Calif.: Inside Sales Exemption May Be Lost Where Commissions Are Paid on a Monthly Basis

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A recent California Supreme Court decision significantly impacts pay practices for commissioned sales employees. On July 14, 2014, the state Supreme Court ruled in Peabody v. Time Warner Cable Inc. that an employer may not attribute commission wages paid in one pay period to other pay periods in order to meet minimum wage requirements. This decision affects California employees who have been classified as exempt from overtime wages because their earnings exceed one and one-half times the minimum wage and whose commissions account for more than one-half of their compensation. Employers may want to evaluate and correct pay practices for inside sales employees to avoid potential lawsuits, including class actions.

Satisfying California's Inside Sales Exemption

Susan Peabody was a Time Warner account executive who sold advertising on the company's cable television channels. Every other week, Time Warner paid her a fixed amount in hourly wages, which equated to $9.61 per hour for a 40-hour workweek. (Note: Effective July 1, 2014, the minimum wage in California is $9 per hour, subject to any local ordinance that sets a higher minimum wage.) Once a month, Time Warner also paid commission wages under its account executive compensation plan. In the 10 months that Peabody worked at Time Warner, she earned and was paid approximately $75,000 in wages.

Peabody sued Time Warner, maintaining that she regularly worked 45 or more hours per week but was never paid overtime wages. She also contended that, for the pay periods in which she received only her hourly wages, she earned and was paid less than the minimum wage.

Time Warner maintained that Peabody fell within California's "inside salesperson" exemption and, thus, was not entitled to overtime compensation. This exemption has two prongs: (1) an employee's "earnings [must] exceed one and one-half (1 ½) times the minimum wage," i.e., $13.50 per hour; and (2) more than half of the employee's compensation must represent commissions. In this case, the second prong was satisfied. However, most of Peabody's paychecks included only hourly wages and equated to less than 1.5 times the applicable minimum wage at that time.

As to the minimum earnings requirement, Time Warner contended that commissions should be attributed not to the pay period in which they were paid, but instead to the weeks of the monthly pay period in which they were earned. Based on the amount that Peabody earned in commission, allocating her commission across multiple pay periods in this manner would have satisfied the inside sales exemption.

The court rejected Time Warner's "monthly pay period" argument because the inside salesperson exemption relieves an employer of only overtime pay obligations. Under Labor Code Section 204(a), and with the exception of certain executive, administrative and professional employees, "[a]ll wages . . . earned by any person in any employment are due and payable twice during each calendar month … ." Employers have the right to define commissions as being earned on a monthly, quarterly or less frequent basis, and there is no obligation to pay unearned commission wages in any pay period. However, whether the minimum earnings prong is satisfied depends on the amount of wages actually paid in a pay period. An employer may not attribute wages paid in one pay period (i.e., in which commissions are paid) to a prior pay period (i.e., in which only hourly wages are paid) to cure a shortfall. In what may be viewed as empathetic to employees, the court stated that "[m]aking employers actually pay the required amount of wages in each pay period mitigates the burden imposed by exempting employees from receiving overtime."

The California Supreme Court's conclusion is consistent with the position earlier taken by California's Department of Labor Standards Enforcement (DLSE). The DLSE opined that, to comply with the inside sales exemption, the earnings of the employee each workweek must exceed 1.5 times the state minimum wage. While the DLSE's policies are "not entitled to deference" by courts, in this instance, the DLSE's interpretation was accurate.

Finally, the California Supreme Court acknowledged that federal law has a commissioned employee exemption from overtime pay, which Time Warner contended permits wage attribution to other pay periods. However, the federal standard differs from California law and does not apply.

What This Means for Employers

It is common for an employer's plan to state that commissions are earned and owed once a month (or less frequently) based, for example, on the receipt of monthly payments from clients before any commissions are earned. This practice need not be abandoned, but it should be reevaluated in light of the Peabody case.

For employees who receive a mix of hourly wages and commissions, employers appear to have at least three options to satisfy the inside sales exemption:

*Increase each employee's hourly rate to ensure that the employee is paid at least 1.5 times the state minimum wage (currently, at least $13.51 per hour) for all hours worked in a workweek, exclusive of commission.

*Revise the commission plan so that commissions are earned and paid each pay period, while ensuring that the employee's total earnings each workweek exceed 1.5 times the minimum wage. *If commissions cannot be calculated each pay period, advance a portion of the commissions to meet the minimum earnings requirement.

As before, employees must continue to be paid at least twice a month, and more than half of their compensation must represent commissions.

Some employers may decide to forgo the inside sales exemption and simply track and pay employees for each straight time and overtime hour worked. Alternatively, employers should consider whether other exemptions apply. At a minimum, employers should consider evaluating their pay practices and commission plans with legal counsel and, as required by law, issue any revised written commissions plans to employees.

Duane Morris LLP is a full-service law firm with more than 700 attorneys in the United States and internationally. Republished with permission. © 2014 Duane Morris. All rights reserved.