California Differs From Federal Law on How to Calculate Flat Sum Bonuses Into Overtime Regular Rate

California also mandates payment of overtime based on “the regular rate of pay for an employee.” The state, however, has not had explicit rules for determining how to calculate the regular rate. As a result, in many cases, California employers have looked to federal rules under the FLSA on those issues.

The California Supreme Court’s new decision in Alvarado v. Dart Container Corporation of California holds that California applies a different rule than federal law for calculating the regular rate – at least with respect to certain flat sum bonuses. The different method results in a higher regular rate, and in turn higher overtime pay when a flat sum bonus covers a particular period. It leaves unresolved, however, how California might calculate the regular rate for other types of pay that may need to be included in an employee’s regular rate.

Different Methods at Issue

Alvarado involved an attendance bonus for weekend work. Hourly employees received a flat sum of $15 for scheduled work on Saturdays or Sundays, if they completed the full shift. The employer calculated the bonus into the regular rate, using the method prescribed in the federal FLSA regulations. In short, the employer added all straight-time hourly wages (at the base hourly rate), plus attendance bonuses earned. It then divided this amount by the total number of hours worked in the period that the bonuses covered – including overtime hours. The employer paid overtime based on the resulting rate.

The plaintiff filed a putative class action lawsuit. He alleged that, instead of dividing the compensation by the total hours worked, the employer should have divided it by the total non-overtime hours only.

With Flat Sum Bonus, Regular Rate Based on Non-Overtime Hours Only

As the California Supreme Court recognized, state law may provide an employee with greater protections than federal law. Based on different provisions of California law, the Court concluded that an employer must determine the regular rate involving a flat sum bonus based only on non-overtime hours, as defined by state law. As a result, in calculating the regular rate for an employee paid a flat sum bonus, 40 hours (the maximum number of hours possible without overtime) is the maximum number that an employer could use to divide an employee’s total compensation in a workweek to determine the employee’s regular rate for overtime purposes. (In California, hours over eight in a workday also count as overtime, even if an employee does not work more than 40 hours in a workweek.) Federal law, in contrast, would allow the employer to divide by the total number of hours an employee worked in the workweek – regardless of the number of hours worked.

The Court emphasized that California has a “longstanding policy of discouraging employers from imposing overtime,” with California’s overtime laws “favoring an eight-hour day and a six-day 40-hour workweek.” The Court rejected the federal formula “because it results in a progressively decreasing regular rate of pay as the number of overtime hours increases, thus undermining the state’s policy of discouraging overtime work.” In addition, the Court noted it generally construes employee protections liberally, so that “we are obligated to prefer an interpretation that discourages employers from imposing overtime work and that favors the protection of the employee’s interests.”

As further support of its conclusion, the Court interpreted “regular” in the term “regular rate of pay” to mean “regular-time (i.e., non[-]overtime).” Based on that reading, the Court determined that, “when non[-]hourly compensation is factored into an employee’s ‘regular rate of pay,’ only non[-]overtime hours should be considered.”

The Court also relied upon Labor Code section 515(d), which governs determining the overtime rate for salaried, non-exempt employees. It provides that such an employee’s salary compensates “only for the employee’s regular, non[-]overtime hours,” with a full-time employee’s hourly rate based on 1/40 of the employee’s weekly salary. Based on this provision, the Court concluded that the Legislature “expressly endorsed” the principle that flat sum, non-hourly compensation should be factored into the regular rate “by dividing the flat sum by the number of non[-]overtime hours that exist in the relevant period” and that “the flat sum compensates the worker for only non[-]overtime hours worked.” The Alvarado decision thus extended this reasoning to calculating the regular rate for overtime – at least with respect to flat sum bonuses that need to be included in the regular rate.

Limits to the Decision?

Alvarado applies a different rule than federal law with respect to flat sum bonuses. The Court, however, expressly limited it decision – at least for now – to flat sum bonuses similar to an attendance bonus: “We limit our decision to flat sum bonuses comparable to the attendance bonus at issue here. Other types of non[-]hourly compensation, such as a production or piecework bonus or a commission, may increase in size in rough proportion to the hours worked, including overtime hours, and therefore a different analysis may be warranted . . . .” Thus, based on Alvarado, further decisions may follow, or be necessary, to resolve other regular rate questions under California law.

The Alvarado decision follows an interpretation by the California Labor Commissioner with respect to flat sum bonuses designed to encourage an employee to remain employed or to report to work on a particular occasion (such as an attendance bonus), rather than as an incentive for increased production for each hour worked. According to the Labor Commissioner, determining the regular rate for the former type of flat sum bonus based on the total number of hours, “would encourage, rather than discourage, the use of overtime.”

Still, the Labor Commissioner has allowed including all hours worked (including overtime hours) in determining the regular rate for employees paid on a piece rate basis, with a production bonus, or by commissions – as federal law allows. The Labor Commissioner reasons that these employees have further opportunity to produce or earn more in piece rate, production bonus, or commission pay when working additional hours, including overtime. Thus, their regular rate actually may increase when they work more time, unlike other employees paid a flat sum bonus. It remains to be seen, however, whether future court decisions will follow this reasoning.

What Employers Should Do Now

The Alvarado decision underscores the importance of employers reviewing their wage payment practices to ensure that they comply with regular rate requirements. This area of the law can be technical and confusing, including in determining what items must be included in the regular rate and how to calculate the regular rate correctly. While the difference in pay to employees may be only “marginally more favorable,” as the Court recognized in Alvarado, errors may result in costly penalties for failure to pay all wages due or not doing so in a timely manner, or for providing inaccurate wage payment statements as a result. The Alvarado decision makes things more difficult for California employers. Because regular rate issues can be complicated, employers should review compliance with counsel.