By Mark Grajski and Maya Harel

In theory, the California Labor Code and the Wage Orders allow employers the freedom to do what employers traditionally have done: pay employees solely with commissions or solely with piece rates. This idea of incentive pay—you reap what you sow— has been around a long time!

But a wave of California judicial court decisions has eroded the once-solid foundations of traditional incentive pay systems. In response, employers have been moving towards complicated hybrid compensation systems.

So what do you need to know when deciding to use one of these incentive or hybrid compensation systems?

Beware: Averaging Earnings Over the Pay Period Is Not Allowed to Satisfy Minimum Wage

Federal law allows employers to average wages over a pay period to meet minimum wage requirements (dividing total compensation by total number of hours worked). California does not. Courts have read California’s minimum wage statute to require employers to pay the minimum wage separately for each hour worked.

The tension between this requirement and traditional commission and piece-rate pay systems became apparent in 2005 in the California Court of Appeal decision in Armenta v. Osmose. In Armenta, employees earned their pay solely through piece rates. The Armenta court held that while the piece rate compensated employees for their “productive time”—time spent actually working on piece-rate tasks—the piece rate did not compensate them for their “non-productive time”—time spent doing anything else.

• What Kinds of Pay Systems Have Employers Used In Response, and Do They Pass Legal Muster?

In an attempt to comply with Armenta, many employers created complicated hybrid hourly and incentive compensation systems. Unfortunately, even these laudable efforts to comply with California law may still expose well-intentioned employers to liability.

For example, in Bluford v. Safeway, the employer paid its truck drivers a certain figure to each mile driven, a piece rate for certain non-driving tasks, an hourly rate for other tasks, and a different hourly rate for unexpected driving delays. Even so, an unsympathetic Court of Appeal held that Safeway’s system violated the Wage Order because the system did not provide separately for an hourly rate for rest breaks, which the Wage Order designates as “hours worked.”

• Another Possibility: What About the Commissioned Salesperson Exemption?

Employees paid on commissions that fall under Wage Orders 4 (professional, technical, clerical, mechanical and similar occupations) and 7 (mercantile industry) may fall under the commissioned salesperson exemption, which would relieve the employer of the obligation to pay daily or weekly overtime premium pay. To meet this exemption, commissioned employees must be paid more than 1.5 times the minimum wage, and commissions must make up most of their compensation. This exemption applies to overtime pay, but not to other employer obligations such as the minimum wage and providing meal and rest breaks.

It remains to be seen whether the Armenta notion that employers must pay the minimum wage separately for each hour worked would apply to commissioned salespeople, particularly because minimum wage requirements are embedded into the exemption in the first place. Of course, we would argue Armenta doesn’t apply in this scenario, but ambitious plaintiffs’ lawyers surely would argue the opposite.

Workplace Solutions: Questions as to the viability of commission and piece-rate compensation plans remain unanswered, making it difficult for employers to know whether their commissioned-based or piece-rate pay systems comply with California law. Even issues of when commissions are paid may lead to liability, as the California Supreme Court recently emphasized in Peabody v. Time Warner Cable, Inc., the subject of a future blog post.

To forestall Armenta-based litigation, one obvious measure is simply to pay incentive-based employees a minimum wage for all hours worked, while reducing the commission or piece rates that otherwise would be paid. This remedial response to California’s peculiarly burdensome wage regulation would reduce, of course, the incentives that commission and piece-rate systems aim to generate. And there are other possible counter-measures to consider as well. There is no one-size-fits-all solution when it comes to compliance with the Labor Code and Wage Order provisions as California courts have come to apply them. Employers that use a performance-based system should consider conducting a comprehensive review of their compensation system to determine compliance and limit potential liability.

Edited by Coby Turner