A California Court of Appeals ruled recently in favor of a federal method for calculating percentage bonuses rather than a state method the court said led to double counting overtime.
The court ruled that employers can calculate nondiscretionary percentage bonuses using the federal Fair Labor Standards Act (FLSA) calculation method detailed in FLSA regulations rather than a method described in the California Division of Labor Standards Enforcement (DLSE) Manual, even though the DLSE method would have resulted in more pay (Lemm v. Ecolab Inc., 87 Cal. App. 5th 159 (2023)).
Lemm was a route sales manager for Ecolab, which meant he was the primary contact with certain customers, visiting them regularly to provide services and sell products and parts. He was a nonexempt employee who regularly worked more than 12 hours per day and more than 40 hours per week.
His compensation was calculated based on an annual Incentive Compensation Plan. Under the plan, his compensation was a combination of hourly wages and a nondiscretionary monthly bonus. The hourly wages, including any overtime or double overtime, were paid every two weeks and were not the issue in this lawsuit — the issue was the bonus and how it was calculated.
Lemm’s monthly bonus was nondiscretionary — meaning he was entitled to it whenever he met specified criteria under his compensation plan. When he met or exceeded his target metrics, his gross wages for the month were increased by a percentage specified in the plan.
To calculate the bonus, Ecolab multiplied Lemm’s gross wages, including straight time, overtime and double overtime wages, by the applicable percentage. As a result, the bonus necessarily included additional overtime compensation. That calculation method is expressly provided for under the Code of Federal Regulations (CFR) 778.210.
Lemm brought a representative suit under California’s Private Attorneys General Act (PAGA) alleging he and other route sales managers failed to receive the proper overtime rate as part of the nondiscretionary bonus. He argued that, under the formula set forth in DLSE’s enforcement manual Section 49.2.4, nondiscretionary bonus payments must be incorporated into the regular rate of pay, which would affect overtime calculations.
He contended that the DLSE method should have been used over the federal method because the DLSE method resulted in higher pay, and California law favors interpretations more protective of — and favorable to — employees.
Ecolab relied on CFR 778.210, which states that a percentage bonus based on straight time and overtime earnings satisfies federal overtime requirements. Ecolab argued that since its bonus was calculated as a percentage of both straight time and overtime, use of the DLSE’s formula would result in the double counting of overtime — “overtime on overtime.”
The court agreed with Ecolab, holding that the calculation of the percentage bonus based on both straight time and overtime wages satisfied Ecolab’s overtime obligations.
The court also agreed that California’s general rule is to choose the interpretation that favors the employee — but giving an employee “overtime on overtime” would be a “windfall” to the employee and inconsistent with the Labor Code and Industrial Welfare Commission Wage Order overtime provisions.
Employers using percentage bonuses as part of their compensation practices should consult with legal counsel about the potential impact of this case on their pay practices.
CalChamber members can read more about Bonuses in the HR Library on HRCalifornia.
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