California Changes the Rules for Calculating Overtime on Employee Bonuses

The California Supreme Court just threw employers a serious curveball with respect to how employers must calculate overtime. And it did so by claiming employers should have known of this calculation method even though the same California Supreme Court declared it void over 20 years ago.

The March 5, 2018 decision of Alvarado v. Dart Container Corp of Cal., fundamentally changes how employers in California must calculate the “regular rate of pay” for overtime purposes when non-exempt employees receive a flat sum bonus that is not explicitly linked to performance/production incentives (i.e., attendance and/or longevity bonuses).

California now expressly departs from federal law on this issue, and has instead dragged up a voided interpretation of how to calculate regular rate, reasoning that “void … does not necessarily mean wrong.”

Federal law requires employers to pay overtime based on an employee’s “regular rate of pay,” which often – but not always – is the same as the employee’s normal hourly rate of pay. However, when an employee works at two different hourly rates during the same workweek (such as with the case of shift differentials) or receives certain types of compensation in addition to an hourly rate of pay (such as a bonus), the employee’s hourly rate and “regular rate” typically will not be the same.

When an employer provides includable bonus compensation¹ to an employee, the federal standard calculates regular rate by dividing the total compensation earned by the total hours worked during the relevant time period. This is best understood with a mathematical example:

Consider an employee who earns $15/hour, works 47 hours in a workweek, and also receives a $50 attendance bonus for that week.

Her regular rate is derived as follows: (($15 x 47) + $50 = $755)/47 = $16.06.

To then determine the employee’s total compensation, you then take the $755 earned at the effective hourly rate and add half the “regular rate” for each overtime hour worked (because you’ve already paid the “one” of the “one and a half times” in the first step) as follows: $755 + ($8.03 x 7) = $811.21.

The California Division of Labor Standards Enforcement (DLSE) opined decades ago that “regular rate of pay” in California for these circumstances must be based only an employee’s “non-overtime” hours, rather than all hours worked in the week, but in 1996, the California Supreme Court found that the DLSE Enforcement Policies and Interpretations Manual provision on this point was a void regulation not entitled to any deference because it was not adopted in compliance with proper legal procedure.

Despite this clear expression, the DLSE nevertheless maintained this interpretation as the proper view of “regular rate” in its Manual. The trial and appellate court rejected the DLSE language on the basis that it was a void interpretation and the prevailing federal approach (outlined above) applied in California. However, the state Supreme Court in Dart Container concluded that even though the DLSE had not acted lawfully in adopting its interpretation, the DLSE view was nevertheless California law and employers should have reasonably known this was the case.

What this means is that “regular rate of pay” – at least in some circumstances – must now be calculated differently in California than anywhere else in the country and that this ruling is retroactive. In California, “regular rate” for certain, flat-sum, non-performance related includable bonuses, now uses only an employee’s non-overtime hours in the denominator and overtime must be paid on the bonus separately from the normal hourly compensation. Using our same example above (and assuming the employee did not work any daily overtime, but only weekly overtime hours), the employee’s total compensation calculated under the “new but retroactive” standard is as follows:

Non-bonus compensation: ($15 x 40 regular hours) + ($22.50 x 7 OT hours) = $757.50

Overtime due on bonus: $50/40 regular hours = $1.25; $1.25 x 1.5 =$1.88; $1.88 x 7 OT hours = $13.16

Total compensation: $757.50 + $13.16 + $50 bonus = $820.66.

Stepping away from the math, what Dart Container means in practical terms is that employers that have paid certain flat-sum bonuses to non-exempt California employees and made adjustments to the regular rate and overtime based on the always-accepted approach (instead of the previously “void” approach) have just been deemed to have paid overtime using an improper method that is less favorable to workers.

Given the wage and hour and class action climate prevailing in California, this sudden change should have employers’ attention, and those that have paid any type of bonus to non-exempt employees in California should seek immediate counsel. Foley & Lardner LLP partners and wage and hour practitioners Christopher Ward, Krista Cabrera and Kamran Mirrafati are fully versed on this new concern and all of California’s other wage and hour challenges, and are available to provide immediate and practical assistance.