California Supreme Court Explains How to Calculate Overtime Pay When Non-Exempt Employees Earn Flat Sum Bonuses

On March 5, 2018, the California Supreme Court issued its long-awaited opinion in Alvarado v. Dart Container Corporation of California, Case No. S232607 (Cal. Sup. Ct., March 5, 2018). The opinion resolves a dispute between an employer and a former employee regarding how his overtime wages should have been calculated for workweeks in which he worked overtime hours and also earned a flat sum bonus. (A flat sum bonus is a bonus whose amount is fixed regardless of the number of hours the employee works.) The calculation method urged by the employee, which would result in slightly higher overtime pay, would treat the bonus as earned only during the non-overtime hours he worked; the employer’s method effectively treated the bonus as earned during all hours he worked.

As an initial matter, the California Supreme Court explained that, for purposes of overtime calculations, flat sum bonuses must be treated as if earned on a per hour basis. Because the flat sum bonus at issue in this case could be payable even if the employee worked no overtime during the workweek, the Court agreed with the employee that the bonus should be treated as fully earned during non-overtime hours only. Therefore, ruling in the employee’s favor, the Court held that the employer should have calculated overtime wages attributable to the bonus by (1) dividing the bonus amount by the number of non-overtime hours the employee worked during the workweek and (2) multiplying that amount by 1.5.

Although it was far from clear under existing law that this employer’s method for calculating overtime wages was improper, the California Supreme Court held that its ruling would apply retroactively. California employers calculating overtime wages using the same method may thus be subject to significant penalties in the event of a claim, and they should quickly revise their pay practices to be consistent with the California Supreme Court’s ruling.

Background – California Law Regarding Payment of Overtime

Under California law, non-exempt employees are entitled to one and one-half times their “regular rate of pay” for all hours worked beyond 8 hours in a workday, beyond 40 hours in a workweek, and for the first 8 hours they work on the seventh consecutive day in a workweek. They are also entitled to twice their regular rate of pay for all hours worked beyond 12 in a workday or beyond 8 on the seventh consecutive day in a workweek.

An employee’s “regular rate of pay” includes not only the employee’s hourly wages but also all other forms of compensation the employee earns during the workweek, including non-discretionary bonuses, commissions, shift differentials, and various other types of pay. If an employee is paid only by the hour, the employee’s regular rate of pay is simply the hourly wage. If an employee receives other forms of compensation, however, things get a lot more complicated, as demonstrated below.

The Supreme Court’s Analysis and Holding in Alvarado v. Dart Container Corporation of California (“Alvarado”)

The employer in Alvarado paid certain employees a $15 “attendance bonus” in addition to their hourly wages if they were scheduled to work on a Saturday or Sunday and they completed their full shifts. Both the employer and the employee in Alvarado agreed that the attendance bonus should be factored into the employees’ regular rate of pay for purposes of calculating any overtime wages due. The dispute was about what method of calculation to use.

The employer (erroneously) calculated the employee’s overtime pay as follows:

Step 1:
Multiply the number of overtime hours the employee worked during the workweek by the employee’s normal hourly wage. This was the base hourly pay for overtime work.

Step 2:
Multiply the number of non-overtime hours the employee worked by the employee’s normal hourly wage. Add together that amount, the amount calculated in Step 1, and the bonus amount. This was the total “base” pay for the workweek.

Step 3:
To calculate the regular rate, divide the total base pay from Step 2 by the total number of hours the employee worked during the workweek.

Step 4:
To calculate the overtime premium, multiply the regular rate from Step 3 by the total number of overtime hours in the workweek and then divide that amount in half.

Step 5:
Add the overtime premium from Step 4 to the total base pay from Step 2. This was the total amount of wages earned for the workweek.

The employer viewed this as a reasonable method for factoring the bonus into the regular rate of pay and calculating overtime wages in part because it complied with a federal regulation regarding overtime pay and because, in the wage and hour context, California courts generally look to federal law for guidance in the absence of controlling state law.

The employee, on the other hand, urged that the following method should have been used instead:

Step 1:
Calculate overtime compensation due from hourly wages by multiplying the normal hourly rate by the number of overtime hours worked and then multiplying that amount by 1.5.

Step 2:
Calculate overtime compensation due from the bonus by dividing the bonus amount by the number of non-overtime hours worked. (This is the per-hour value of the bonus.) Multiply that amount by the number of overtime hours worked and then multiply the result by 1.5.

Step 3:
Combine the amounts calculated in Step 1 and Step 2 to calculate the total amount of overtime compensation due for the workweek. (To calculate total wages for the workweek, add this amount to the bonus plus the hourly pay due from non-overtime hours worked.)

The employee viewed this method as proper, both because it would result in slightly higher overtime pay and because it was consistent with guidance from California’s Division of Labor Standards Enforcement (DLSE).

The California Supreme Court held that the DLSE’s guidance on this issue was not binding, but it also concluded that it was persuasive in light of the DLSE’s expertise and competence in the area of labor law. The Court also took note of California’s public policy discouraging employers from requiring more than 8 hours of work in a day (or 40 in a week), and it observed that California employment law must be liberally construed in favor of workers. As a result, the Court concluded that it was “obligated to prefer an interpretation that discourages employers from imposing overtime work and that favors the protection of the employee’s interests.” The Court thus concluded that the employee’s proposed method was the proper method, and that the employer’s method was incorrect.

The Court limited its decision to flat sum bonuses and noted that a different method of overtime calculation might be appropriate where non-exempt employees earn other forms of compensation in addition to their hourly wages, such as production or piecework bonuses or commissions, because in those cases the employees’ compensation would increase in proportion to the number of hours they worked, including overtime hours. Nevertheless, the Court did not definitively say how it would rule if it were to consider such a case.

Employers unsure whether they are using the proper method of overtime calculation should seek legal advice to avoid the significant damages and penalties that can result from improper calculation of overtime. We have extensive counseling and litigation experience in this area. If you would like to discuss these issues further, or have any questions about this blog, please contact us.