The “regular rate” of pay is a wage-hour concept that employers must understand to calculate overtime properly.  Failing to calculate correctly the regular rate can result in overpayment or underpayment of overtime pay. In the latter case, multitudes of penalties can result, dwarfing the underlying wages owed. Additionally, employers planning to pay bonuses and other non-hourly compensation to non-exempt employees ought to understand the cost of such programs may be higher than they appear because of the overtime premium due on the additional pay.

The regular rate can be tricky.  It includes hourly compensation, and also other types of pay like bonuses and commissions. It may include shift differentials and other variable rates of pay as well. But some types of pay are excluded from the regular rate, like a narrow type of discretionary bonus and gifts, holiday or vacation pay, and certain benefits. There are a number of federal regulations explaining what is included and excluded.  California law tends to borrow from these regulations when it comes to overtime pay.

Until it doesn’t. 

And that brings us to today’s news. The California Supreme Court just decided how to calculate the “regular rate”  when an employer pays an employee a fixed bonus for attendance / working on certain days (like weekends in this case).The case today is Alvarado v. Dart Container Corp. The opinion is here.

Dart paid employees a bonus of $15.00 per shift for working Saturdays or Sundays, over and above their hourly rate.  Dart apparently included the $15.00 bonuses in the regular rate. But they calculated the regular rate by dividing those bonuses among all the hours in the pay period, along with the hourly compensation.  

So, for example, if an employee earned $10 / hour, and worked 85 total hours in the pay period (80 straight and 5 overtime), Dart would calculate the regular rate as follows:

Base rate: $10.00 per hour X 85 hours = $850.00.  Plus bonus ($15.00) = $865.00 / 85 hours worked = $10.176 / hour as the regular rate.

For an employee who worked 5 hours of “time and a half” overtime (as in the example above), the employer would owe:

80 hours at straight time of 10.00 / hour = $800, plus

Bonus of $15.00, plus

Overtime pay of 1.5 x 5 hours x $10.176 per hour = $76.32

Total pay:  $891,32.

You get this, right?  It makes sense?  Well forget it, mostly.*

*In fact, the above method of calculating overtime may work in some circumstances. For example, if the $15.00 were a commission or production bonus, the employer might well be justified in dividing the bonus among all the hours worked in the pay period. How do I know this?  The Court said so, but not definitively. That will be the subject of a future case, but it appears to be the correct way of calculating overtime. 

This case, though, dealt with a bonus given to employees for accomplishing a certain task, but only during certain hours worked. That is, they showed up for their Saturday and / or Sunday shifts.  Dart followed the first example given above, based on a federal regulation used to calculate the regular rate under the federal Fair Labor Standards Act.  Alvarado claimed that California law required calculating the regular rate only by including the straight time hours worked. 

The Court agreed with Alvarado and the employees.  The Court decided it would unfairly dilute the overtime premium to allow spreading the value of the bonus among all the hours worked.  Rather, the Court held that this sort of fixed bonus – unrelated to the entire pay period’s production or sales – must be included in the regular rate, but divided only among the “straight time hours” actually worked during the pay period.  The Court’s holding is consistent with a statement in the DLSE Enforcement and Interpretations Manual, section 49.2.4.2.

In our example above, the employee worked 85 hours, but only 80 hours at straight time. Applying the same figures as above, the Court’s decision means the regular rate has to be calculated like this:

Base rate: $10.00 per hour X 85 hours = $850.00.  Bonus pay of $15.00 / 80 hours = $0.1875 / hour.  Regular rate = $10.00 base + $0.1875/hour bonus = $10.1875..  As you can see, that’s higher than the first calculation of $10.176.

So, that employee would earn:

80 hours at straight time of 10.00 / hour = $800, plus

Bonus of $15.00, plus

Overtime pay of 1.5 x 5 hours x $10.1875 per hour = $76.41.

Total pay:  $891.41.

That doesn’t seem like a big difference. But that’s only because I included just one bonus and the employee worked only 5 hours of overtime in the pay period, the employee worked 85 total hours, and the bonus was modest.  If the employee in question had worked just 40 non-overtime hours, and 5 hours of overtime, for example, or if the employee’s flat bonuses were $60 instead of $15, the difference would be greater.  

The important point, though, is that the failure to calculate the regular rate correctly resulted in underpayment of overtime for all employees who received these flat bonuses, for years.  The miscalculation results in wage statement penalties, PAGA penalties, and let’s not forget 30 days’ pay for former employees.

Applying the Court’s ruling to the calculation above is deceptively easy.  It will be more complicated in real-world settings because the regular rate may have to be calculated based on just straight time hours for some forms of compensation, and total hours for other forms. Additionally, when extra compensation is attributable to more than one pay period (like a quarterly bonus), that can cause additional calculations to attribute the quarterly payment to the correct pay period in the correct amount.

Again, the Court’s decision may not apply to overtime calculations based on production bonuses, piece rates, or commissions. That is because those forms of payment often depend on and vary with the number of hours worked, including overtime hours.  Therefore, the Court seemed to say that it would be appropriate to include overtime hours in the regular rate for that sort of variable compensation. But the Court did not firmly decide the issue, as stated.

I’m not going to go through the Court’s complete rationale for the decision, because it doesn’t really matter. To summarize, though, as stated, Dart relied on a straightforward federal regulation, expressly allowing calculation of the overtime based on total hours worked in the pay period.  The Court, however, followed the rationale expressed in the DLSE Manual, which does not have the “force” of law.  The Court spent a great deal of time explaining that, although the DLSE Manual is not a real regulation, and is not automatically to be followed like a statute or the wage orders, the courts may follow the DLSE’s position when it is persuasive.  So, the Court could have gone either way here, but chose the calculation method that (1) discourages overtime and (2) maximizes employee earnings. The Court didn’t care about these complexities or added costs.

Given the DLSE Manual’s provision, the Court also had no sympathy for Dart’s argument that the Court’s method should be applied prospectively (going forward only).  Therefore, this decision is retroactive and puts in jeopardy all employers who calculated overtime incorrectly in the past.

The decision, authored by Justice Ming Chin, was unanimous. But the Chief Justice filed a concurring opinion, in which a majority of the Court joined.  The Chief Justice wrote that the Division of Labor Standards Enforcement could have written formal regulations regarding how to calculate overtime, which would have removed some of the uncertainty from this issue.  Although the DLSE’s Manual contains guidance regarding the regular rate, it is not binding on courts.  As a result, Dart won this case in the superior court and the court of appeal.  Perhaps the DLSE will issue some regulations about some of the less certain aspects of wage-hour law. to provide some certainty.

In any event, employers must immediately review the types of compensation they include in the regular rate of pay, make adjustments for how to calculate the regular rate, and brace for lawsuits concerning past overtime pay calculations. To make calculation of the regular rate less costly and more simple, it may be advisable to pay hourly differentials to incentivize weekend work and forego flat-sum bonuses that are not related to production.  (When there are different hourly rates of pay during a given pay period, one uses a “weighted average” of the rates to calculate the appropriate regular rate.)  

A final note – The Court’s opinion gives more force to the DLSE Manual than practitioners may have given it before. in other contexts, courts have rejected the DLSE’s rationale expressed in the Manual and opinion letters.  But this decision explains that the DLSE Manual should be considered and, when persuasive, followed by the courts.

Have a nice day. 

 

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