Suppose a group of your salaried employees sues your company under the Fair Labor Standards Act, claiming they’ve been improperly classified as exempt and are entitled to overtime pay for the last three years. And suppose you’re concerned about the strength of your exemption defense and want to calculate your potential exposure. Do you calculate the employees’ overtime hours at 1.5 times their regular rate? Or can you assert that even if the employees were improperly classified, their salary paid them at a straight time rate for all their overtime hours, and therefore any liability should be calculated at only a half-time rate?

The answer depends on how many hours the employees’ salary was intended to cover.

Here’s why. The FLSA requires that employers pay non-exempt employees overtime pay for hours worked in excess of 40 per week at a rate not less than one and one-half times the employee’s regular rate of pay. 29 U.S.C. § 207(a)(1). The regular rate must be “must be drawn from what happens under the employment contract.” 29 C.F.R. § 778.108. Suppose you agree to pay an employee a weekly salary of $1,000 for a 40 hour workweek. The regular rate is determined by dividing total compensation by the number of hours the salary is intended to compensate. 29 C.F.R. § 778.113. Here, the employee’s regular rate is $25 per hour. If a court determines that the position is non-exempt, your company will be liable for overtime at 1.5 times the regular rate, i.e. $37.50.

Employers and salaried employees often do not have a specific agreement as to how many hours of work are required or expected. But if the facts warrant a conclusion that the salary was intended to cover a 40 hour workweek, the employer will still be liable for overtime hours at 1.5 times the regular rate. In a recent case, Talbot v. Lakeview Center, Inc., Case No. 3:06cv378/MCR/MD (N.D. Fla., February 2, 2010), the employer posted two job opening advertisements that listed the hours of employment as 8 a.m. to 5 p.m., Monday through Friday. Plaintiffs were expected to be on the job during normal business hours and did not believe they were permitted to work fewer than 40 hours per week. Although plaintiffs understood that evening or weekend work would sometimes be required, the employer used a “flex time” arrangement that permitted plaintiffs to arrive at work late if required to work on an evening or weekend. The court found these facts consistent with a contract for a 40 hour week and held that the employer was liable for overtime at 1.5 times the regular rate.

For employers, there is a better way. If you’ve made it clear to salaried employees that their salary covers all hours worked, irrespective of the number of hours they work, you can argue that the employees’ salary already compensated them at a straight time rate for all hours worked, and that even if the employees are found to be non-exempt, any overtime should be calculated at a half-time rate. Courts sometimes characterize this as a retroactive application of the “fluctuating workweek” method.

Under the Department of Labor’s “fixed salary for a fluctuating workweek” rule, “where there is a clear mutual understanding of the parties,” an employer can pay a non-exempt employee a fixed salary that serves as compensation for all hours worked if it is sufficient to compensate the employee for all straight time hours worked at a rate not less than the minimum wage and the employee is paid an additional one-half of the regular rate for all overtime hours. See 29 C.F.R. § 778.114. To be clear, when you treat employees as exempt, you are not actually utilizing the “fluctuating workweek” method because, by definition, you are not paying the employees any overtime. But if your exemption argument fails, many courts will allow you to apply the rule retroactively to limit overtime liability to a half-time rate.

For example, in Blackmon v. Brookshire Grocery Co., 835 F. 2d 1135 (5th Cir. 1988), the plaintiffs had been promoted with the understanding that they would be paid a fixed weekly salary, and would work whatever number of hours were required to get the job done. The trial court found that plaintiffs were not exempt and calculated overtime at 1.5 times their regular rate. On appeal, the Fifth Circuit Court of Appeals, citing the fluctuating workweek rule, held that a half-time rate was appropriate. In Saizan v. Delta Concrete Prods. Co., 209 F. Supp. 2d 639, 640 (M.D. La. 2002), the court, citing Blackmon, reached the same conclusion. In Sutton v. Legal Services Corp., 11 W.H Cas.2d 401, 404 (D.C.Sup.2006), the court stated that “virtually every court that has considered the question” has upheld the remedial use of half-time in failed exemption cases.

A January 14, 2009 Department of Labor opinion letter (FLSA2009-3), in which the DOL endorsed the fluctuating workweek method to compute the retroactive payment of overtime to misclassified employees, lends support to Blackmon and similar cases.

But recently, at least two courts have held that the fluctuating workweek method cannot apply retroactively. In In re Texas EZPawn Fair Labor Stds. Act Litig., 633 F. Supp. 2d 395 (W.D. Tex. 2008), the court stated that applying the method not only as a way to pay an employee, but also as a way to remedy misclassification, is inconsistent with the remedial provisions of the FLSA. In Russell v. Wells Fargo and Co., No. C 07-3993 (N.D. Cal. Nov. 17, 2009), the court reached the same conclusion and specifically found the DOL opinion letter (FLSA2009-3) unpersuasive.

In Torres v. Bacardi Global Brands Promotions, Inc., 482 F. Supp. 2d 1379 (S.D. Fla. 2007), the court side-stepped the issue altogether and held that the application of the fluctuating workweek method was not at issue because the employer was not relying on it. The court nevertheless agreed with the employer that because the plaintiff had “already received his regular rate for all hours worked,” he was only entitled to half-time for those hours worked in excess of forty per week.

While there is some disagreement in the case law about whether it is proper to use a half-time rate to calculate overtime liability in a failed exemption case, there is little or no disagreement that half-time is applicable, if at all, only where the employees’ salaries were intended to cover all hours worked. If the evidence shows that the employees’ salaries were intended to cover a 40-hour workweek, the employer’s half-time argument will fail.

And make no mistake, the difference between calculating overtime at a half-time rate and 1.5 times the regular rate is dramatic. As noted above, an employee who is paid a $1,000 weekly salary for a 40-hour workweek has a regular rate of $25 per hour. Ten hours of overtime will cost the employer $375 in back pay (25 x 1.5 x 10 = $375). Now consider an employee who is paid a $1,000 weekly salary with a clear understanding that her salary covers all hours worked. In a week in which the employee works 50 hours, the regular rate is $20 per hour. Using a half-time rate, the employer’s liability for ten hours of overtime is only $100 (20 x 0.5 x 10 = $100), a $375% difference.