The High Cost of Misclassifying Your Employees

Last year, the California Supreme Court opened the floodgates to litigation by employees who claim that they have been misclassified as exempt workers when, in fact, they are non-exempt and entitled to overtime pay.  In Cortez v. Purolator Air Filtration Products Company (2000) 23 Cal.4th 163, the California Supreme Court declared that an employee who believes he has been improperly classified as exempt can bring an action on behalf of both himself and all other similarly situated employees under California’s Unfair Business Practices Act.  If successful, the employee and all other similarly situated employees will be entitled to overtime pay for the four-year period prior to the filing of the complaint, as well as to penalties and attorneys’ fees.

Since the Supreme Court’s decision, hundreds of lawsuits have been filed in California state courts in which current and former employees of California employers claim that they were improperly classified and, consequently, are entitled to overtime pay.  While most of those cases have settled before trial, one case against Farmers Insurance Exchange went to trial last July and resulted in an award to the former employees of $90 million, plus interest and attorneys’ fees.  Given the potential dollar amounts involved in these cases, it is anticipated that the use of these suits in California will continue to increase, subjecting you to potentially staggering liability if you are out of compliance with federal or state wage and hour laws.

Federal v. State Wage and Hour Laws
The Fair Labor Standards Act (“FLSA”) provides the framework for determining exemptions from overtime requirements under federal law.  To qualify as an exempt employee under the FLSA, an employee must meet a two-part test.  First, he must be paid on a salary basis.  Second, he must meet the duties test for executive, administrative, or professional employees as set forth in the FLSA.

For California employers, however, the FLSA does not generally provide a definitive answer as to whether an employee is exempt or non-exempt.  California state law imposes different requirements, which are generally more stringent than the federal standard.  Where state and federal law conflict, the employee is entitled to the standard that provides greater protection (or the standard that imposes a higher threshold for determining exempt status – generally California law).  Because the California test will generally be the test that employers should use to determine if their employees are exempt or non-exempt, the remainder of this article focuses on California’s wage and hour laws with respect to exemptions.

California Exemptions
Like federal law, California provides three basic types of exemptions:  executive, administrative and professional.  To apply for any of these exemptions, the employee in question must receive compensation of at least $2,166.66 per month or $26,000 per year.  In addition, the employee must be paid on a salary basis, meaning that the pay received by the employee must be a fixed sum from week to week and may not be subject to reduction because of variations in the quality or quantity of work performed.  An employee will not be considered to be paid on a “salary basis” if deductions are made for absences from work caused by the employer or the operating requirements of the business.  In addition, an exempt employee’s salary may not be reduced due to time missed for sickness or accident.  An employer may reduce an exempt employee’s salary because of the employee’s absences for personal reasons, so long as deductions are made in increments of full work days.

If an employee meets both of these requirements, she may be considered for exempt status using one of the following tests:

Executive Exemption
An executive employee is one who meets the salary test described above and, in addition, meets the following requirements:

•    The employee’s duties and responsibilities involve the management of the enterprise in which he is employed or of a customarily recognized department or subdivision of that enterprise;

•    The employee customarily and regularly directs the work of two or more other employees;

•    The employee has the authority to hire or fire other employees, or his suggestions and recommendations as to the hiring, firing, advancement, promotion, or any other change of status of employees is given particular weight;

•    The employee customarily exercises discretionary powers; and

•    The employee is primarily engaged in the duties described above.
“Primarily engaged” means that more than one-half of the employee’s work time is spent performing the duties described above.

Administrative Exemption
An administrative employee is one who meets the salary test described above and, in addition, meets the follows requirements:
•    The employee’s duties and responsibilities involve either (1) the performance of office or non-manual work directly related to management policies or general business operations of the employer or the employer’s customers, or (2) the performance of functions in the administration of a school system or educational establishment or institution, or of a department or subdivision of those, in work directly related to the academic instruction or training carried on in the system, establishment or institution;

•    The employee customarily and regularly exercises discretion and independent judgment;

•    The employee (1) regularly and directly assists a proprietor or employee employed in a bona fide executive or administrative capacity, (2) performs specialized or technical work requiring special training, experience or knowledge under only general supervision, or (3) executes special assignments and tasks under only general supervision; and

•    The employee is primarily engaged in the above duties.

Professional Exemption

A professional employee is one who meets the salary test described above and, in addition, meets the following requirements:

•    The employee is licensed or certified by the State of California and is primarily engaged in the practice of one of the following recognized professions:  law, medicine, dentistry, optometry, architecture, engineering, teaching, or accounting; or

•    The employee is primarily engaged in an occupation commonly recognized as a learned or artistic profession; and

•    The employee customarily and regularly exercises discretion and independent judgment in the performance of her duties.
It is important to note that there are exceptions to these tests, including exceptions pertaining to pharmacists, registered nurses, and computer programmers.  It is also important to note that an employee’s job title, job description and employment contract are not determinative as to whether an employee is exempt.  Rather, a court will look at the actual job duties performed by the employee to make that determination.  In addition, it is of no consequence that others in your industry have classified their employees in a particular manner.  Many U.S. employers are out of compliance with wage and hour laws, particularly employers who do business in California.  In order to ensure compliance with California’s tough exemption requirements, you should periodically review your employees’ duties and their classifications to make sure that, in the unfortunate event that an employee brings a lawsuit against you, you can properly defend yourself.