Alerts and Updates

The California Supreme Court... held that when employers give flat-rate bonuses to employees who qualify for overtime, the bonus must be factored into the employee’s regular rate of pay by dividing the amount of the bonus by the total number of nonovertime hours actually worked during the relevant pay period and using 1.5, not 0.5, as the multiplier for determining the employee’s overtime rate of pay.

Businesses with employees in California, take note: In a case likely to create headaches for businesses with employees in the Golden State, the California Supreme Court has spoken on how to calculate overtime for employees who receive flat-sum bonuses. The formula differs from federal law, which many employers currently follow.

In a decision with far-reaching consequences, the California Supreme Court, in the case of Alvarado v. Dart Container Corporation of California, held that when employers give flat-rate bonuses to employees who qualify for overtime, the bonus must be factored into the employee’s regular rate of pay by dividing the amount of the bonus by the total number of nonovertime hours actually worked during the relevant pay period and using 1.5, not 0.5, as the multiplier for determining the employee’s overtime rate of pay.

It is important to note that the Court specifically stated that its ruling only applies to the inclusion of flat-sum bonuses such as those at issue in the Alvarado case, and does not apply to other types of nonhourly compensation, such a production or piecework bonuses or commissions.

The retroactive nature of the decision, and the prospect of significant monetary penalties for noncompliance, creates some urgency for employers in California to quickly evaluate overtime, bonus and pay practices.

Background and Battle of the Formulas

Plaintiff Hector Alvarado worked for Dart Container Corporation as a warehouse associate for two years. He and other employees were paid on an hourly basis and received an “attendance bonus” as an incentive for working weekend shifts. Dart Container, as required by both state and federal law, factored the bonus into employees’ overtime rates for each pay period.

Alvarado questioned the employer’s practice of adding total base hourly wages to bonus wages and dividing the sum by total hours actually worked, including overtime hours, to reach Alvarado’s regular hourly rate of pay. That regular hourly rate of pay was then multiplied by 0.5 to determine the overtime premium, which was paid for each overtime hour (or fraction thereof) worked. That formula is prescribed by the federal Fair Labor Standards Act and is followed by numerous employers in California.

Alvarado proposed an alternative formula that combined the employee’s total base hourly wages with bonus wages and divided the sum by nonovertime hours worked to reach the employee’s regular hourly rate of pay. In Alvarado’s formula, the smaller denominator resulted in a higher regular rate of pay from which the overtime premium would be calculated.

California’s Division of Labor Standards Enforcement Manual—To Follow or Not?

The Court considered the California Department of Industrial Relations’ “Division of Labor Standards Enforcement’s [DSLE] Enforcement Policies and Interpretations Manual,” which interprets the impact of nonproduction bonuses on overtime calculations in a manner identical to Alvarado’s proposal. In an oft-cited decision, the California Supreme Court previously held that the DLSE manual represents an impermissible “underground” regulation because the information contained within was not subject to public comment and was not binding in the courts. The manual subsequently took on less significance, except in DLSE administrative hearings and investigations.

Supreme Court Agrees with Alvarado and Follows, But Does Not Rely Upon, the DLSE Manual’s Overtime Formula

While going to great lengths to emphasize that it was not overruling its prior holding that the DLSE manual was not citable authority and that it remains an impermissible “underground” regulation, the Supreme Court unanimously held that it independently had reached the same conclusion as the DLSE manual, relied upon by Alvarado.

The Court determined that only nonovertime hours should be considered in calculating overtime when bonuses are involved. It emphasized that California public policy strongly disfavors overtime and that employment statutes should be construed in favor of employees. The Court reasoned that a contrary formula, including overtime hours, would dilute the value of each regular hour worked by the employee and would encourage overtime. However, the Court suggested a different result may apply for nonincentive bonuses, i.e. a production or piecework bonus or commission.

Ruling Applies Retroactively

To the dismay of Alvarado’s employers and all others like it that have been calculating overtime using the FLSA rules for flat-rate bonuses, the Court held that its ruling applies retroactively. It was not sympathetic to concerns that employers who had reasonably relied upon the FLSA formula and had disregarded the DLSE manual as noncitable authority (consistent with the Supreme Court’s prior ruling) were now potentially exposed to penalties.

What This Means for Employers

Employers who pay flat-sum bonuses to nonexempt employees in California should promptly evaluate their practices and formulas for calculating overtime. Employers with operations in multiple states with centralized payroll processing should ensure that California employees’ overtime is calculated and processed differently to comply with this new ruling. Employers are reminded that prevention is critical—controlling overtime costs through effective policies, enforcement and trainings may help blunt the impact of the decision.

Because the ruling applies retroactively, and penalties may attach, employers should consider payroll audits with the assistance of counsel. Moving forward, employers may also wish to consider the characterization and timing of flat-sum bonuses to potentially lessen the impact of this decision on future payments.

Finally, it is no longer safe for employers to assume that the DLSE manual is a void “underground” regulation when forming policies and practices; the polices and underlying reasoning in the DLSE manual should be considered in making decisions about wage practices in California.