On July 14, 2014, the California Supreme Court held in Peabody v. Time Warner Cable, Inc. that employees qualify for the California “commissioned employee” exemption in a pay period only if they receive “earnings [that] exceed one and one-half (1-1/2) times the minimum wage” in that two-week pay period.  The Court held that an employer may not satisfy the minimum earnings prong of the exemption by reassigning wages from a different pay period for employees who are paid commissions that are calculated monthly.  In addition, as explained below, while the Court expressly declined to address the issue, its reasoning will lead plaintiffs’ counsel to argue that more than half of an employee’s pay in a pay period must “represent commissions” if the employee is to meet the exemption in that pay period.

Background

Defendant Time Warner had classified the plaintiff, a former account executive named Susan Peabody, as exempt under the commissioned employee exemption.  After Peabody’s separation of employment from Time Warner, she brought a class action lawsuit alleging misclassification, unpaid overtime, and other wage and hour violations.

Time Warner paid Peabody her hourly wages on a biweekly basis, and her commissions on a monthly basis.  Under Time Warner’s compensation plan, Peabody and other account executives earned a commission only upon the occurrence of three events:  (1) procurement of an order, (2) broadcast of the advertising, and (3) collection of the revenue from the client.  Thus, commissions were not paid during every biweekly pay period because of the frequency with which Time Warner was able to collect revenue from its clients and thereafter calculate commissions based on that revenue.

The Commissioned Sales Exemption

The commissioned employee exemption, which Time Warner cited to argue that Peabody was exempt from overtime pay, applies to certain sales employees covered by IWC Wage Order 4 or 7.  It provides that the overtime provisions in the Wage Order “shall not apply to 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.”  (Wage Order No. 4, subd. 3(D).)  The provision does not identify the time period for which the employee’s pay must exceed one and one-half time the minimum wage, so many employers use whatever period was used for calculating commissions.  It is commonplace to use a period of one month or one quarter to the extent the commissions were calculated based on monthly or quarterly targets.  Prior to the California Supreme Court’s ruling in Peabody, there was no binding precedent on whether the requirements of the commissioned employee exemption must be satisfied in every biweekly pay period in order for the exemption to apply.

The Question Presented to the California Supreme Court

Time Warner did not dispute that Peabody regularly worked 45 hours per week and was paid no overtime.  It argued, however, that she fell within California’s commissioned employee exemption and thus was not entitled to overtime compensation.  Time Warner also recognized that Peabody did not earn at least $12 per hour (1.5 times the minimum wage) in each pay period.  It argued, however, that commissions should be reassigned from the pay periods in which they were paid to the monthly commission period over which they were earned.  Attributing the commission wages in this manner would satisfy the exemption’s minimum earnings prong because reallocating the commissions increased the employee’s hourly pay to more than 1.5 times the minimum wage.

Plaintiff’s argument against the application of the exemption addressed only the “1-1/2 times minimum wage” component of the exemption and not the “majority commissions” prong.  In other words, Plaintiff argued that the exemption did not apply in any 2-week pay period in which the employee did not receive a sum of at least 1.5 times the minimum wage for each hour worked in that pay period.

The Peabody action is actually a federal action, and it reached the California Supreme Court only because the Ninth Circuit certified a question to the California Supreme Court on substantive California wage and hour law.  As ultimately formulated, the question posed to the California Supreme Court to decide was: “May an employer, consistent with California’s compensation requirements, allocate an employee’s commission payments to the pay periods for which they were earned?”

The California Supreme Court’s Conclusion

The California Supreme Court rejected Time Warner’s argument that it should look at compensation received and hours worked over the monthly commission period in applying the exemption.  The Court held that the employer cannot satisfy the commissioned employee exemption in those pay periods where the employee does not actually receive more than 1.5 times the minimum wage.  The Justices unanimously agreed that it would be inconsistent with Labor Code Sections 204 (timing of wage payments) and 226 (itemized wage statements) if the employer could attribute commissions over a month to meet the exemption:

• “Section 204(a), for example, requires that semimonthly paychecks include the wages earned during that pay period.”  (Emphasis in original).

• “Section 226 requires that the paychecks be accompanied by an itemized statement listing the ‘(1) gross wages earned… (5) net wages earned, [and] (6) the inclusive dates of the period for which the employee is paid.’”

• Although it recognized that DLSE opinions are not entitled to deference, it agreed with the DLSE’s published guidance on this issue:  “The [DLSE] has identified those requirements that must be met to satisfy the commissioned employee exemption [including that] the payment of the earnings of more than 1.5 times the minimum wage… must be made in each pay period.  Therefore, it is not permissible to defer any part of the wages due for one period until payment of the wages due for a later period.”  (Emphasis in original).

Thus, the Court held that “[r]eassigning wages in the manner suggested by Time Warner would ignore the obligations imposed by these statutory provisions.”  It concluded that an employer satisfies the minimum earnings prong of the commissioned employee exemption only in those pay periods in which it actually pays the required minimum earnings.  An employer may not satisfy the prong by reassigning wages from a different pay period.

The Court Refused to Apply Federal Standards

The Court also rejected Time Warner’s contention that federal law, which permits the type of wage attribution Time Warner advocated, was instructive:  “We have previously cautioned against confounding federal and state labor law … where the language or intent of state and federal labor laws substantially differ.  Unlike state law, federal law does not require an employee to be paid semimonthly.  It also permits employers to defer paying earned commissions so long as the employee is paid the minimum wage in each pay period.  In light of these substantial differences from California law, reliance on federal authorities to construe state regulations would be misplaced.”

Payment of Commissions on a Monthly or Less Frequent Basis Can Still Be Permissible

Labor Code Section 204 establishes biweekly pay periods.  The Peabody Court made clear, however, that an employer does not violate Section 204 by paying commissions monthly if the commissions are earned based on conditions that can be satisfied only monthly (e.g., monthly sales volume).  While all earned wages, including commissions, must be paid no less frequently than biweekly, the Court emphasized that “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.”  Accordingly, while employers using such systems may be less likely to qualify for the commissioned employee exemption, the mere fact that they pay commissions based on a monthly calculation does not constitute a violation of Labor Code Section 204.

Second Element of Commissioned Employee Exemption Not Expressly Addressed

At footnote 4 of the decision, the California Supreme Court states that it expressed no opinion on whether the same limitations on payment of 1.5 times the minimum wage also apply to the requirement in the commissioned employee exemption that the majority of the pay must represent commissions.  Apparently, the plaintiff did not raise the argument.  Nonetheless, employers who pay commissions on a monthly basis with a smaller base salary payment mid-month should be concerned that a later decision will adopt the California Supreme Court’s reasoning in Peabody to hold that the “majority commissions” prong must be met every pay period as well.   While compensation systems can be modified to meet the narrowed exemption, it is likely that many employers who pay commissions calculated based on an employee’s monthly or quarterly sales activity will need to modify existing systems to address this issue.

Takeaway

Monthly and quarterly commission systems are common.  This decision will likely spur more class actions against employers who utilized the commissioned employee exemption.  Companies utilizing a system where commissions are paid less frequently than semi-monthly should review their policies and ensure that any employees classified as exempt under the commissioned employee exemption still qualify based on the Peabody decision.  If you have any questions about this decision or how it could impact your employment practices, please do not hesitate to consult a Sheppard Mullin labor and employment attorney.