On March 5, 2018, the California Supreme Court settled a previously ambiguous area of wage and hour law in California: How an employee’s overtime rate should be calculated when an employee has earned a flat sum bonus during the pay period. Unfortunately, the court decided the matter squarely against employers and determined that its ruling should apply RETROACTIVELY. As a result, California employers who pay their employees a flat sum bonus need to take immediate action to reduce the potential for wage and hour claims.
Some Background on the Issue
To better understand the impact of this case, it’s necessary to understand how the payment of non-discretionary bonuses impact an employee’s overtime compensation. Non-discretionary bonuses are those that an employer pays when the employee meets certain criteria, such as level of production or by working a specified number of days or specific days in the week. Such bonuses are different from discretionary bonuses, such as a holiday bonus, which the employer may choose to pay or not at their discretion.
When an employee earns a non-discretionary bonus during a pay period, the employer must include the bonus in the calculation of the employee’s regulate rate of pay and corresponding overtime compensation. Regular rate is calculated by adding all compensation earned by an employee during the pay period and dividing that number by the total hours actually worked by the employee. Compensation included in the regular rate calculation includes hourly pay, piece rate, commissions, non-discretionary bonuses, and the value of meals and lodging. The employee’s overtime is calculated by dividing the regular rate by ½ and multiplying that number by the total overtime hours worked (in California, generally all hours over 8 in a day and 40 in a week).
Thus, as the basis for calculating the overtime rate, the manner in which regular rate of pay is calculated can have a significant impact on the employee’s overtime compensation.
The New Rule
The employer in Alvarado v. Dart Container Corporation of California calculated its employees overtime for non-discretionary attendance bonuses in compliance with the federal Fair Labor Standards Act (and similar to the formula discussed above):
- Multiply the number of overtime hours the employee worked in the pay period by the employee’s straight time rate (i.e., the employee’s normal hourly rate). This gave the employer the employee’s base hourly pay.
- Add (a) the total hourly pay for non-overtime work during the pay period; (b) any non-hourly compensation the employee earned during the pay period, including any attendance bonuses; and (c) the base hourly pay (from step one above). The result is the total base pay. Divide the total base pay by the total number of hours the employee worked, including overtime hours. This gives the regular rate.
- Multiply the regular rate of pay from (step two) by the total overtime hours worked and then divide that amount in half. The result is the overtime premium.
- Add the base hourly pay (from step one) and the overtime premium (from step 3) to get the total overtime compensation.
The employee sued the employer claiming that the employer’s method of calculating overtime compensation diluted the employee’s regular rate of pay and reduced the employee’s overtime compensation by including overtime hours when calculating the regular rate on the employee’s attendance bonus. The employee advocated for the formula used by the Division of Labor Standards Enforcement (DLSE) in its Enforcement Manual which allocates the attendance bonus only to non-overtime hours worked in the pay period.
To the consternation of the employer, the court sided with the employee. The court found that since the attendance bonus is earned regardless of whether the employee works any overtime hours, it should be treated as being earned by only non-overtime hours. Otherwise, the bonus would act to reward employers for having employees work overtime by decreasing the employee’s overtime pay rate the more hours the employee worked.
Accordingly, the court found the following method appropriate under California law:
- Calculate the overtime compensation attributable only to the employee’s hourly wages, by multiplying the employee’s hourly rate by 1.5 and multiplying that number by the number of overtime hours.
- Calculate the overtime compensation attributable only to the employee’s bonus, by dividing the attendance bonus by the number of non-overtime hours the employee worked. Then multiply that number by 1.5 and multiply that number by the number of overtime hours worked.
- Add the amounts in step one and two to get the total overtime compensation for the pay period.
As the court noted, the key distinction between the employer’s method and the one advocated by the employee was the divisor used to calculate the per-hour value of the bonus: the employer divided the bonus by the total hours actually worked (regular and overtime hours) while the employee divided the bonus only by the non-overtime hours worked. The employee’s method was found marginally more favorable for employees.
As a final nail in the coffin of California employer’s, the court determined that this new rule, and all wage and hour liability associated with it, should apply retroactively. This means employers may be held liable for their past and current practices of paying out overtime for attendance bonuses if they used the method permitted by the FLSA, even if those payments occurred before this ruling.
The only saving grace is that this ruling was limited to attendance bonuses and other flat sum bonuses comparable to attendance bonuses. Thus, payment of overtime for production or piecework bonuses is unchanged by this ruling and employers may still follow the formula found in the FLSA. Indeed, even the DLSE uses a method similar to that found in the FLSA for calculating overtime for such bonuses.
California employers who pay their employee’s attendance bonuses should immediately review their procedures for paying out overtime compensation for such bonuses to ensure they are compliant with this new rule. The wage and hour implications of incorrectly paying overtime are severe and include potential statutory and civil penalties. In addition, wage and hour violations are prime subject matter for class action lawsuits. As a result, this new ruling could trigger class claims if not handled properly.
California employers who pay their employees attendance or other similar flat sum bonuses may also want to consider having their payment practices reviewed by legal counsel familiar with California’s wage and hour laws. Legal counsel may also be able to assist employers in crafting the messaging to employees relating to any changes in their overtime compensation from this new rule so as not to put employees on notice of any potential wage and hour issues.