Peabody Decision Tightens Requirements for Commission Payments and Exempt Status
State and federal law create an exemption from overtime compensation for employees engaged in sales who satisfy specific criteria. Although the requirements under each set of laws are not identical, each generally provides that the exemption applies only if the employee earns more than 150% of the minimum wage and if more than 50% of his or her income is derived from commissions. A recent decision from the California Supreme Court clarifies the manner in which commissions must be paid and the manner in which the applicability of the overtime exemption is determined.
In Peabody v. Time Warner Cable, Inc., the employee earned both an hourly wage and commissions. The company paid the employee’s hourly wages on a biweekly basis, but paid commissions only in every other paycheck. Peabody filed suit, alleging that she did not qualify as exempt from overtime compensation during those pay periods in which her wages did not include any commissions, since the money paid to her during those pay periods did not exceed 150% of the minimum wage and did not consist primarily of commission payments. Time Warner argued that it satisfied the criteria for the exemption because commissions earned by Peabody and her colleagues should be allocated not just to the pay period in which they were actually paid, but also to the earlier pay periods in which they were earned.
The Supreme Court rejected Time Warner’s arguments, holding that “all earned wages, including commissions, must be paid no less frequently than semimonthly.” According to the Supreme Court, “whether the minimum earnings prong is satisfied depends on the amount of wages actually paid in a pay period,” and employers satisfy the minimum earnings test only in those pay periods in which (a) they actually pay at least 150% of the minimum wage to the employee and (b) more than 50% of the wages actually paid to the employee consist of commissions.
Many employers include commissions as one element of the compensation paid to certain employees, and some employers, like Time Warner, do not always pay commissions during the pay periods in which they are earned. In the wake of the Peabody decision, employers should review their commission plans to assure that commissions are paid at least semimonthly, and should assure that employees who are classified as exempt under the sales exemptions satisfy the minimum earnings test during every pay period.
Employers in California should also recall that Labor Code section 2751 requires commission agreements to be set forth in writing, and requires employers to provide signed copies of the agreements to their employees. Disputes concerning commissions are common because both employers and employees sometimes focus myopically upon the amount of commission to be paid if certain goals are achieved, neglecting to give due consideration to other critical issues. When creating or drafting a commission plan, employers should address several key questions:
- When does a commission accrue? Commissions can accrue when an employee procures a customer or a purchase order, or when an invoice is issued to the customer, or when the company receives payment from the customer, or at other defined times. Designating the event that triggers accrual of the commission is perhaps the most important element of a commission plan. Employers should be particularly wary of establishing plans that link the accrual of commissions to the procurement of a customer, since commissions can arguably continue to accrue even beyond the termination of employment under such plans.
- How is the commission calculated? Employers and employees sometimes focus solely on the rate at which commissions accrue on a sale without defining the base on which the commission is calculated. Commissions may be based on gross revenue, gross profit, or some other defined base. Plans should also clearly identify any revenue excluded from the base, such as taxes or shipping costs.
- What happens if the goods are returned because they are defective, or if an order is cancelled? Returns of defective merchandise are common, as are cancellations of orders. Many commission plans also do not address the effect of a cancelled or returned order upon the employee’s right to a commission.
Failure to address any of the issues described above can easily lead to controversy and litigation. Commission plans should eliminate potential sources of confusion and controversy by defining the employee’s right to a commission as clearly and precisely as possible, eliminating ambiguity and addressing foreseeable “bumps in the road” such as a customer’s failure to pay.
What Should Employers Do Now?
- Employers should review their commission plans to assure that commissions are paid at least semimonthly, and assure that the wages paid to employees who are classified as exempt under the sales exemptions satisfy the minimum earnings test during every pay period. Specifically, employees classified as exempt under the sale exemptions must receive wages during every pay period that (a) equal or exceed 150% of the minimum wage, and (b) consist primarily of commissions.
- Employers that have not confirmed the terms of their commission and bonus plans in writing should do so immediately in order to comply with Labor Code section 2751.
- Employers that have not submitted their commission plans to review by counsel in the past two years, would be wise to do so at this time.