Employers breathed a sigh of relief when the California Supreme Court issued its December 29, 2011 ruling reversing the Court of Appeal's decision in Harris v. Superior Court ("Harris I"). But in a disturbing development this week, the Court of Appeal on remand stuck to its prior holding and issued a decision on the administrative exemption that appears largely to ignore the guidance the California Supreme Court provided. As explained below, the resulting decision is unpersuasive and a good candidate for a second review (if not a summary reversal and remand).

Background Facts and Earlier Proceedings in Harris I

In this case, plaintiffs were claims adjusters at insurance companies Liberty Mutual and Golden Eagle. Plaintiffs alleged that their employers had erroneously classified them as exempt pursuant to the administrative exemption. Instead, plaintiffs argued that they were just non-exempt "production" employees who did not perform the type of job that could be covered by the administrative exemption.

The trial court initially certified a class for the time period prior to 2001, but denied certification after 2001, finding that changes in the governing wage order created individualized issues that were not subject to classwide resolution. The plaintiffs argued that, both before and after 2001, the court should examine the position using the so-called "administrative/production worker dichotomy," which was a judicial gloss created to determine whether workers performed a type of job that could qualify as "administrative" in the first instance. This test distinguishes between administrative employees primarily engaged in administering the business affairs of a company and production-level employees whose primary duty is producing the goods or services of the company. In previous precedent, Bell v. Farmers Insurance, California appellate courts held that Farmers’ claims adjusters were "production" workers rather than administrative workers under the dichotomy.

At the appellate level in Harris I, in a 2-1 split decision, the Second District Court of Appeal sided with the plaintiffs, holding that adjusters were non-exempt production employees. It held that the administrative/production dichotomy rendered all of the putative class members non-exempt production workers both before and after 2001. It also announced a test that to qualify as an administratively exempt employee, an employee had to primarily spend his or her time on "work at the level of policy or general operations" as opposed to work in the "day-to-day" operations of the business. This appellate decision came under fire for the fact that it was not tethered in any way to the Department of Labor regulations that govern the administrative exemption under California law, because it seemed inconsistent with how the exemption had been applied in many other contexts, and because it was so vaguely defined. Under the test the court of appeal announced, the adjuster class was entitled to class certification and to summary judgment on liability, much like the adjusters had obtained in Bell v. Farmers Insurance.

The California Supreme Court granted review in Harris I to decide how the administrative/production dichotomy applied under California law and, more generally, how the administrative exemption is properly interpreted. The California Supreme Court waited some four years to issue a decision, but ultimately did so on December 29, 2011, and reversed the Court of Appeal. The California Supreme Court's decision was unanimous but narrow. In essence, the Court held that for the period from 2001 forward, the two-justice majority in the Harris I appellate decision had erred in applying the administrative/production dichotomy. Instead, they should have analyzed the exemption by looking to the actual text of those federal Department of Labor ("DOL") Regulations that were expressly incorporated into the governing IWC Wage Order, 4-2001.

The California Supreme Court then provided some limited guidance on the application of the administrative exemption. The Court construed the requirement that work be "directly related to management or business operations" as having a "qualitative" and "quantitative" element. The qualitative element was simply an examination of whether the employee's work is administrative in nature. Separately, the work must be of substantial importance to the management or business operations, which the California Supreme Court labeled as a "quantitative" test (even though it is not really quantitative in concept). The Court announced, however, that it was not addressing the application of the quantitative element as applied to insurance adjusters because the importance of adjusters' work was not at issue in the rulings below.

The California Supreme Court refrained from deciding the ultimate issue of whether some or all of the claims adjusters met the administrative exemption. Instead, the Court directed the Second District Court of Appeal on remand to examine 29 C.F.R. 541.205(a), (b), and (c) and "consider the particular facts before them and apply the language of the statutes and wage orders at issue." Of note, 29 C.F.R. 541.205(c) lists "claims agents or adjusters" as examples of employees who can qualify for the administrative exemption.

The California Court of Appeal Largely Failed to Follow the Directive of the California Supreme Court on Remand

On remand, the Second District was faced with deciding (1) whether the trial court's order decertifying the class for the period governed by Wage Order 4-2001 should be reversed; and (2) whether the plaintiff class was entitled to summary adjudication on the administrative exemption. Two of the three judges on the panel (the "two-justice majority") determined that decertification should be reversed and summary adjudication should be granted to the plaintiff class for the entire class period. In reaching this conclusion, the two-justice majority utilized essentially the same reasoning the majority had utilized in Harris I, except they replaced all references to the "administrative production dichotomy" with references to the "qualitative test." The ensuing analysis seemed to misunderstand the directive of the California Supreme Court.

The decision is truly breathtaking in its unpersuasiveness and intellectual confusion. First the two-justice majority attacked an argument that the defendants never asserted. The Court of Appeal noted that, if the text of the regulations were read literally, "every type of work directly relates to management policy, because every employee does work that carries out, or is governed by, management policy." Because such a broad construction would allow every employee to meet the qualitative aspect of the exemption, the Court determined that some other test must be fashioned to limit the exemption. But there was no need to stake out such an extremist position, especially since a maximalist reading of “related to management or business operations” presumably could not be harmonized with the totality of the DOL regulations that California Supreme Court directed the Court of Appeal to consider.

Rather that look through the DOL regulations closely to try to devise a test that could be harmonized with the regulations as a whole, the two-justice majority just re-announced the earlier standard that, to meet the exemption, the employee must primarily perform work "at the level of policy or general operations," a phrase that appears nowhere within the governing DOL regulations. Instead, that test the two-justice majority announced is a variation on language used in factually dissimilar federal appellate decisions applying the exemption to wholly unrelated jobs. Notably, the two-justice majority did not even acknowledge that Ninth Circuit precedent existed addressing the very issue of whether claims adjusters are exempt (Miller v. Farmers Insurance).

The two-justice majority did acknowledge that the new test it announced was seemingly inconsistent with language in the DOL regulations that "claims agents and adjusters" can meet the exemption and language that duties that qualify as administratively exempt include "advising management, planning, negotiating, and representing the company," which are all examples of duties claims adjusters routinely perform. The two-justice majority’s explanation for its departure from the plain text of the DOL regulations does not hold up to scrutiny.

First, the two-justice majority noted that the mere fact that claims adjusters performed duties that were expressly listed in the regulations was not sufficient to make their jobs exempt, but rather those types of duties must be performed at the level of policy making or general business operations to qualify as exempt. The majority noted that a legal secretary might plan out a schedule, negotiate with a vendor, and advise management on the best day to file a motion, yet those duties would not make the secretary exempt. The analogy is a bit of a red herring, in that a secretary's primary duties do not involve any of those duties and, moreover, the secretary would be deemed non-exempt even if the secretary performed some of those duties for the reason that the work was not of substantial importance (the quantitative test) and because such a job does not involve the customary and regular exercise of discretion and judgment (another essential element of the exemption). Indeed, former 29 C.F.R. 541.205(c)(1) makes this very point in noting that secretarial work does not meet the importance (quantitative) element of the exemption.

Second, the two-justice majority noted that the California Supreme Court held that it was not deciding the application of the "quantitative" portion of the exemption, yet the reference to "claims adjusters" qualifying as exempt is in the portion of the DOL regulations addressing the "quantitative" aspect of the exemption. In other words, former 29 C.F.R. 541.205(c) purports to list examples of type of administrative jobs that are of "substantial importance" as necessary to meet the quantitative element of the exemption. The majority thus reasoned that the inclusion of insurance adjusters in that regulation is irrelevant to the qualitative portion of the exemption, but that reasoning is not sound. The DOL would have no reason to address claims adjusters at all in the administrative exemption regulations if such a job was not administrative in nature. As such, a more logical reading would be that Section 541.205(c) addresses only jobs that are "qualitatively" exempt, but distinguishes exempt and non-exempt "administrative" jobs.

For example, Section 541.205(c)(1)—which is expressly quoted in the California Supreme Court's Harris I decision—distinguishes the work of a bank cashier from that of a bank teller as an example of an exempt and non-exempt job, respectively, even though it is evident from the regulation that both of those jobs are "qualitatively" exempt. What makes the two-justice majority's decision even less persuasive is that the majority noted that numerous federal decisions have found insurance adjusters to be exempt using these very regulations as support, but the two-justice majority waved these decisions aside on the ground that the regulations at issue purportedly address only the "quantitative" aspect of the exemption.

Dissenting Justice Rothschild, who was one of the two justices in the original Harris I majority opinion, did not actually disagree with the reasoning of the majority, but ruled that she would decline to reach the issues the majority reached because the only argument that plaintiffs raised below was the administrative/production dichotomy, and the California Supreme Court held that the dichotomy did not support a finding that the employees are non-exempt under Wage Order 4-2001. But Justice Rothschild did not take issue with any aspect of the majority's reasoning in the manner that the dissent in the original Harris I appellate decision (by retired Justice Vogel) had sharply rejected the majority opinion's formulation of the administrative/production dichotomy. In fact, Justice Rothschild expressly endorsed the majority's conclusion that Section 541.205(c) "relates only to the quantitative component of the 'directly related' requirement."

Limited Impact of the Decision

Fortunately, unlike when Harris I initially came down in 2007, there is now a sizeable body of established law on the administrative exemption that is simply inconsistent with the narrow standard the two-justice majority announced. For example, the decision is inconsistent with United Parcel Service Wage and Hour Cases, 190 Cal. App. 4th 1001 (2010), where a hub supervisor and center manager was held to meet the administrative exemption as a matter of law despite an utter absence of evidence that the employee at issue made policy or performed work outside of "day to day" operations management. The case also is inconsistent with the Ninth Circuit Miller decision, notwithstanding that both decisions interpret the same DOL regulations as applied to insurance adjusters. Accordingly, whether or not the California Supreme Court grants review again (as it should), employers will have ammunition to argue that Harris should not be followed outside of state court insurance adjuster cases (if even there).