In a case of first impression, the Ninth Circuit held in Flores v. City of San Gabriel  that an employer was liable to a class of employees for failing to include cash-in-lieu of benefits payments in its calculation of the regular rate for overtime purposes and that such payments are to be viewed as compensation for hours worked under the FLSA.  The Court also found the City’s failure to make further inquiry into the correctness of its designation of the benefits payments as excludable to be a willful violation of the statute, triggering an extended statute of limitations as well as liquidated damages.

In Flores, the City provided a Flexible Benefits Plan to its employees, whereby the City paid them a monthly allowance to purchase and maintain medical, dental, and vision benefits.  Employees were required to use a portion of the funds for dental and vision benefits, but could decline to use the remainder of the funds upon proof that the employee had alternate medical coverage (e.g. through a spouse).  If declined, the employee would receive the unused portion of the medical benefits allotment as a cash payment ($1,036 to $1,304 per month), that was added to his or her regular paycheck.  For the four years relevant to the lawsuit, from 42% to 46% of the City’s total plan contributions were paid to employees as cash for unused benefits.  The City designated all of the cash-in-lieu-of benefits payments as “benefits” not tied to hours worked by the employees, and therefore excluded them from calculation of the employees’ regular rate of pay.

A class of current and former police officers employed by the City filed a collective action under the FLSA, alleging that by failing to include the cash-in-lieu of benefits payments in calculating their regular rate of pay, the City willfully underpaid them overtime compensation.  The trial judge ruled in favor of the plaintiffs, finding that the City improperly excluded the cash-in-lieu of benefits payments from the regular rate of pay, except to the extent that such payments were made to trustees or third parties as part of a bona fide plan.  However, the judge also found that the City’s violation was not willful, limiting the period of recovery on the claim to two years (instead of three – for willful violations), and that plaintiffs were not entitled to liquidated damages.  Both sides appealed to the Ninth Circuit.

The Ninth Circuit affirmed in part and reversed in part, albeit acknowledging that it was a “close call” on an issue of first impression, holding that the City’s plan was not a bona fide benefits plan for purposes of exclusion under the FLSA -- not only because payments were not made to a third party or trustee, but because the cash payments were greater than “incidental”. 

Using a standard the Concurring Opinion by Judge Owens labeled (in a sly Game of Thrones reference) as coming dangerously close to a “qyburnian resurrection” of theJiffy June standard where willfulness could be found when the FLSA was merely “in the picture”, the Circuit Court, unlike the trial court, concluded that the City acted willfully in violating the law by failing to “take affirmative action to assure” its classification of the payments complied with the FLSA.  While ultimately agreeing with the “willfulness” finding, Judge Owens pointed out that the standard for willfulness was more than negligence.

Notwithstanding the lack of legal precedence on the issue, nor the potential negative impact of discouraging employers from offering flexible benefit plans to employees, the Ninth Circuit’s opinion left the issue of the classification of these payments to the legislature, and not the courts, to address.

Until the legislature provides clarity on this issue, employers with flexible benefits plans should audit their payroll practices to avoid overtime pay liability and costly penalties if any compensation is being paid directly to employees in lieu of benefits.  Carefully evaluating the true cost of maintaining those plans in light of the Flores decision’s possible impact on overtime costs is another consideration for employers, especially those with workforces that are largely hourly.  Ignoring the possibility of a willfulness finding due to ongoing practices could lead to a Mountain1 of unanticipated costs.