The Commissioned Salesperson Exemption Just Got More Difficult to Establish

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Many California employers rely on California's commissioned salesperson exemption from overtime for their inside sales employees.  That exemption, however, is becoming increasingly difficult to establish.  A recent decision of the California Supreme Court, Peabody v. Time Warner Cable, Inc., erects additional hurdles to its availability.

Summary:  Recall that to be exempt from overtime under the commissioned salesperson exemption in California, (1) the employee must have earnings that exceed 1.5 times the minimum wage and (2) more than half of the employee's compensation must be in the form of commissions.   The Peabody decision holds that the 1.5 times minimum wage requirement must be met in each paycheck.  Therefore, if one of the two paychecks for the month consists solely of hourly wages or an advance on commissions, that amount must equal at least $13.50 per hour (based on the current $9/hour minimum wage) for each hour the employee worked in the pay period. 

The Peabody v. Time Warner Decision

Susan Peabody worked for Time Warner as a commissioned salesperson, selling advertising on cable television channels.  Peabody received $769.23 every other week in hourly wages ($9.61 per hour for a 40 hour workweek).  Approximately once per month, she was paid commissions earned during the preceding month.  Time Warner did not pay Peabody overtime, determining that she was exempt under California's commissioned salesperson exemption. 

After her Time Warner employment ended, Peabody brought a wage and hour complaint in state court.  Time Warner Cable removed her lawsuit to federal court, where it obtained dismissal of the entire action through summary judgment.  Peabody appealed, and the Ninth Circuit Court of Appeals requested that the California Supreme Court rule on the legal question presented by Peabody's claim:  whether she met the exemption during pay periods where her paychecks were too low to meet the requirement of 1.5 times the minimum wage.

The California Supreme Court started with the statutory requirement in Labor Code section 204 that "'[a]ll wages . . . earned by any person in any employment are due and payable twice during each calendar month . . . .'"  This requirement applies to commissioned salespersons.  The Court explained that while the Division of Labor Standards Enforcement (DLSE) may allow employers to calculate commissions on a monthly basis or at whatever point they are earned, that fact had no bearing on Labor Code section 204's twice per month payment requirement.

Time Warner argued that Peabody met the requirement of 1.5 times the minimum wage, because the monthly commissions she was paid in one pay period were properly attributed to all pay periods during the month.  The Court rejected that argument.  It held that to decide whether a commissioned salesperson makes over 1.5 times the minimum wage for each hour worked, only the wages paid during a given pay period can be considered.  "An employer may not attribute wages paid in one pay period to a prior pay period to cure a shortfall."  The Court announced that its "interpretation narrowly construes the exemption's language against the employer with an eye toward protecting employees."

What Employers Need To Do Now

Most employers pay commissions only once per month, or even quarterly.  That practice is now questionable under the commissioned salesperson exemption.   Now, each paycheck must be in an amount equal to or greater than 1.5 times the minimum wage, i.e., at least $13.50 per hour at the $9.00 minimum wage.  To the extent the minimum payment exceeds any base paid to the employee, it can be characterized as an advance against future commissions.

The Peabody court did not address the other requirement for the exemption, that commission comprise at least half of all compensation.  The DLSE's enforcement position on this requirement is two-fold:  (i) commissions need not be paid in each paycheck but rather can be paid less frequently as they are earned; but (ii) the 50% commission requirement must be satisfied in each workweek.  There are obviously difficult practicalities with determining to which week a given commission can be attributed.  Key to compliance with the DLSE's view would be providing payroll detail to commissioned salespersons indicating the date of the transaction to which the commission or commission advance is attributable.  It is also critical to audit exempt status each month, and to pay overtime in any workweek in which the commission threshold is not met.

In addition, it is unclear whether a court examining the issue will ultimately follow the DLSE's position on measuring the 50% commission threshold and instead insist that it be met in each paycheck.  Employers may therefore want to consider a commission payment system in which commissions or commission advances are paid each pay period to ensure that each paycheck is comprised half or more of commissions or advances against future commissions. 

Finally, employers should also take this opportunity to review the other requirements of the commissioned salesperson exemption and to ensure their commission plans fully comply with this technically complicated overtime exemption.   These requirements are summarized below.

Other Issues With The Commissioned Salesperson Exemption

The California commissioned salesperson exemption is a narrow exemption and becoming narrower all the time.   There is also a federal exemption under the FLSA that is narrower in one respect than the California exemption.  Below, we have detailed these and other issues with the commissioned salesperson exemption:

  • The California exemption is only available to employers under two wage orders:  Wage Order 7, covering the "Mercantile Industry," i.e., wholesale, retail and rental businesses; and Wage Order 4, which applies only when an "industry" wage order does not cover the employer, and only then to its "Professional, Technical and Clerical Occupations."  Thus, for example, hotels and restaurants, who are covered by Wage Order 5 ("Public Housekeeping Industry"), cannot use the commissioned salesperson exemption.

  • California strictly limits what it considers to be a "commission" applicable to the compensation requirements of the exemption.  In contrast to the FLSA, a "commission" can only be earned by employees actually engaged in sales.  Under the FLSA, any incentive payment that is a percentage of the invoice will typically qualify as a commission. 

  • On the other hand, the FLSA's commissioned employee exemption under section 7(i) is limited to employees working in retail establishments.   Some employers such as wholesalers and financial institutions, are not considered "retail" in nature and will be unable to establish the exemption under federal law.

  • The decision in Gonzalez v. Downtown LA Motors, 215 Cal.App.4th 36 (2013), indicates that employees compensated on an incentive basis (piece rate or commission) must be paid separately for any hours in which they are prevented from earning incentive pay, at the minimum wage or higher.  Therefore, employers will want to ensure that they separately compensate commissioned salespersons for time spent in meetings, rest breaks, and other tasks not directly related to sales activities.

  • To ensure that the 1.5 times minimum wage requirement is met, employers must keep accurate time records for all employees they wish to exempt from overtime under the commissioned salesperson exemption.

  • The commissioned salesperson exemption is a limited one.  It does not exempt employees from the right to meal and rest periods, or to meal and rest period premiums when those rights are denied.

  • All commission plans must now be in a written document that clearly spells out when commissions are earned, characterizes commission payments prior to earning as advances, and avoids any forfeiture of earned commissions.  

Topics:  DLSE, Employer Liability Issues, Exempt-Employees, Exemptions, Labor Code, Minimum Wage, Over-Time, Sales Commissions, Time Warner, Wage and Hour

Published In: Labor & Employment Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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