No Good Deed Goes Unpunished - California Supreme Court Decision May Change the Way Employers Calculate Overtime

California is a difficult landscape for employers, and last month, the California Supreme Court made that landscape all the more difficult.  In a case called Alvarado v. Dart Container Corp., the California Supreme Court issued a decision that determines how to calculate overtime when a non-exempt, hourly employee is paid a flat-sum bonus.  The decision veers away from the well-publicized federal Fair Labor Standards Act (FLSA) method and, brace yourself…the Alvarado ruling applies retroactively.  

Since the decision fundamentally changes the way in which overtime is calculated, employers should read on with care to understand how the new retroactive interpretation will be applied.

The Alvarado Class Challenges Overtime Rate Calculations 

Hector Alvarado, a food service worker, on behalf of himself and on behalf of other employees pursuant to the Private Attorneys General Act of 2004, alleged that their employer, Dart Container Corporation of California, underpaid overtime compensation for weeks in which they had earned a bonus.  Dart paid its employees a flat-sum “attendance bonus” for completion of full shifts on Saturday or Sunday, the least popular workdays of the week.  In calculating each employee’s overtime rate of pay, Dart followed the federal FLSA method.  Specifically, Dart included each employee’s bonus compensation in calculating each employee’s total earnings and included each employee’s overtime hours in calculating each employee’s total hours worked.  Dart then divided each employee’s total earnings by total hours worked to derive the regular rate of pay for purposes of calculating overtime compensation.  Seems logical, right?  The California Court of Appeal agreed, siding with Dart.

California Law Leaves Open Questions

But then California’s Supreme Court examined the issue.  To give some background, California overtime law entitles non-exempt, hourly employees to 1 1/2 times their “regular rate of pay” for work in excess of eight hours per day or 40 hours per week and for any work performed on a seventh consecutive workday.  The “regular rate of pay” is a term of art that cannot be equated to an employee’s hourly wage rate.  The regular rate of pay must include compensation that is not attached to hours worked and, for this reason, can fluctuate from week to week.  Non-hourly compensation that must be factored into the “regular rate of pay” includes any bonuses earned that are non-discretionary (i.e. Dart’s “attendance bonus”).

The dispute in the Alvarado case stemmed from how to factor Dart’s flat-sum “attendance bonus” into the calculation of each employee’s regular rate of pay for determining overtime compensation.  Plaintiff Hector Alvarado, on behalf of himself and the class, contended that Dart should have divided total compensation not by total hours worked but by regular hours only (i.e., non-overtime hours).  Alvarado’s method applied the formula endorsed by the California Department of Labor Standards Enforcement (DLSE).

Recognizing that California law had left the issue open, the California Supreme Court reviewed the following possible divisors for calculating the per-hour value of a flat-sum bonus:  

(1) The number of hours the employee actually worked during the pay period, including overtime hours (the FLSA formula used by Dart);

(2) The number of non-overtime hours the employee worked during the pay period (the DLSE formula used by Alvarado); or

(3) The number of non-overtime hours that exist in the pay period, regardless of the actual number of hours worked by the employee.  

Alvarado Court Holds That Only Non-Overtime Hours Worked May Be Considered The California Supreme Court decided that the second option was most appropriate, which was the DLSE method argued by Alvarado.  The Court held that, where a flat-sum bonus is awarded that is not tied to production, the regular rate of pay must be calculated by dividing the bonus only by the employee’s non-overtime hours worked during the pay period.

The Court explained that California law differed from the FLSA in that it is more protective of employees than the FLSA.  California labor laws also reflect a policy of discouraging overtime work.  Bearing this in mind, the Court made the following observations:  

• The third option of using all non-overtime hours in the pay period would dramatically reduce overtime pay rates for part-time employees who might work less than forty hours in a workweek.  Seeing no other basis for this option, the Court ruled it out and reviewed the other options.
• The first option, the FLSA method which includes the total number of hours worked, including overtime hours, would result in a lower regular rate of pay than the second option of the DLSE method using total non-overtime hours worked.
• Since Dart’s employees could earn the flat-sum “attendance bonus” without working overtime hours, the DLSE method best reflected the state’s policy of discouraging overtime hours.  Stated differently, the DLSE option would eliminate an incentive for employers to encourage employees to work more overtime hours in order to give employees a lower rate of pay for overtime hours worked.

Having determined that the DLSE method guaranteed the highest regular rate of pay and hence the highest overtime rate, the Court held that Dart failed to properly compensate employees for overtime compensation during pay periods where the employee earned the “attendance bonus.” Dart urged the Court at oral argument to apply its decision prospectively only since Dart had reasonably relied upon the FLSA method of calculation.  Although several justices noted the uncertainty created by California’s unclear authority in this area, the Court rejected Dart's request and held that its decision applied retroactively.

Navigating Alvarado’s Aftermath

Because the Alvarado ruling applies retroactively, employers who pay flat-sum bonuses who have relied upon the FLSA method of calculating overtime are at high risk of exposure to claims for unpaid wages, penalties, interest, and attorneys’ fees, as well as various related California statutory claims.  Going forward, any employers that pay bonuses to their non-exempt, hourly employees should have their practices reviewed by legal counsel for compliance.  Although the California Supreme Court limited its decision to flat-sum bonuses, the decision may be interpreted to affect the treatment of other types of bonuses in overtime calculations.  In the wake of Alvarado, the sad truth is that employers must be very careful in paying bonuses or other forms of non-discretionary pay since these payments open them to the risk of being sued for not calculating overtime compensation properly.  As the old adage goes, no good deed goes unpunished.

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