Employers who pay salespeople on commission should be alert to the risk of wage and hour violations that may arise from misclassifying these workers as exempt from either or both minimum wage and overtime rules. In California the situation has recently become more complex especially with respect to inside commissioned salespeople.
Here are three important takeaways:
- Since 2013, California law has required that employers who pay employees on commission provide them with a written contract which sets forth the method by which the commission is to be computed and paid. This law further requires that the employer provide a signed copy of the commission agreement to the employee and obtain a signed receipt for it. If this requirement somehow slid under the radar, now is the time to address it.
- Employees must be paid their commissions at least twice a month, contrary to many employers’ practice of paying that portion of compensation only once a month.
- Whether inside commissioned salespeople are exempt from overtime rules is to be determined on a weekly basis. When commissions vary from one week to the next, an employee may be covered by overtime rules in one week and exempt the next.
Basic Minimum Wage and Overtime Rules in California
In general, under both the Fair Labor Standards Act and California law, employees must be paid a minimum wage and overtime after a certain number of hours. In California for the remainder of 2015, the minimum is $9.00 per hour, but higher in certain localities. On January 1, 2016, the state minimum wage will increase to $10.00 per hour.
In addition, in California, employees must be paid overtime at a rate of one and one-half times their regular rate of pay for more than 40 hours per week or eight hours per day. The minimum rate of pay increases to twice the regular rate for hours per day in excess of 12 or after 8 hours worked on the seventh consecutive day.
This affects all employees unless they fall within a statutory exemption. The focus of much labor law litigation is on the meaning and application of the exemptions.
Exemption for Commissioned Salespeople
Both the FLSA and California law exempt certain commission-based salespeople from some or all of these basic wage and hour rules, but the laws draw a distinction between outside salespeople and inside/retail salespeople.
Outside Sales Exemption
Outside salespeople are exempt from both minimum wage and overtime requirements. An employee is an outside salesperson if the employee’s primary duty is making sales or obtaining orders or contracts for services or the use of facilities from paying clients or customers and the employee spends more than half of his or her working time away from the employer's place of business.
Under California law "outside sales activities" do not include time spent:
- making sales by mail, telephone or the internet;
- at a home office, or some other fixed location, as a headquarters from which to make calls; or
- making incidental deliveries, providing maintenance or repair services, or engaging in collection activities.
Inside Sales Exemption
The exemption for inside salespeople is more limited. Commissioned inside sales people may be exempt only from overtime rules. Under section 7 of the FLSA, commissioned employees working for retail or service establishments need not be paid overtime if:
- the employee's regular rate of pay exceeds one and one-half times the applicable minimum wage for every hour worked in a workweek in which overtime hours are worked; and
- more than half the employee's total earnings in a representative period consists of commissions.
To satisfy the first part of the test, the employee's regular rate of pay must be computed on the basis of hours of work in that particular workweek and the employee's compensation attributable to such hours.
The second part of the test, which requires a determination of the percentage of compensation that is made up of commissions, is harder to apply because an employee’s commissions may vary from one week to the next. The federal approach permits the employer to even out these fluctuations by looking at a 'representative period' of not less than one month.
Now It Gets Complicated
The California statute is different, however, in two significant ways.
First, rather than limiting the commissioned employee exemption to the retail and service sectors, California's Wage Orders create a commissioned employee exemption for workers in the mercantile or retail industry governed by Wage Order No. 7, as well as those who work in "professional, technical, clerical, mechanical and similar occupations" governed by Wage Order No. 4. Thus, California law permits a greater segment of the working population to be considered exempt from overtime rules than federal law does.
But even the exceptions have exceptions. Many employers who pay marketing personnel on commission, including restaurants, hotels and health clubs, are not governed by either of those wage orders. Presumably then, a commissioned inside sales person at a health club might have to be paid overtime even though a similarly commissioned salesperson working in the service sector might not .
Secondly, although the California exemption uses the same two-pronged test to determine which commissioned employees need not be paid overtime, it does not apply the second prong — the one that looks at the percentage of total pay comprised of commissions — in the same way. California provides no guidance about how employers should deal with fluctuating commissions. There is no provision permitting the determination to be made over a representative period.
It was not clear how that determination was to be made until the California Supreme Court’s decision in Peabody v. Time Warner Cable, Inc. in the latter half of 2014.
Peabody v. Time Warner Cable, Inc.
Time Warner Cable employed Susan Peabody as an account executive. She sold advertising on the company's cable television channels. The company paid Peabody straight hourly wages on a biweekly basis but calculated and paid Peabody's commissions about once a month.
The company acknowledged that most of Peabody's paychecks included only hourly wages at a rate that was less than one and one-half times the minimum wage. After she left Time Warner’s employ, Peabody sued for various wage and hour violations, including failure to pay overtime.
Time Warner argued that Peabody fell within the commissioned inside sales exemption under Wage Order 4 because her commission earnings could be reassigned from the biweekly pay periods in which they were paid to earlier pay periods in which they were earned.
The California Supreme Court explained that California Labor Code section 204(a) generally provides that wages are due and payable twice during each calendar month and that, contrary to fairly common practice, this requirement applied to commission wages, as well. As a first point of clarity, the Court emphasized that commissions should be paid in the semimonthly pay period in which they are earned, rather than at some later date.
Secondly, the Court rejected the notion that commissions paid in one pay period can be attributed to another pay period. It held that, "[w]hether the minimum earnings prong is satisfied depends on the amount of wages actually paid in a pay period," and that employers "may not attribute wages paid in one pay period to a prior pay period to cure a shortfall." Thus, unlike under federal law, California employers may not average commissions over a longer period in order to determine what a representative period is. The exemption must be satisfied on a pay period basis.
What Employers Should Do
As a threshold matter, employers who pay employees on a commission basis should ensure that they have written agreements that detail the specifics of the payment arrangement.
With respect to outside salespeople, it remains important for employers to keep careful time logs of time spent outside the office making sales in order to justify the exemption from both minimum wage and overtime rules.
With respect to inside salespeople, some payroll and recordkeeping changes may be in order. First of all, commissions must be paid at least twice monthly. Potential civil penalties apply for not paying all wages in a timely manner.
Secondly, Peabody requires employers to monitor the earnings of commissioned employees weekly for the first part of the two-pronged test and every pay period for the second prong. An employee could easily be exempt under the "commissioned employee" exception in one pay period and non-exempt in the next.
For pay periods in which these employees are not exempt, the employees must be paid overtime in accordance with California law. Further, employers must maintain time records on commissioned employees as those employees are exempt only from overtime requirements and not from meal and rest periods or other requirements for non-exempt employees.
Misclassifying an employee as exempt from wage and hours laws can have serious consequences for an employer. Further, the exemption for inside commissioned salespeople may not be as broad as some employers had previously thought. This is a very opportune time to review payroll and recordkeeping practices to ensure that payment practices are in accordance with the law.