared (e.g., each party keeping 50% of the fee or agreeing that Party B will invoice the client for the whole fee, keep the amount to which it is entitled and pay the other party). The only "legalese" we recommend using is something like: "This memorandum constitutes the full agreement between the parties and supersedes all prior oral and written agreements or understandings." Just to be safe, get it signed or have it emailed between at least one person from each party.
Common Pitfalls in Referral Agreements
In the quest to find ways to incentivize other businesses and individuals to refer customers, many companies create referral agreements. In theory, they sound like a great idea, but they also tend to be poorly designed and run afoul of the law. Here are some common mistakes made when drafting a referral agreement. Hopefully, you will be lucky and avoid these errors.
- Failing to commit to have the referral agreements in writing. Too often, companies set up referral programs with other businesses without formalizing the terms. This is a big mistake because it is too easy for other parties to run afoul of federal and state laws relating to referral fees when the terms are not clearly defined. In some circumstances, state law also requires any commission or referral fee agreements to be in writing.
- Missing key terms/parts to the referral agreement. When you do put the referral agreements in writing, you then have to make sure you are including all the right terms. Some of the things you might want to consider including are: who can make referrals, the scope of the referrals (e.g. specific markets, including limitations as to industry and/or geography), commission structure, payment schedule, enforcement mechanisms, etc.
- Leaving ambiguity in the referral agreement. This is one of the most common problems with referral agreements-that is, the agreed terms have no teeth. You might think of the agreed upon terms as "soft" conditions. For example, if a company agrees to pay a 5% commission on all net sales for referred clients, the contract should specify exactly who is exempt from receiving the commission. Is it just your company’s principals? Do they have to be actively working at the company at the time of the referred client sales? How long do you have to pay the commissions after referral is made? If you do not include these types of details in your referral agreement , then you run the risk of future disputes with the referring party over what those terms mean or how the agreement should be applied in real life.
- Copies of the referral agreement aren’t given to the parties and/or filed. Make sure you provide a copy of the referral agreement to the referring party and provide one for your own records. Having a record of all the terms agreed to will help if there are any future disputes between the parties. It is also helpful for accounting purposes in collecting any commissions due. Also, if you are required to give a copy of the agreement to the referring party under state law, keep in mind that not having a copy could get you on the wrong side of state regulators.
- Not having an attorney review your referral agreement before it is executed and/or after certain terminations of the referral agreement. Sometimes people create referral agreements without consulting an attorney because they believe the agreements are simple contracts and nothing in the law should prohibit them. Others let referral agreements languish and become obsolete without seeking legal review, thinking the state of the law does not change significantly. However, matters that could be deemed minor at one point, become a lot more significant when viewed from a new perspective. At that point, you may wish you had validated whether you were in compliance with the law relating to referral agreements. Most laws have very specific limitations, such as requiring certain disclosure terms in writing, certain timing requirements, warnings, licensing and/or registration. Unfortunately, it is only after the fact when you wish you had legal counsel to review the referral agreement. You also may wish you had sought advice on whether your referral agreement requires updating to comply with new laws and emerging practices. It is never too early to start the process and when in doubt, it is better to err on the side of caution and anticipate issues by consulting with your attorney.
Referral Agreement Sample
Below is a sample referral agreement. This agreement is only an example, and should not be used without the advice of counsel.
REFERRAL AGREEMENT
THIS REFERRAL AGREEMENT ("Agreement") is made this _____ day of _____________, 20__, by and between [Referring Entity], with a principal place of business at _______________ ("Referring Entity"), and [Receiving Entity] with a principal place of business at ________________ ("Receiving Entity") (collectively the "Parties" and each a "Party").
- Engagement of Receiving Entity. The Referring Entity hereby refers to the Receiving Entity all prospective sellers of [Specify Goods/Services] that the Referring Entity brings to the Receiving Entity ("Sales Lead"). The referrals are for [additional Services offered by Receiving Entity], and are not subject to exclusivity outside of the terms of this Agreement.
- Commission. Upon the closing of a sale made pursuant to a Sales Lead, as defined in Schedule 1, with the Receiving Entity, the Referral will pay the Referring Entity a commission of ____ percent (__%) of the purchase price for any such referral.
- Term. This Agreement shall commence as of the date first above written and shall continue for a term of [Number] ([Number]) year(s) from such date, and may be extended by written agreement of the Parties. After the initial period, this Agreement shall automatically renew for successive [Number] ([Number]) year(s) periods. This Agreement shall terminate, however, upon a violation by of any applicable federal, state or local law or regulation, or upon the bankruptcy, insolvency or death of either party.
- Confidential Information. Each Party, its employees, representatives, agents and affiliates concerning the other Party’s proprietary or confidential information, "Confidential Information". Confidential Information does not include: a) information that was in the public domain at the time of disclosure through no fault of the disclosing Party; b) information that is disclosed to the disclosing Party by a third party that has a right of disclosure; c) information that is in the possession of the receiving Party at the time of disclosure; d) information that is independently developed by the employees or agents of the receiving Party who had no prior knowledge of the Confidential Information; or e) information that is required by law, regulation, court order or subpoena to be disclosed. The Parties hereby agree to use their best efforts to protect the Confidential Information during and after the termination of this Agreement.
- Notices. Any notices or communications under this Agreement must be in writing, and delivered by registered or certified mail, by a recognized overnight carrier, by facsimile (with confirmation) or by e-mail with confirmation to the Parties as follows: [Contact Name, Contact Title] at ____________________.
[Signatures to be determined by counsel upon advance drafting of document per facts of each matter.]
Legal Aspects of Referral Agreements
When it comes to referral agreements – particularly in the healthcare and real estate industries – there are a multitude of legal considerations in the U.S. The law can vary by state, so it’s important to understand federal and state-specific laws, regulations, and how they apply to each specific agreement.
Federal Employment Laws
From a federal standpoint, there are no laws specifically addressing referral agreements. That said, federal employment laws could come into play if the agreement is found to violate these laws. Some of the laws that would apply here include the Fair Labor Standards Act (FLSA), Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act (ADA), and the Immigration and Nationality Act (INA). Should the agreement violate any of these laws or other employment-related laws, a business could be found liable for damages and/or penalties.
Federal Healthcare Laws
In the healthcare industry, federal healthcare laws could render some referral agreements illegal. Under the Anti-Kickback Statute (AKS), a referral agreement based on compensation could be found to be illegal if it has the potential to induce Medicare or Medicaid payments. An agreement could violate the AKS even if there is no government payment involved. Regarding Medicare-related agreements only, referral agreements that involve the sharing of bona fide employee benefits do not generally violate the statute.
Realtors and other professionals involved in real estate transactions are often prohibited from entering into referral agreements. Under the Real Estate Settlement Procedures Act (RESPA), a referral agreement is illegal if an individual or firm is paid simply to refer buyers to settlement services providers.
Antitrust and Sharman Antitrust Act
Both state and federal anti-kickback laws outlaw heightening competition detrimentally and creating barriers to market entry. Some states, like California, have adopted language similar to the federal Sherman Antitrust Act, which prohibits contracts and decisions that restrain trade. Under California law, both civil and criminal penalties can be assessed in the event of an antitrust violation. A referral agreement could potentially lead to both criminal and civil penalties when it violates these antitrust restrictions.
Referral Agreement Advantages
Referral agreements can significantly enhance the success of your business development efforts. They offer several key benefits to businesses by allowing them to:
Referral agreements allow businesses to expand their reach into new markets by partnering with an existing firm that has more relationship depth and breadth within the target market. The referrals are often delivered at the perfect time when the prospect is seeking solutions . Providing a client with a new supplier that can address their needs is a value-add that strengthens your relationships with your clients.
Increasing the volume of sales through referrals is an essential strategy and is why top performing firms — whether referral oriented or not — invest time and energy into a systematic referral program. Most successful businesses receive the majority of their business through referrals but many miss the opportunity to convert casual referrals into strategic referral partners.