Appellate Court Holds That Percentage Bonuses Can Be Calculated Using FLSA Method
In a pro-employer decision addressing the overlap of federal and California wage and hour law, the California Court of Appeal for the Second Appellate District upheld summary adjudication for the employer, finding that the employer’s calculation of overtime on a nondiscretionary bonus using the Fair Labor Standards Act’s (“FLSA”) calculation method set forth in 29 C.F.R. section 778.210 (“CFR 778.210”) was permissible, even though it resulted in less pay than the calculation method set forth in the California Division of Labor Standards Enforcement (“DLSE”) Manual.
In Lemm v. Ecolab, Inc., the plaintiff sued his employer, Ecolab, under the Private Attorneys General Act (“PAGA”), claiming that Ecolab improperly calculated the overtime due on a nondiscretionary bonus paid to him and all other similarly situated employees. The parties stipulated to have the trial court determine the overtime calculation issue based on cross-motions for summary adjudication.
In this case, the plaintiff was employed as a nonexempt route sales manager who regularly worked more than 12 hours in a day and more than 40 hours in a week. He was paid hourly wages, including any applicable overtime and double-time wages, every two weeks. He was also eligible to receive a nondiscretionary, monthly bonus, which would be paid every four to six weeks. Eligibility for the bonus was governed by an Incentive Compensation Plan (the “Plan”). Under the Plan’s terms, eligibility for the bonus depended on meeting or exceeding certain targets. If eligible, the Plan provided for a bonus payment in the amount of 22.5 percent of the worker’s gross wages earned during the monthly bonus period. The percentage multiplier used to calculate the bonus amount could increase for workers who exceeded the eligibility targets (i.e., greater sales meant a percentage multiplier).
As a result, the bonus payments, as a percentage of gross wages earned comprised of regular and overtime wages, necessarily included additional overtime compensation. That methodology is expressly provided for under federal law, specifically, CFR 778.210. (Sample calculations are provided in the Court of Appeal decision.)
In the summary adjudication motions, the plaintiff argued that under California law, nondiscretionary bonus payments must be incorporated into the regular rate of pay, which in turn would affect overtime calculations. The plaintiff argued that the formula set forth in section 49.2.4 of the DLSE Manual should be used instead of the calculation permitted in CFR 778.210 because the DLSE Manual’s method resulted in higher pay, and thus, as stated by the California Supreme Court in Alvarado v. Dart Container Corp. of California (2018) 4 Cal.5th 542, the court must use the formula more favorable to California employees.
Ecolab argued that CFR 778.210 was the proper method of calculating the overtime due on the monthly bonus because that section applied to bonuses that are known as percentage bonuses, which are paid as a percentage of gross earnings that have already incorporated straight time, overtime, and double time wages for each bonus period. Thus, Ecolab argued, if the plaintiff’s method of calculation were to be used, it would result in the double counting of overtime, or “overtime on overtime.”
The trial court granted Ecolab's summary adjudication motion and denied the plaintiff’s motion, finding that Alvarado's holding was limited to flat sum attendance bonuses, not percentage bonuses like the one at issue in this case. (The bonus at issue in Alvarado was a pre-determined, flat sum, attendance bonus, which is significantly different than the variable, percentage of wages production bonus at issue here.) Thus, using the calculation permitted by CFR 778.210, in this case, was not at odds with the rationale of Alvarado or the DLSE Manual’s guidance on calculating flat sum bonuses. The trial court stated, “Ultimately, [Ecolab's] position makes logical sense. Simply put, a requirement for an employer to pay overtime on a percentage bonus that already includes overtime pay makes the employer pay 'overtime on overtime.' This is not a requirement under the law. By paying a bonus based on a percentage of gross earnings that includes overtime payments the employer automatically pays overtime simultaneously on the bonus amount.”
The Court of Appeal agreed. While recognizing that overtime compensation in California was governed by both federal and state law and that federal law did not preempt state law in this area, the Court stated that federal cases may provide persuasive guidance because California wage and hour laws were modeled to some extent on federal law. Similar to this case, courts in the Ninth Circuit and California District Courts had previously upheld using the percentage of bonus calculation set forth in CFR 778.210 under federal and California law.
The Court of Appeal also recognized the principle stated in Alvarado that while the DLSE Manual could be considered as a compilation of the DLSE’s expertise and competence, a court could adopt the DLSE Manual’s interpretation only if the court, through its exercise of independent judgment, determined that the DLSE Manual’s interpretation was correct based on the facts at issue in the particular case. The Court then determined that the calculation used in Alvarado and the DLSE Manual dealt with how to calculate an employee's overtime pay rate when the employee has earned a flat sum bonus during a single pay period, not the type of percentage bonus at issue in this case.
The Court of Appeal recognized that Ecolab demonstrated that the plaintiff and alleged aggrieved persons would have been paid the same amount regardless of whether Ecolab used the DLSE Manual formula as applied to percentage bonuses or the CFR 778.210 formula, so long as the calculation first eliminated overtime on overtime. The Court determined that while as a general rule, courts must adopt the construction that favors the protection of employees, that general rule did not require courts to interpret state law to give an employee "overtime on overtime," when such an interpretation would be inconsistent with the fundamental principles of overtime and would result in a windfall to employees.
This Court of Appeal decision emphasizes that courts and employers need not always follow the DLSE Manual’s guidance on calculating overtime on nondiscretionary bonuses if the guidance does not address the type of bonus at issue and does not make sense under the circumstances. Regular rate of pay overtime calculations can be tricky, so employers should contact their favorite CDF attorney to ensure that they are complying with federal and state law.