On May 15, 2017, the Supreme Court of the United States rejected the City of San Gabriel, California’s attempt to overturn the Ninth Circuit Court of Appeal’s expansive interpretation of what employers must include as “wages” when establishing the regular rate of pay to calculate overtime under the Fair Labor Standards Act (FLSA). The Third, Sixth, and Tenth Circuits all previously narrowly construed Section 207(e)(2) of the FLSA, which allows employers to make certain exclusions from the “regular rate” of pay, thereby taking those amounts out of the calculation for overtime pay.   

The Supreme Court’s refusal to hear the appeal strikes a blow to public sector employers that have relied on California’s wage exclusions when providing certain payments to employees for opting out of medical benefits. This leaves the door open for public sector employees and their unions to challenge and expand what public employers must consider as “remuneration” when determining their employees’ regular rate of pay and, subsequently, when calculating their overtime in the context of these benefit offerings.

The City of San Gabriel, like many other public sector employers, allows employees who purchase less medical insurance coverage because of a spouse’s plan or other personal circumstance to receive the balance in the form of “cash-in-lieu” payments. The city did not include these payments in determining the employees’ regular rate of pay. Instead, it relied on Section 207(e)(2) of the FLSA, which authorizes employers to exclude from the regular rate any  payments made for occasional periods when no work is performed due to vacation, holiday, illness, failure of the employer to provide sufficient work, or other similar cause; reasonable payments for traveling expenses or other expenses incurred by an employee in the furtherance of the employer’s interests and properly reimbursable by the employer; and other similar payments to an employee that are not made as compensation for his or her hours of employment. The city considered its payment to be “in lieu” of benefits and argued that the payment should fall under the exception for “other similar payments” and thus was not includable in overtime calculations.

The FLSA requires employers to compensate employees at one and a half times their “regular rate” of pay for overtime hours. To properly calculate that “regular rate” of pay, the employer must take into account “all remuneration for employment paid to, or on behalf of, the employee,” subject to certain statutory exclusions. The city’s employees sued, alleging their overtime pay had been diluted because the city didn’t count their “in-lieu” payment for benefits in its calculation of their regular rate of pay, which, in turn, reduced their overtime.

The city won summary judgment in July of 2014, in a ruling holding that the city wasn’t required to include the total value of the police officers’ “in lieu” payments in its calculation of their regular rate of pay. But, on appeal, the Ninth Circuit ruled that, even though the “in lieu” amount wasn’t a payment based on the number of hours worked, it was nonetheless compensation that must be included in the regular rate of pay for purposes of calculating overtime.

The Ninth Circuit relied on the U.S. Department of Labor’s interpretation of the rule, which states that it is not feasible to list all of the items that may properly be excluded from the regular rate of pay, and instead offers examples of what would and would not qualify. The Ninth Circuit also determined that the city failed to show that it attempted to comply with the FLSA in good faith and therefore reversed the district court’s denial of liquidated (double) damages. The court of appeals found the city’s compliance efforts and analysis of whether these payments should be considered “wages” for the purposes of calculating the regular rate of pay to be “paltry.” It stated that an employer that “fail[s] to take the steps necessary to ensure its practices complied with [the FLSA]” and that “offers no evidence to show that it actively endeavored to ensure such compliance” fails to avoid a finding of willfulness under the statute.

San Gabriel urged the Supreme Court to step in and clarify the rule to eliminate confusion, saying that forcing the city to count the “in lieu” payments in the regular rate would result in employers deciding to simply eliminate these types of cash-out plans entirely—a result that would be to the detriment of employees, increasing costs and putting increased pressure on taxpayer dollars. The Supreme Court declined the invitation, allowing the Ninth Circuit decision to stand.

Key Takeaways

Public sector employers in the Ninth Circuit, and those in other circuits that have not addressed this issue, may want to review their respective medical benefit plans to determine if they provide such “in-lieu” payments and analyze whether they include such payments in their  regular rate of pay and calculation of overtime. Additionally, employers may want to review their general pay practices and analyze what payments they include when determining an employee’s regular rate of pay.