In a recent and surprising appellate decision favorable to California employers, explicit mutual wage agreements between employees and employers were upheld as being consistent with California’s otherwise inflexible wage and hour laws.

Prior to AB 60 which reinstated overtime for all hours worked in excess of 8 in a day for California’s non-exempt employees, employers were allowed to pay a salary that was designed to compensate workers for all hours worked, including overtime, where the employee entered into an explicit mutual wage agreement that paid a salary or amount that included compensation for straight time and anticipated overtime hours. In order to establish an explicit, mutual wage agreement, the employer was required to show that the parties entered into an agreement that specified (1) the days that the employee would work each week; (2) the number of hours the employee would work each day; (3) that the employee would be paid a guaranteed salary of a specific amount; (4) that the employee was told the basic hourly rate upon which his salary was based; (5) that the employee was told his salary covered both his regular and overtime hours; and (6) the agreement must have been reached before the work was performed.

In 2000, the Legislature enacted Labor Code Sec. 515(d) which states: "For the purpose of computing the overtime rate of compensation required to be paid to a non-exempt full-time salaried employee, the employee’s regular hourly rate shall be 1/40th of the employee’s weekly salary." Following AB 60, the California Division of Labor Standards Enforcement took the position that the new statute precluded these explicit mutual wage agreements and that any salary must be divided by 40 hours to calculate the regular rate and time and half of that rate must be paid for all overtime in addition to the salary. The result was a higher amount of total wages due than intended by the employer due to the additional burden of anticipated overtime. On February 7, 2011, in Arechiga v. Dolores Press, Inc., the California Appellate Court provided a rare employer-friendly decision that harmonized the interplay between the case law allowing explicit mutual wage agreements and Labor Code section 515. The court held that Labor Code section 515 does not prohibit "explicit mutual wage agreements," by which an employer and employee may agree to a fixed salary, to include both basic wages and overtime compensation so long as overtime is actually paid at not less than one and one-half times the basic rate.

The appellate court rejected the interpretation set forth in the Enforcement Policies and Interpretations Manual of the Divisions of Labor Standards Enforcement outlawing explicit mutual wage agreements, and instead, embraced the Supreme Court’s ruling last year in Martinez v. Combs, 49 Cal.4th 35, 50 fn 15 (2010) which held that the policies in the DLSE enforcement manual were not entitled to deference because they were not adopted in compliance with the Administrative Procedure Act.

Having rejected the DLSE’s interpretation, the trial court found that Arechiga and his employer had entered into an explicit mutual wage agreement when they orally agreed he would work 11 hours a day, 6 days a week for a total of 66 hours per week. They further agreed that his salary of $880 would include 26 hours of overtime pay each week. The only written confirmation of this agreement was a statement “Employee shall be paid a salary of $880.” Arechiga argued that because of Labor Code section 515, the salary of $880 could only be considered compensation for the regular 40 hour work week and thus his hourly rate was $880 divided by 40, or $22 per hour and did not include his regularly scheduled 26 hours of overtime. The trial court found that California case law did not support Arechiga’s assertion that Labor Code section 515(d) abolished explicit mutual wage agreements, and the Court of Appeals agreed noting that both federal courts and the Judicial Council of California Civil Jury Instructions continue to acknowledge the viability of the explicit mutual wage agreement doctrine.

While this appellate decision is undoubtedly a win for employers in California, until the state’s Supreme Court decides to grant or deny review of this decision, employers should exercise caution before making any changes in reliance on this appellate ruling. However, if upheld, this ruling provides employers substantially more flexibility to make pay arrangements with non-exempt employees that include overtime, and significantly limits exposure for those employers who still have these explicit mutual wage agreements in place.