Fixed Salary for Non-Exempt Employees Cannot Include Overtime as of January 1, 2013

by Ogletree, Deakins, Nash, Smoak & Stewart, P.C.

Recently, the California Advice Group received the following question from a human resources manager concerning salaried non-exempt employees. As the law is changing in this area, it is a very timely question.

Question #1

I run human resources for a mid-sized accounting firm. As you can imagine, our business gets slammed at tax time, at the end of each quarter, and at the end of the fiscal year. Administrative support employees are non-exempt from overtime laws, and during the busy times, they work a significant amount of overtime every day. They don’t like the income uncertainty caused by the fluctuating need for overtime. To give them peace of mind and cut down on my payroll headaches, I surveyed the last couple of years’ payrolls, determined the company’s average overtime obligation, and have decided to pay affected employees a constant income that is high enough to include overtime pay. Under the plan, non-exempt employees would not receive additional overtime pay during the busy periods but neither would they be docked if they did not work any overtime during non-peak months.

Before I hold a meeting with employees, is this legal?

Short Answer

Not after December 31, 2012. Commencing January 1, 2013, California Labor Code section 515(d) will be amended to read:

(d)(1) For the purpose of computing the overtime rate of compensation required to be paid to a nonexempt full-time salaried employee, the employee’s regular hourly rate shall be 1/40th of the employee’s weekly salary.

(2) Payment of a fixed salary to a nonexempt employee shall be deemed to provide compensation only for the employee’s regular, nonovertime hours, notwithstanding any private agreement to the contrary. (emphasis added)

Background Information

Until recent legislative action, explicit mutual wage agreements were supported by case law in California. The law is set to change on January 1, 2013.

Subsection (a) of California Labor Code section 515 describes the authority of the California Industrial Welfare Commission to establish employee exemptions from overtime payments under California wage and hour laws.

(a) The Industrial Welfare Commission may establish exemptions from the requirement that an overtime rate of compensation be paid pursuant to Sections 510 and 511 for executive, administrative, and professional employees, provided that the employee is primarily engaged in the duties that meet the test of the exemption, customarily and regularly exercises discretion and independent judgment in performing those duties, and earns a monthly salary equivalent to no less than two times the state minimum wage for full-time employment. [. . .]

Currently, subsection (d) sets forth the method by which an employer must calculate overtime rates for non-exempt employees who are paid on a salary basis:

(d) For the purpose of computing the overtime rate of compensation required to be paid to a nonexempt full-time salaried employee, the employee’s regular hourly rate shall be 1/40th of the employee’s weekly salary.

The language in subsection (d), that non-exempt employees could be paid on a “salaried” basis, paved the way for the California Court of Appeal to hold that explicit mutual wage agreements were enforceable under certain circumstances. Carlos Arechiga v. Dolores Press, Inc., 192 Cal. App. 4th 567, 571 (2011), citing Espinoza v. Classic Pizza, Inc. 114 Cal. App. 4th 968, 974 (2003).

The Arechiga Case

Carlos Arechiga (Arechiga) was hired as a janitor by Dolores Press, Inc. (Dolores) in January 2000. Arechiga and Dolores verbally agreed that Arechiga would be paid a flat rate of $880 per week for a 66 hour week. Arechiga was a non-exempt employee and—but for the agreement—he would be entitled to overtime payment of 1-1/2 times his regular hourly rate for 26 hours per week under this schedule.

In 2003, Dolores required Arechiga to sign a written employment agreement, ostensibly to protect the company’s confidential information. The agreement included a written provision memorializing the prior verbal salary agreement. In 2006, Dolores terminated Arechiga, and he sued his former employer for non-payment of overtime claiming that California Labor Code section 515 outlawed explicit mutual wage agreements that contravened the employer’s overtime obligations.

Summary judgment was granted in favor of the employer, and the California Court of Appeal affirmed the lower court’s judgment, holding that:

Under California law, when there is an explicit mutual wage agreement between the parties, even a fixed salary like the one [Arechiga] received serves to adequately compensate him for both overtime and regular pay. . . . In order to establish an explicit, mutual wage agreement, [Employer] was required to show that the parties entered into an agreement that specified (1) the days that [Arechiga] would work each week; (2) the number of hours [Arechiga] would work each day; (3) that [Arechiga] would be paid a guaranteed salary of a specific amount; (4) that [Arechiga] was told the basic hourly rate upon which his salary was based; (5) that [Arechiga] was told his salary covered both his regular and overtime hours; and (6) the agreement must have been reached before the work was performed.

Arechiga v. Dolores Press, 192 Cal. App. 4th at 571-571.

The Legislative Reaction

After publication, critics of the Arechiga case swung into action. Bringing the matter to the California State Legislature, critics argued that the California Court of Appeal had improperly interpreted and followed the Fair Labor Standards Act (the federal statutes governing wage and hour) despite the fact that it contradicted California wage and hour laws on the same subject.

The legislative history for amending Labor Code section 515(d) indicates:

Critics of the Arechiga decision have argued that it improperly relied upon this federal court precedent, because in California the statute explicitly defines the “regular rate of pay” for nonexempt salaried employees (at Labor Code section 515(d)). Thus, these critics distinguish California law by noting that the legislature decided to expressly define this term precisely to ensure that employees’ right to overtime pay would not be subverted by private agreements.

The legislature also took note of the fact that the state’s own policy manual, The California Division of Labor Standards Enforcement’s (DLSE) Enforcement Policies and Interpretations Manual, instructed the DLSE’s administrative law judges, who were deciding labor claims, that explicit mutual wage agreements were disallowed under section 515(d):

Salaried Non-Exempt – Explicit Written Agreement No Longer Allowed.

In the past, California law has been construed to allow the employer and the employee to enter into an explicit mutual wage agreement which, if it met certain conditions, would permit an employer to pay a salary to a non-exempt employee that provided compensation for hours in excess of 40 in a workweek. . . . Such an agreement (backing in the regular rate) is no longer allowed as a result of the specific language adopted by the Legislature at Labor Code § 515(d). To determine the regular hour rate of pay for a non-exempt salaried employee, one must divide the weekly salary paid by no more than forty hours.

DLSE Enforcement Policies and Interpretations Manual, section 49-3.

Accordingly, AB 2103 was enacted to amend section 515 to expressly overturn the Arechiga case. Governor Jerry Brown signed AB 2103 into law, and it will take effect on January 1, 2013.  It will amend California Labor Code section 515(d) to read:

(d)(1) For the purpose of computing the overtime rate of compensation required to be paid to a nonexempt full-time salaried employee, the employee’s regular hourly rate shall be 1/40th of the employee’s weekly salary.

(2) Payment of a fixed salary to a nonexempt employee shall be deemed to provide compensation only for the employee’s regular, nonovertime hours, notwithstanding any private agreement to the contrary.

Mary E. Wright is a shareholder in the San Francisco office of Ogletree Deakins, and she serves as the firm’s general counsel.


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.

© Ogletree, Deakins, Nash, Smoak & Stewart, P.C. | Attorney Advertising

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