United States: California Supreme Court's Recent Overtime Ruling Likely To Cause Payroll Problems

Executive Summary: On March 5, 2018, the California Supreme Court issued a ruling clarifying how employers must handle flat-sum bonuses (i.e., additional compensation that does not change depending on the number of hours worked by an employee) in the calculation of overtime. Under this ruling, an employer must calculate a non-exempt employee's additional overtime by dividing the amount of the flat-sum bonus by the actual number of non-overtime hours worked by the employee; then multiplying that per-hour value by 1.5 (or 2, depending on the applicable multiplier to use) and by the number of overtime hours worked. The ruling clarifies an important technical aspect of overtime calculations and upends many employers' previous understanding of what the law requires. Although this decision is limited to flat-sum bonuses and does not apply to other forms of non-hourly compensation, employers should promptly have their incentive/bonus compensation plans reviewed for compliance.

Discussion

On March 5, 2018, the California Supreme Court issued Alvarado v. Dart Container Corporation of Cal., S232607 (Mar. 5, 2018), addressing how employers must incorporate flat-sum bonuses (i.e., additional compensation that does not change depending on the number of hours worked by an employee) in the calculation of overtime. The decision is expected to upend many companies' overtime calculation practices, as well as impact how and whether employers offer incentive and/or bonus compensation to their employees.

Background and Facts of Case

California, like federal law, requires employers to pay non-exempt employees overtime. Like federal law, California law requires overtime to be based on the employee's "regular rate of pay." "Regular rate of pay" is a term of art and is not the same as the employee's normal hourly wage rate. Rather, it is intended to reflect an employee's total compensation and includes adjustments to the normal hourly rate to reflect additional compensation the employee has earned, with limited exceptions.

For decades, many employers operating in California operated on the understanding that California followed the federal standards in calculating the "regular rate of pay" for flat-sum bonuses. Generally, this would permit an employer to calculate an employee's "regular rate of pay" by dividing the employee's total compensation for the week (not including any overtime premiums, which is what the "regular rate of pay" would impact) by that employee's total hours worked for that same week. Generally, to determine total overtime pay, the "regular rate of pay" would then be then be divided in half (to obtain the per-hour overtime premium rate) and multiplied by the total number of overtime hours (to obtain the total overtime premium wages). The total overtime premium wages would then be combined with the total overtime base compensation (the total number of overtime hours multiplied by the employee's normal hourly rate) to obtain the total overtime wages owed.

The employer in Alvarado used the same formula—already adopted under the federal Fair Labor Standards Act—in calculating its hourly employees' overtime compensation. In that case, in addition to paying its employees on an hourly basis, the employer also offered "attendance bonuses"—fixed sums of money for each Saturday or Saturday the employee worked. Hector Alvarado, one of Dart Container Corp.'s former employees, challenged his employer's formula as being in conflict with state standards. Alvarado argued that, conceptually, the flat-sum bonus should be viewed as applying to only his regular, non-overtime hours and that it should not be viewed as compensation for his overtime hours. Thus, Alvarado argued that the overtime value of the flat-sum bonus should be calculated by dividing the bonus amount by only his non-overtime hours, as opposed to his total hours, and that the resulting "regular rate" be multiplied by 1.5. This amount would then be combined with the overtime value of the regular wages (the total number of overtime hours multiplied by the employee's normal hourly rate multiplied by 1.5) to obtain the total overtime wages owed.

Ultimately, the California Supreme Court ruled in Alvarado's favor. In so ruling, the Court reasoned that because the form of compensation involved a fixed-value amount that had no direct relevance to the actual number of hours worked, the amount could not be seen as compensation for any overtime hours worked. The Court then held that, as a result, the per-hour overtime value of the bonus could only be calculated by dividing the bonus by the actual number of non-overtime hours worked by the employee, as opposed to the total number of total hours worked.

What Does This Mean?

This ruling will likely cause confusion concerning how overtime should be calculated in California. In practical terms, it impacts two separate portions of how overtime is calculated, both of which are beneficial and can offer more overtime compensation to the employee. First, it impacts the divisor that must be used when calculating the "regular rate of pay," requiring the divisor to equal the actual number of non-overtime hours. Second, it impacts the multiplier utilized to determine the overtime pay rate, requiring the use of a 1.5 multiplier (as opposed to a .5 multiplier). Note: The multiplier may be different in cases where an employee has worked sufficient overtime to qualify for a larger multiplier under California law. Below is an illustration explaining the differences between the federal law (which still may be applied to non-hourly compensation methods that are not considered flat-sum bonuses) and the new standards (applying to flat-sum bonuses).

Suppose a company hired an hourly part-time employee whose normal hourly rate is $10/hour but could receive a $100 flat-sum bonus for each day worked on a weekend. The employee typically works 3 days during the week, 8 hours a day, but in one particular week, the employee worked one of his scheduled days on a Saturday and worked 1 hour of overtime (California law, unlike federal law, requires daily overtime compensation, as well as weekly overtime). Hence, the employee worked a total of 25 hours (1 hour of overtime) and earned a $100 bonus for working on Saturday

Federal Standards

Under existing federal regulations, the employer calculates overtime by taking the total compensation earned and dividing by the total hours worked for that workweek to get the "regular rate of pay." The additional overtime pay is calculated by multiplying half of the regular rate by the overtime hours worked. Thus:

($240 (regular pay) + $10 (base component of overtime) + $100 bonus) / 25 total hours worked = $14 regular rate

Additional overtime premium = $14 x0.5 x 1 overtime hour worked = $7

Total overtime = $10 (base rate) + $7 = $17

Total Compensation

$240 regular wages (24 hours x $10)

$17 overtime wages

$100 bonus

$357 total pay

California's New Regular Rate Standard for Flat-Sum Bonuses

Under the new decision, California requires an employer to calculate a non-exempt employee's additional overtime by dividing the amount of the flat-sum bonus by the actual number of non-overtime hours worked by the employee, then multiplying that result by 1.5 (to determine a per-hour value) and by the number of overtime hours worked (to determine total overtime wages owed). This additional overtime is then added to the overtime compensation attributable to the employee's hourly wages (calculated by multiplying the employee's normal hourly rate by 1.5 and then by the number of overtime hours). Thus:

($100 bonus) / 24 actual non-overtime hours worked = $4.17

Overtime from Bonus = $4.17 x 1.5 x 1 overtime hour worked = $6.26

Overtime from Hourly Wages = $10 x 1.5 x 1 overtime hour worked = $15

Total Overtime = $21.26

Total Compensation

$240 regular wages (24 hours x $10)

$21.26 overtime wages

$100 bonus

$361.26 total pay

Bottom Line: The ruling is expected to have a wide-ranging impact on how overtime is calculated in California. Further, and although the decision is limited to flat-sum bonuses, the decision may also call into question what is considered a flat-sum bonus. As a result, it is highly recommended that employers offering incentive/bonus compensation plans to their hourly employees in California have their plans reviewed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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