Kelly A. Knight is an attorney and mediator based in Los Angeles, CAlifornia. He handles matters throughout California.

California Supreme Court clarifies that flat-sum bonuses must be divided by the number of nonovertime hours worked when calculating the "regular rate of pay" for overtime purposes.

This is huge, folks. The California Supreme Court just issued Alvarado v. Dart Container Corporation of California, 2018 WL 1146645 (Cal. (March 5, 2018)), slip opinion linked here. In doing so, the Cal Supremes clarified a major ambiguity in employment law: in determining the "regular rate of pay" for overtime purposes, whether a flat-sum bonus must be divided by the actual number of total hours worked during the pay period, the actual number of nonovertime hours worked, or just the actual number of nonovertime hours that exist in the pay period regardless of hours actually worked (e.g., 40 hours for a full-time employee misclassified as exempt). 

The Court of Appeal held for the employer, accepting the employer's argument that in the face of no authority on point, a federal regulation governed and should control the result. The employee argued that the flat-sum bonus should be divided only by the actual number of nonovertime hours worked in the pay period, resulting in a larger increase in the regular rate of pay for overtime purposes than the employer's calculation. 

Result? The Cal Supremes held that the flat-sum bonus must be divided by the actual number of nonovertime hours worked during the pay period when calculating the regular rate of pay for overtime purposes. A major ambiguity in California employment law has now been clarified.

The other major holding is that this clarification and interpretation operates retroactively, not just prospectively. 

And there are other important portions of and takeaways from this opinion, including that (1) a court should the DLSE Enforcement Manual provisions in interpreting California wage-and-hour laws when presented by the parties and (2) "regular rate of pay" for purposes of overtime compensation refers to nonovertime hours. These portions of the opinion could have huge impact on future cases.

More discussion on and excerpts from the Alvarado opinion:

The Alvarado case involved an employer that paid a flat-sum bonus consisting of an additional fifteen dollars for each day of weekend work that an employee performed, regardless of what other weekday shifts or hours the employee worked. See slip op. at 2. In other words, the bonus was a sort of incentive bonus to incent employees to work weekends, and the bonus came in the form of a flat sum of fifteen dollars. But the issue raised by the employee was how that bonus was factored into the employer's overtime calculation. Among other things, the employer was dividing the flat-sum attendance bonus by the total number of hours worked during the pay period, including overtime hours worked. Id. This yields a lower increase to the regular rate of pay than if the flat-sum bonus was divided into just the nonovertime hours worked. 

If you're new to this area of law, this is all likely very confusing. You should read the full opinion, as it provides a nice primer on how California treats overtime compensation and the policy reasons for it (discouraging work beyond forty hours in a workweek, etc.), the underlying legal framework (combination of statutory law (the California Labor Code), wage orders issued by the Industrial Welfare Commission, etc.). But here's a short blurb on the "regular rate of pay," which is the rate on which overtime premium compensation is calculated:

Significantly, an employee’s “regular rate of pay” for purposes of Labor Code section 510 and the IWC wage orders is not the same as the employee’s straight time rate (i.e., his or her normal hourly wage rate). Regular rate of pay, which can change from pay period to pay period, includes adjustments to the straight time rate, reflecting, among other things, shift differentials and the perhour value of any nonhourly compensation the employee has earned.

Slip op. at 8.

There was no dispute between the parties that the flat-sum incentive bonus must be factored into the regular rate of pay. The dispute was whether the bonus must be divided by all nonovertime hours or whether it must be divided by all hours worked (including overtime hours) in the pay period to derive the per-hour effect of the bonus on the regular rate of pay:

Here, the attendance bonus that defendant pays for weekend work is incentive pay for completing a full work shift on a day that is unpopular for working (a Saturday or a Sunday). Nonetheless, it is part of an employee’s overall compensation package, and therefore both parties agree that its per-hour value must be determined so that the employee’s regular rate of pay — and, derivatively, the employee’s overtime pay rate — reflects all the various forms of regular compensation that the employee earned in the relevant pay period. In other words, for the limited purpose of calculating overtime pay, the attendance bonus (which is earned all at once by completing a weekend work shift) is treated as if it were earned on a per-hour basis throughout the pay period. The question then arises whether the bonus is treated as if it were earned throughout the entire pay period (including any overtime hours), or whether the bonus is treated as if it were earned throughout only the nonovertime hours of the pay period. It is this question that lies at the heart of the parties’ disagreement.

Id. at 9.

The California Division of Labor Standards Enforcement (DLSE) had a provision right on point in its Enforcement Manual (the policy manual for how it enforces wage-and-hour laws) that interpreted this situation in the manner the plaintiff in Alvarado advocated: dividing flat-sum bonuses only by the number of nonovertime hours actually worked. But interpretations in the DLSE Enforcement Manual, where not merely a restatement of prior agency decisions, are in effect legislative regulations; therefore, if not passed following the stringent criteria in the California Administrative Procedures Act (APA) (California's law regarding agency rule-making/regulation-making), the regulations are void.  But—and this is key—that doesn’t mean that the interpretations are worthless:

[W]hen the APA applies, administrative policies that are not adopted in accordance with its requirements are “void” regulations that are “not entitled to any deference.” (Tidewater, supra, 14 Cal.4th at p. 577; see Reilly v. Superior Court (2013) 57 Cal.4th 641, 649 [reaffirming Tidewater]; Morning Star Co. v. State Bd. of Equalization (2006) 38 Cal.4th 324, 340 [same]; Morillion v. Royal Packing Company, supra, 22 Cal.4th at pp. 581– 582 [same]; Armistead v. State Personnel Board (1978) 22 Cal.3d 198, 204 [stating same rule as Tidewater]; see also Gov. Code, § 11340.5, subd. (a).) But “void,” in this context, does not necessarily mean wrong. If the policy in question is interpretive of some governing statute or regulation, a court should not necessarily reject the agency’s interpretation just because the agency failed to follow the APA in adopting that interpretation; rather, the court must consider independently how the governing statute or regulation should be interpreted. “If, when we agreed with an agency’s application of a controlling law, we nevertheless rejected that application simply because the agency failed to comply with the APA, then we would undermine the legal force of the controlling law. Under such a rule, an agency could effectively repeal a controlling law simply by reiterating 13 all its substantive provisions in improperly adopted regulations. . . . The DLSE’s policy may be void [if adopted in violation of the APA], but the underlying wage orders are not void. Courts must enforce those wage orders just as they would if the DLSE had never adopted its policy.” (Tidewater, at p. 577, italics added.)

Id. at 12-13.

The Cal. Supremes continued that agency interpretations should be viewed as a tool available to a court and may even be particularly persuasive given the agency's special familiarity with the subject, even where the regulation is legally void and does not carry force of law:

In Yamaha, we concluded that the annotations were “ ‘entitled to some consideration by the Court.’ ” (Yamaha, supra, 19 Cal.4th at p. 15.) We emphasized that “[c]ourts must . . . independently judge the text of the [governing] statute,” but in exercising that independent judgment, courts may “tak[e] into account and respect[] the agency’s interpretation of [the statute’s] meaning,” whether “embodied in a formal rule or [a] less formal representation.” (Id. at p. 7.) We characterized the agency’s interpretation of the statute as “one among several tools available to the court,” saying that “[d]epending on the context, it may be helpful, enlightening, even convincing,” or “[i]t may sometimes be of little worth.” (Id. at pp. 7–8.) What made the agency’s interpretation more, rather than less, persuasive was the extent of the agency’s “special familiarity” with the problem at issue, and we expressly extended that principle to interpretations that were not adopted in accordance with the APA. (Id. at p. 11.) “It is this ‘expertise,’ expressed as an interpretation (whether in a regulation or less formally . . . ), that is the source of the presumptive value of the agency’s views.” (Ibid., italics added.)

Id. at 13-14.

[A]n agency’s underground interpretive regulation should not be afforded any special weight or deference, but it is nonetheless something a court may consider, and assuming the court is persuaded that the agency’s interpretation is correct, the court may adopt it as its own. Moreover, the persuasiveness of the agency’s interpretation increases in proportion to the expertise and special competence that are reflected therein, including any evidence that the interpretation was carefully considered at the highest policymaking level of the agency. 

Id. at 14-15.

"[E]ven void sections [of the DLSE Enforcement Manual] continued to serve the laudable purposes of promoting agencywide uniformity of decision and notifying the public of the agency’s interpretations of the law."  Id. at 15.

When faced with an agency interpretation that did came into being without satisfying the Administrative Procedures Act, a court should still look to the interpretation and take it into consideration:

Agency interpretations set forth in void underground regulations are not entitled to any special judicial deference (Tidewater, supra, 14 Cal.4th at pp. 576–577), but they may very well be correct (id. at p. 577), and the public benefits from knowing them. Moreover, a court that is exercising its independent judgment should certainly take the agency’s interpretation into consideration, having due regard for the agency’s expertise and special competence, as well as any reasons the agency may have proffered in support of its interpretation (Yamaha, supra, 19 Cal.4th at pp. 11 and 14), and if the court is persuaded, it may, of course, adopt the agency’s interpretation as its own. Thus, when an agency like the DLSE sets forth an interpretive policy in a void underground regulation, the deference that the agency’s interpretation would normally enjoy is absent, but in its place the agency has its power to persuade.

Id. at 16.

Here, the DLSE Enforcement Manual addressed the exact issue the parties were disputing:

The DLSE Manual addresses that precise question in section, saying: “If the bonus is a flat sum, such as $300 for continuing to the end of the season, or $5.00 for each day worked, the regular bonus rate is determined by dividing the bonus by the maximum legal regular hours worked during the period to which the bonus applies. This is so because the bonus is not designed to be an incentive for increased production for each hour of work; but, instead is designed to insure that the employee remain in the employ of the employer. . . .” (DLSE Manual, supra, §§, p. 49-9, italics added.)

Id. at 17.

The Alvarado court determined that this portion of the DLSE manual is in effect a void regulation that was not adopted in accordance with the APA. See id. at 17. But the DLSE’s interpretation may nevertheless may be correct, and the Court of Appeal therefore erred in concluding that, because there was no state law governing, the issue must be decided on federal law. Id. at 18. After all, the DLSE's interpretation may have been correct, and a court may take into account the DLSE's "expertise and special competence," with the DLSE manual constituting a "formal compilation that evidences considerable deliberation at the highest policymaking level of the agency." Id. at 18-19.

If you're an employment-law practitioner, you know that just the Alvarado court's analysis up to this point is a powerful state from our state's high court regarding the potential impact of the DLSE Enforcement Manual. 

Now to the ultimate result in the case.

The Alvarado court based its decision on two “overarching principles” that guided its analysis: “First, the obligation to pay premium pay for overtime work reflects a state policy favoring an eight-hour workday and a six-day 40-hour workweek, and discouraging employers from imposing work in excess of those limits. [citation and footnote omitted] Second, the state’s labor laws are to be liberally construed in favor of worker protection.” Id. at 19-20.

Looking at the situation with those principles in mind, where an employee works no overtime hours at all, the full bonus is factored into the regular rate of pay, meaning the full bonus is earned using only nonovertime hours. It therefore mares sense that the bonus is earned with nonovertime hours:

Significantly, however, the weekend attendance bonus at issue here is payable even if the employee works no overtime at all during the relevant pay period. It follows, then, that the bonus is properly treated as if it were fully earned by only the nonovertime hours in the pay period, and therefore only nonovertime hours should be considered when calculating the bonus’s per-hour value.

Id. at 20-21.

In a key interpretive portion of the opinion, the court further explained that the very meaning of the phrase "regular rate of pay" refers to "regular-time" or nonovertime hours:

The foregoing point finds support in the plain meaning of the phrase “regular rate of pay.” As noted, an employee’s regular rate of pay changes from pay period to pay period depending on whether the employee has earned shift differential premiums or nonhourly compensation. Therefore, the word “regular” in this context does not mean “constant.” Furthermore, Labor Code section 510 and the IWC wage orders define the overtime rate of pay as a multiple of the regular rate of pay, thus juxtaposing what is “overtime” and what is “regular.” It follows, then, that the word “regular” in the phrase “regular rate of pay” refers to “regular-time” (i.e., nonovertime). (Cf. Lab. Code, § 515, subd. (d)(2) [arguably using the word “regular” synonymously with the word “nonovertime”].) That interpretation implies that when nonhourly compensation is factored into an employee’s “regular rate of pay,” only nonovertime hours should be considered.

Id. at 21.

The Cal. Supremes bolstered this conclusion by looking to Skyline Homes and Labor Code section 515(d), which provides that the regular rate of pay is “1/40th the employee’s weekly salary” and payment of a fixed salary is deemed to only compensate for nonovertime hours. See id. at 24. These also stand for the proposition that flat sums compensate only for nonovertime hours worked. Id.

The next question was whether the divisor (denominator in the equation) for the flat sum should be forty hours regardless of the actual hours worked, or whether it should be the actual hours worked. The Alvarado court concluded that only actual hours worked should be used because dividing by a full forty hours (regardless of the employee working fewer hours) would “dramatically reducing the overtime pay rates of part-time employees in California”; “would contradict the principle that our state’s labor laws must be liberally construed in favor of worker protection”; and would not further “this state’s policy of discouraging the imposition of overtime work [citation] if we were to permit employers to dilute the value of the flat sum bonuses that their part-time employees earned, fictionally treating those bonuses as if the part-time employees were working fulltime schedules.” Id. at 26-27. 

For employees with fixed weekly salaries, the divisor is 40 when determining the regular rate for overtime purposes (salary divided by 40). Id. at 27. But where flat-sum bonuses are involved, for purposes of determining what addition to the regular rate the bonus adds, “the divisor is the number of nonovertime actually hours worked in the relevant pay period.”  Id.

What about the argument that this particular flat-sum bonus was only incentivizing weekend work, so there should be no relationship to weekday work at all, and if you make it so that the regular rate of pay is increased, then overtime pay earned during the weekdays will actually be increased when the point of the bonus is to reward only weekend work? Rejected. Regular rate of pay is a factor of all sorts of things:

It might be argued that defendant’s attendance bonus is different from other types of flat sum compensation because the bonus rewards only weekend work. According to this reasoning, overtime work done on a weekday (i.e., Monday through Friday) should not increase the size of the attendance bonus, because the bonus has no relation to weekday work. This argument, however, misunderstands what regular rate of pay is. Not all employees earn at a fixed pay rate throughout a pay period, and therefore regular rate of pay is a weighted average reflecting work done at varying times, under varying circumstances, and at varying rates. (See Lab. Code, § 246, subd. (l)(1) [referring to “the regular rate of pay for the workweek”]; see also DLSE Manual, supra, § 49.2.5, p. 49-10 [setting forth the DLSE’s “Weighted Average Method” for calculating regular rate of pay when worker has varying pay rates]; 29 C.F.R. § 778.115 (2008) [setting forth the federal “weighted average” policy].) Thus, it is often the case that overtime worked during a low-paying shift is compensated based on an overtime pay rate that reflects, as part of a weighted average, higher pay rates earned during higher-paying shifts.
The attendance bonus must not be viewed in isolation; rather, it is a component of the employee’s regular rate of pay for the entire pay period, and overtime worked at any point during the workweek must, by law, be compensated at a multiple of that regular rate of pay.

Id. at 31-32.

Importantly, the Cal. Supremes rejected the defendant’s argument that the court’s interpretation be applied prospectively only, and not retrospectively, on grounds that it relied on a federal regulation and that employers across the state would be exposed to costly penalties. The Cal Supremes reasoned that it was the defendant who failed to consider the DLSE’s own interpretation, the defendant’s own interpretation of Labor Code section 510 and the wage order was “strained,” and to apply the interpretation retroactively only would give a “free pass” to employers for their past conduct:

Defendant’s counsel argued that, if applied retroactively, a holding in plaintiff’s favor will force employers all over the state to pay costly civil penalties. Counsel attempted to cast defendant in a sympathetic light, stating that defendant reasonably followed a federal regulation that was directly on point, doing so because in Tidewater, supra, 14 Cal.4th at page 572, this court had declared the relevant state regulations to be void. But defendant must not have read Tidewater very carefully, because if it had done so, it would have seen that although the DLSE’s enforcement policies may, in some cases, be void underground regulations, they may nonetheless be accurate interpretations of binding state law. (Tidewater, at p. 577.) Moreover, it is defendant’s interpretation of Labor Code section 510 and Wage Order No. 1, not the DLSE’s, that is strained, because defendant’s interpretation requires us to read the word “regular” in the phrase “regular rate of pay” as if it somehow did not refer only to regular-time but also to overtime. In short, defendant cannot claim reasonable reliance on settled law. Furthermore, if we were to restrict our holding to prospective application, we would, in effect, negate the civil penalties, if any, that the Legislature has determined to be appropriate in this context, giving employers a free pass as regards their past conduct. (See Lab. Code, §§ 203, subd. (a), 226, subd. (e), 2699; Bus. & Prof. Code, § 17206.) In doing so, we would exceed our appropriate judicial role. Accordingly, we see no basis for limiting our holding to prospective application.

Id. at 36-37.

Justice Chin wrote for the majority, with Justices Corrigan, Liu, Cuellar, and Perren (sitting by assignment from the Second Appellate District) concurring.  Chief Justice Cantil-Sakauye issued a concurring opinion (which was joined by Justices Corrigan, Liu, and Kruger) to state that this ambiguity in the law (i.e., whether the DLSE’s interpretation was correct) could have been at least partially avoided had the DLSE promulgated its interpretation and enforcement-manual provision on this issue through the APA rulemaking procedure. That would have resulted in a regulation that was entitled to greater weight under the law “and would have provided a more robust basis for employers and employees to structure their affairs. Regrettably, more was not done to help employers meet their statutory responsibilities, or to ensure that employees receive the overtime pay they are due.”  Slip op. concurring op. at 2 (Cantil-Sakauye, C.J., concurring).


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