Payback Time

By John H. Douglas and Jean Kosela

On Nov. 5, 2007, the California Supreme Court announced a widely anticipated decision in a case, Gattuso v. Harte-Hanks Shoppers, Inc., that - at least on the surface - seemed to call into question some fundamental conceptual distinctions in California wage and hour law.

The issue on appeal, according to Justice Joyce L. Kennard, was whether a California employer can satisfy its obligation under Labor Code Section 2802(a) to "indemnify its employees for expenses they necessarily incur in the discharge of their duties" by paying them "increased wages or commissions instead of separately reimbursing them for actual expenses."

Though the unanimous court purported to answer that question affirmatively, careful review of the decision suggests that Kennard may have actually answered her "issue" statement in the negative. While Harte-Hanks' bacon may yet be saved by the decision, employers hoping for a significant lightening of their compliance burden when it comes to expense reimbursement will be sorely disappointed.
     
Factual Backdrop
Harte-Hanks published advertising booklets and leaflets, including the Pennysaver and California Shopper. It employed an inside salesforce to sell advertising space telephonically, as well as an outside sales force, which drove their own automobiles to call on customers. Harte-Hanks paid its salespeople a combination of base and commission pay, and with few exceptions, did not separately reimburse its outside salespeople for use of their automobiles. Rather, it claimed, outside sale personnel were paid higher base pay and commission rates than inside sales personnel.

Harte-Hanks' method of "expense" reimbursement is actually common among businesses that rely on outside sales personnel to sell a variety of products (such as magazine subscriptions) on a door-to-door basis under limited, if any, supervision (particularly outside of California).

Such businesses benchmark an average commission earnings-to-expenses ratio based on the historical performance of "successful" members of their sales forces. Using that data, the employer sets an enhanced commission rate for outside sales people that is treated as a combination of commission earnings for the employee's labor (that is, wages) and a presumptively reasonable expense reimbursement budget.

The plaintiffs in the case, Frank Gattuso and Ernest Sigala, both worked as outside salespeople for Harte-Hanks in Southern California. After their employment ended, both sued, seeking indemnification under Section 2802 of the California Labor Code for expenses they incurred in using their own automobiles and seeking class status.

Harte-Hanks responded that it had already reimbursed the plaintiffs' automobile-related expenses. When the plaintiffs moved for class certification, the trial court denied their motion, having found that Labor Code Section 2802 allows employers to reimburse automobile expenses through increased compensation in the form of base salary and/or enhanced commission rates; and that employers and employees can agree on amounts to be reimbursed, or in the absence of such agreement, reimbursement can be any "reasonable" amount.

As a result, the trial court found, individualized inquiries were necessary to determine whether there had been any "meeting of the minds" between each class member and the company regarding automobile expense reimbursement; and whether the amount actually reimbursed had been "reasonable." The Court of Appeal agreed, and found no abuse of discretion in the denial of class status. The Supreme Court affirmed the Court of Appeal's finding that Harte-Hanks' reimbursement methodology was permissible - but reversed the order denying class certification.
     
Employee Indemnification
At the core of the Supreme Court's decision is a provision of the California Labor Code rarely interpreted by the appellate courts - Section 2802 - subdivision (a) of which provides (in relevant part) that "An employer shall indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties," and subdivision (c) of which defines "necessary expenditures or losses" as including "all reasonable costs."

The litigants all agreed that an employer can comply with Labor Code 2802 by reimbursing an employee's actual expenses incurred in using an automobile for the employer - though the litigants and the court also viewed the methodology as so cumbersome to be effectively infeasible. Consistent with the enforcement policy long held by the California Department of Labor Standards Enforcement, the litigants and the court also viewed the IRS-sanctioned mileage reimbursement methodology as complying with Labor Code 2802. However, the court conceded that this methodology also yielded only an approximation of actual expenses and that these varied based on factors including the make and model of automobile driven, frequency of new car purchase and geographic variations in gasoline and insurance costs.

As certain "actual" expenses (such as depreciation) were within the employee's control, the court also acknowledged that an employer could view certain expense claims as "unreasonable" - and thus, that "a mileage rate for automobile expense reimbursement may be a subject of negotiation and agreement between employer and employee."

Nonetheless, the court was also careful to observe that California Labor Code Section 2804 renders any agreement by an employee for other than "full expense reimbursement" "null and void."
     
Payment Methods
The court, disagreeing with the plaintiffs, also found a third methodology - one that it and the litigants referred to as "lump sum" reimbursement - consistent with Labor Code Section 2802. Asserting that Section 2802 did not restrict "the methods by which the employer may calculate reimbursement," Harte-Hanks had maintained that "Section 2802 require[d] only that whatever method is used result in full reimbursement for actual expenses necessarily incurred by the employee."

The plaintiffs, in contrast, insisted that "lump-sum" reimbursement did not sufficiently correlat" the employee's reimbursement to incurred expenses. In siding with Harte-Hanks, the court found that Section 2802 did not preclude "lump sum" reimbursement - as long as the after-tax amount received by the employee was sufficient to cover all actual (reasonable) expenses.

The court next decided that employers need not necessarily "segregate" amounts paid for expense reimbursement from amounts paid as salary or commission. Though the court allowed that Labor Code Section 200 - defining wages as "all amount for labor performed" - reflected a "valid and important distinction" between wages and business expense reimbursement - it found combining expense reimbursement with wages was permissible so long as it did not "seriously hamper or effectively preclude enforcement of the various statutory" obligations governing payment of wages or "contractual obligations."

What was necessary, the court found, was for the employer to "provide some method or formula to identify the amount of the combined employee compensation payment that is intended to provide expense reimbursement." In order to comply with California Labor Code Section 226's requirement that employees be provided accurate records of wage payments, moreover, the court found that "employers that provide business expense reimbursement to employees through increases in base salary or commission rates should, in providing the documentation required by section 226, subdivision(a), separately identify the amounts that represent payment for labor performed and the amounts that represent reimbursement for business expenses."
     
Balance of Power
Thus, when all the qualifications to its holding in Harte-Hanks are considered, the court's decision may not actually alter anything in the balance of power between the plaintiffs' bar and employers in California. The decision may give some employers with significant outside sales forces a stronger hand in linking sales performance to presumptively "reasonable" expense budgets. However, as the court acknowledged, an "employer that chooses to link expense reimbursement to employee performance by providing automobile expense reimbursement through an increase in commission rates," still runs "a risk that the employee, for whatever reason, may earn less commission income than the employer anticipated, so that the increase in the commission rate may be insufficient to provide full reimbursement for the automobile expenses the employee necessarily incurred."

The bottom line is that though Section 2802 may not prohibit the method of expense reimbursement, the employer is still be obligated to "make up the difference" if there is a shortfall. Failure to "make budget" fundamentally remains a disciplinary issue.

Finally, in a coda to its decision, the Supreme Court reversed the lower court's judgment on the certification motion and posed three questions to be considered on a class basis on remand: first, whether Harte-Hanks had a policy or practice of reimbursing outside sales personnel for automobile expenses by paying them higher commission rates and base salaries; second, whether Harte-Hanks had established a method to apportion the enhanced "compensation" payments between compensation for labor and for expense reimbursement; and third, whether the amount paid for expense reimbursement was sufficient to reimburse the employees "for the automobile expenses they reasonably and necessarily incurred?"

Depending on how the facts play out on remand, the court's decision may well leave Harte-Hanks' outside sales personnel in the driver's seat as they seek reimbursement for automobile expenses.

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