California Supreme Court Narrows the Inside Sales Exemption in California

The California Supreme Court unanimously decided the following:  "an employer may not attribute commission wages paid in one pay period to other pay periods in order to satisfy California‟s compensation requirements."

This decision will affect employers and employees trying to qualify for the inside sales exemption for sure, which was the issue before the court.  Will it affect other areas of wage-hour law?  What other areas?  Gee, you ask a lot of questions.   Read on.

Here are the relevant facts per the Court:

From July 2008 to May 15, 2009, Susan Peabody was a Time Warner account executive selling advertising on the company's cable television channels. Every other week, Time Warner paid $769.23 in hourly wages, the equivalent of $9.61 per hour, assuming a 40-hour workweek. About every other pay period, Time Warner paid commission wages under its account executive compensation plan.

Peabody claimed she worked more than 40 hours per week.  In some weeks, she worked 48 hours.  In those weeks, she would earn less than minimum wage per hour if there was no commission payment that week.

Hold the phone - Time Warner claimed Peabody was an exempt, inside sales person.  To qualify under the inside sales exemption, she must, among other things, satisfy two compensation criteria.  The one that matters here is "'that an employee's 'earnings exceed one and one-half (1 1/2) times the minimum wage” (ibid.), i.e., $12 per hour. '"

Peabody of course did not earn $12.00 per hour in base pay.  As shown above, she earned less than $10.00 per hour. So, for the exemption to apply, commissions would have to make up the difference.

Time Warner paid its commissions about once a month.  And therein lies the issue the Court decided.  Could Time Warner allocate the monthly commission payments over the course of the month in which they were paid?   Could Time Warner allocate the commissions across the time period during which the commissions were "earned"?

No, no, and.....no, said the California Supreme Court, unanimously.  Yes that was three "nos."

It was clear in this case that Peabody did not receive 1.5 times minimum wage for the hours worked on many of her paychecks.  Time Warner argued that the commissions it paid Peabody "counted" towards the period during which the commissions were "earned."  So, if the commission check was paid on March 23 for commissions earned in February, then the minimum wage calculation had to take into consideration those commission wages.

Agreeing with Peabody, the Court rejected that argument.  The Court held that commissions may be earned over time. It may be that a sale occurs in January, but is not earned until payment is received in April.  That's fine with respect to wage-hour law governing commissions.

But if the commission check is paid in April because the commissions are finally earned, then those commissions are counted towards minimum wage only during the (bi-weekly or semi monthly) pay period  for which the pay check is paid.

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 to a prior pay period to cure a shortfall.

The Court then explained why it was making satisfying the exemption difficult:

Making employers actually pay the required minimum amount of wages in each pay period mitigates the burden imposed by exempting employees from receiving overtime. This purpose would be defeated if an employer could simply pay the minimum wage for all work performed, including excess labor, and then reassign commission wages paid weeks or months later in order to satisfy the exemption‟s minimum earnings prong. 

Finally, the court refused to rely on Fair Labor Standards Act cases interpreting the federal inside sales exemption, aka "7(i)."  Under federal law, the employer may pay commissions at greater intervals than per pay period and still comply with the exemption.

So, bottom line re inside sales exemption in California:

- to satisfy the exemption, the employee must receive in each pay check at least 1.5 times the minimum wage, for the hours worked during the applicable workweeks covered by that pay check. That means $13.50 per hour worked, starting July 1 of this year.  An employer who pays commissions less frequently than semi-monthly or bi-weekly must pay a sufficient hourly rate to ensure the 1.5 times minimum wage threshold is met.

-  This requirement will increase the non-commission earnings, by increasing the hourly pay required to maintain the exemption. That will have two consequences. First, payroll expense will increase absent a reduction in the commission rate.  Second, the inside sales exemption depends on a second criterion:  the employee must make more than 50% of wages from commission.  Paying a higher hourly rate will make it harder for employers to meet that 50% threshold.

Moving on... on the bright side the Court unanimously endorsed the view that commissions are earned when conditions are met, even if there is a delay between when a sale occurs and when commissions are earned:

an employment agreement may require receipt of a client's payment before any commissions on sold advertising are earned. If a client routinely pays its bills on the 15th of each month, commissions will be earned and owed once a month. Yet this does not create a monthly pay period in contravention of section 204(a). To summarize, section 204 establishes semimonthly pay periods, but there is no obligation to pay unearned commission wages in any pay period. Commissions are owed only when they have been earned, even if it is on a monthly, quarterly, or less frequent basis.

(emphasis is mine).

Finally, some thoughts:

-   If commissions are only counted towards minimum wage in the pay period during which they are actually received, will that holding also affect the "regular rate of pay" calculation in California?  Overtime pay is based on the "regular rate of pay."  The "regular rate of pay" can include hourly wages and commissions.  The calculation of the "regular rate" may include allocating periodic payments like bonuses or commissions over the periods during which they are earned. So, if  commissions are only counted towards wages earned in the pay period in which payment is made, then should those commissions be counted for overtime earnings purposes only during that same pay period?

If this Peabody rule applies outside the inside sales exemption context, then during the pay period when the commission check is received, there will be a high regular rate of pay, and during non-payment weeks, the regular rate of pay will be low.   That could drastically affect employees' overtime pay calculations.  What about quarterly bonuses?  If Peabody is extended to overtime calculations, will "retroactive" overtime still be due for pay periods during which the bonuses were not paid?

My guess is that the courts will continue to allocate periodic payments over longer periods of time for overtime purposes.  For one thing the allocation of commissions or bonuses over more than one pay period for overtime purposes is settled federal law, and California appears to have followed that rule.

-  I still want to know if the inside sales exemption is valid in California under Wage Order 4, which applies to businesses that do not involve a "retail concept."  Under federal law, there is no inside sales exemption outside of retail, e.g., you can't have an  exempt, inside salesperson at a hospital.   Under state law, there appears to be a broader exemption because non-retail employees can qualify for the state exemptoin. If federal law requires overtime, but a state law exemption applies, isn't that an issue?  Can you be exempt under state law, but non-exempt under federal law?  (I also ask a lot of questions.)

The case is Peabody v. Time Warner Cable and the opinion is here.

Be careful out there!

Greg

Court of Appeal: Rare Opinion on Inside Sales Exemption

Tyrone Muldrow and a class of recruiters sued their employer, Surrex Solutions Corporation,  for unpaid overtime, meals and breaks.  The trial court held that the employees were exempt undre the "inside sales exemption" and that the company had adequately provided meals and breaks.  The Supreme Court issued a "grant and hold" order pending the decision in Brinker Restaurant Corp. v. Superior Court (2012) 53 Cal.4th 1004, 1037.

On remand after Brinker, the Court of Appeal reaffirmed its earlier decision.  It's blogworthy because of the discussion of the "inside sales exemption" under the wage order .

The exemption is contained in both wage order 4 and wage order 7.  The court did not address which wage order applies, but quoted from wage order 7:

California Industrial Welfare Commission (IWC) Wage Order No. 7-2001 exempts from this statutory overtime compensation requirement "any employee whose earnings exceed one and one-half (1 1/2) times the minimum wage if more than half of that employee's compensation represents commissions." (Cal. Code Regs., tit. 8, § 11070, subd. (3)(D).)

Under federal law, this is known as the "inside sales" or "7(i)" exemption.

For the above exemption to apply, the employees had to be "selling" a product or service. 

Appellants' primary job duty was to recruit "candidates" for employer "clients." Surrex's clients would place "job orders" with Surrex and appellants would search for potential candidates to fill the job orders. Appellants would use various resources to find candidates, including an internal database that Surrex maintained and various "on-line job boards."

The court decided that these recruiters were "selling" the recruiting services, and that the other activities they engaged in were part of the sales process.

The court then decided that the compensation the recruiters received were "commissions" because they were sufficiently related to the sales price - the revenue the business received for placements:

the sole argument that appellants offer to support their contention that the term "commissions" in the commissioned employees exemption (Cal. Code. Regs., tit. 8, § 11070, subd. (3)(D)) should be construed as excluding commission systems such as Surrex's, is that such a formula is "too complex." Appellants' contention that the Surrex's commission system is "too complex" is neither factually accurate nor legally relevant. The formula was clearly stated in the employees' employment agreements and, in most cases, could be calculated simply by knowing the candidate's "bill rate" and "pay rate" (both of which the consulting service managers, themselves, negotiated).15 In any event, appellants fail to cite any authority for the proposition that complexity is, or should be, a factor in determining whether a compensation scheme constitutes a commission under relevant California law.

The court also decided that the commission plan was "bona fide" because the commissions regularly exceeded draw.

So, the court decided that the trial court was correct because the inside sales exemption applies.


There are a couple of things the court did not decide that might have affected the outcome. First, the court did not appear to actually decide if Wage Order 4 or 7 is the correct one. The court quoted from Wage Order 7, which applies to all employees working in the "mercantile" industry.   The definition of "mercantile" applies to the sale of goods, not recruiting agencies. From the Wage Order: "'Mercantile Industry' means any industry, business, or establishment operated for the purpose of purchasing, selling, or distributing goods or commodities at wholesale or retail; or for the purpose of renting goods or commodities."

Rather, Wage Order 4 applies to occupations such as office workers, if an industry order does not apply.

The applicable Wage Order actually does not affect the exemption under California law because that exemption is contained in both Wage Order 4 and 7. (The Court should have cited the correct one, though).   The issue, though, is that the federal "7(i)" exemption applies only to "retail" establishments. In fact, the applicable Department of Labor regulations specifically exclude employment agencies from the definition of a retail establishment. See regulation here.  I can't say for certain that Surrex is not a "retail" establishment under federal law, but someone probably should take a look at that issue if he/she hasn't already. 

This is one of the few instances in which California law is less generous than federal law. Although an employee may be exempt under California law, if an employee is not "exempt" under federal law, then federal law will require overtime for work performed over 40 hours in a work week. I may have missed something, but the court's opinion does not seem to address federal law, or the wage order issue. Yet, the court does acknowledge the existence of the 7(i) exemption at footnote 14 of the opinion. Annnyyyway, I may be nuts, or someone has some splaining to do, or both! The message to our dear readers remains:   Please do not apply the inside sales exemption unless you consider both state and federal law.
 The case is Muldrow v. Surrex Solutions Corp. and the opinion is here.