California Employers Not Required To Pay “Overtime On Overtime”

Seyfarth Synopsis: Under the Fair Labor Standards Act (FLSA) and applicable federal regulations, percentage of earnings bonuses can be excluded from the calculation of the regular rate of pay for purposes of calculating overtime pay. A California Court of Appeal has now held that California law does not require a different method of calculation. Percentage of earnings bonuses that are calculated on overtime are lawful and the employer is not required to make supplemental overtime payments on the bonus. Lemm v. Ecolab Inc.

The Facts

Stephen Lemm worked for Ecolab as a non-exempt route sales manager. Under the terms of Lemm’s Incentive Compensation Plan, Lemm earned hourly wages and a nondiscretionary monthly bonus. Lemm earned the monthly bonus by meeting or exceeding one of two target metrics. If Lemm met either goal, the Company increased his gross wages by at least five percent.

Lemm’s “gross wages,” for purposes of calculating the monthly bonus, included straight time, overtime, and double time wages. The Company did not incorporate the bonus into Lemm’s regular rate of pay for purposes of calculating Lemm’s overtime wages.

In 2019, Lemm served a notice under California’s Private Attorneys General Act (PAGA) on the Labor and Workforce Development Agency (LWDA) and the Company. After the LWDA did not take action in response to Lemm’s notice, he filed a representative PAGA suit against the Company claiming that the Company underpaid its sales managers’ overtime wages in connection with the monthly bonus.

The Trial Court Decision

Code of Federal Regulations section 778.210 expressly authorizes “percentage of earnings” bonuses, which are paid as a percentage of gross earnings, including overtime and double time wages. The Regulations do not require that additional overtime be paid on the bonus.

In the trial court, the Company moved for summary adjudication on Lemm’s overtime claim, arguing that the monthly bonus qualifies as a percentage of earnings bonus, which can be excluded from the regular rate of pay as a matter of federal law. Lemm filed a cross motion for summary adjudication, arguing that California law required to Ecolab to incorporate the monthly bonus into the regular rate of pay, and make a supplemental overtime payment on the bonus.

The trial court granted the Company’s motion and denied Lemm’s, finding that: “Ultimately, [the Company’s] position makes logical sense. Simply put, a requirement for an employer to pay overtime on a percentage bonus that already includes overtime pay would make the employer pay ‘overtime on overtime.’ This is not a requirement under the law. By paying a bonus based on a percentage of gross earnings that includes overtime payments the employer automatically pays overtime simultaneously on the bonus amount.”

The Court of Appeal’s Decision

The California Court of Appeal affirmed the trial court’s ruling, concluding that the Company was not required to pay additional overtime wages in connection with its monthly bonus. The monthly bonus provided for the simultaneous payment of overtime compensation due on the monthly bonus by way of a percentage increase to Lemm’s straight time and overtime earnings.

There was no dispute that the terms of the Company's monthly bonus calculation complied with the overtime provisions of the FLSA. Lemm, however, argued that the California Labor Code is more protective of employees than federal law, and that California law requires a different method of calculation.

Lemm relied on the California Supreme Court’s decision in Alvarado v. Dart Container Corp. of California, 4 Cal. 5th 542 (2018). In Alvarado, the California Supreme Court determined how to calculate an employee’s overtime pay rate when the employee earned a so-called “flat sum bonus.” The Court of Appeal rejected Lemm’s reliance on Alvarado, as Alvarado concerned a type of bonus not at issue in this case (i.e., a flat sum bonus). The Court of Appeal also noted that the payment of overtime compensation is governed by both federal and state law, and it is only when state law provides more protection to employees that federal law does not control. As the California Labor Code is silent in relation to percentage of earnings bonuses, there was no reason for the Court of Appeal to deviate from federal law in this case.

Finally, as the Court of Appeal noted, while the California Labor Code is often said to be protective of employees, that does not mean employees must receive a windfall in the form of “overtime on overtime,” which would result from Lemm’s interpretation.

What Lemm Means for Employers

Percentage of earnings bonuses allow employers to pay bonus compensation to non-exempt employees, without having to make cumbersome and administratively complex supplemental overtime payments after-the-fact. Provided the California Supreme Court does not grant review of the decision, it appears that California employers may provide percentage of earnings bonuses without having to pay additional overtime under the California Labor Code.