When a non-exempt employee is entitled to overtime compensation, the hourly rate of pay on which overtime calculations are based is known as the employee's “regular rate of pay.” If an employer does not determine the regular rate of pay properly, it will calculate overtime pay incorrectly, exposing itself to potential liability.

An employee's regular rate of pay will be equal to his or her straight-time hourly rate if the employee's compensation consists solely of hourly wages during the pay period, but the regular rate can vary from the straight-time rate because the regular rate calculation includes other forms of compensation as well, such as bonuses paid for productivity or quality of work. In other words, an employer calculating the regular rate of pay for a non-exempt employee must consider not only the employee’s straight-time hourly rate, but also bonuses paid for productivity or quality of work.

How should employers calculate the regular rate of pay during weeks in which an employee receives a flat sum bonus? Early last week, the California Supreme Court provided direction on that issue in Alvarado v. Dart Container Corporation of California.

Dart Container Corporation provided a \$15 attendance bonus to each employee who completed working a scheduled weekend shift. The company used a formula consistent with the federal regulations interpreting the Fair Labor Standards Act (FLSA). By way of example, assume that an employee earning \$20 per hour works 45 hours during a week and receives a \$100 bonus for her work. To calculate the employee's regular rate of pay under the FLSA regulations, the employer would multiply the total number of hours worked by the straight time hourly rate (45 x \$20 = \$900), add to that amount the sum received as a bonus (\$900 + \$100 = \$1,000), and divide that sum by the total number of hours worked to obtain the regular rate of pay (\$1000/45 = \$22.22). The employee is then entitled to be paid \$1,055.45 for the week (40 hours at \$22.22 plus 5 hours at \$33.33).

The plaintiff, Hector Alvarado, filed a complaint alleging that Dart Container Corporation’s method resulted in an underpayment of wages. Alvarado argued that the company should have calculated the regular rate of pay consistent with guidance from California’s Division of Labor Standards Enforcement (DLSE) Manual which specifically addresses flat sum bonuses. Under the DLSE’s method, only the straight time hours worked, rather than all hours worked, are used in the initial calculations, resulting in a higher regular rate of pay. Under Alvarado’s method, the total earnings in the previous example would be divided by the straight time hours worked (\$1000/40), resulting in a higher regular rate of pay (\$25.00) and therefore a higher overtime rate (\$37.50).

The Court of Appeal, after first confirming that federal regulations do not preempt more protective California law, ruled that the DLSE Manual’s provisions do not carry the force of law and declined to apply them. Fundamentally, the court ruled that, in the absence of state law to the contrary, the company’s reliance on federal regulations in computing Alvarado’s overtime was sound.

The California Supreme Court reviewed and rejected the Court of Appeal’s opinion. The Supreme Court first determined that the flat sum attendance bonus must be treated as if it were earned on a per-hour basis, through the relevant pay period. Significantly, the court noted that attendance bonus at issue would be payable even if the employee works no overtime during the relevant pay period. On that basis, the Supreme Court determined that Alvarado and the DLSE are correct – under California law, the proper divisor for purposes of calculating the regular rate of pay when an employee earns a flat sum bonus should include only the number of non-overtime hours the employee worked during the pay period.

What Should Employers Do Now?

• Carefully review current practices on calculating the regular rate of pay for employees who receive flat sum bonuses – Having received clear direction for the California Supreme Court, employers should make sure its current practices are in alignment with the law. Further, the Supreme Court explicitly determined that it decision applies retroactively. Accordingly, and with respect to past inconsistent practices, employers may be wise to confer with counsel.
• The Supreme Court’s decision appears limited to flat sum bonuses – The Supreme Court touched on bonuses designed to incentivize employees for increased production for each hour worked – bonuses that increase in rough proportion to the number of hours worked (such as a production bonus, piecework bonus, or commission). Though it did not issue clear guidance, the Supreme Court suggested that such bonuses would be calculated according to the method advocated by Dart in the first instance.