Wage and Hour Law Update : Wage & Hour Lawyer & Attorney : Jackson Lewis Law Firm : Minimum Wage, Overtime & Service Contracts

As discussed in prior postings, a central issue in determining the application of the FLSA’s “7(i)” exemption is whether the payments to the employee constitute bona fide commissions.  In early July, Judge Gregory Frost of the Southern District of Ohio issued another ruling on this issue, finding that the compensation paid to managers and assistant managers at certain Mr. Tire Auto Service Centers constituted bona fide commissions for purposes of the exemption.  McAninch v. Monro Muffler Brake, 2011 U.S. Dist. LEXIS 71827 (S.D. Ohio July 5, 2011). 

McAninch involved a compensation scheme under which a manager or assistant manager received a percentage of the controllable profit for the store if the store met budgetary targets.  When the store deviated in performance from the precise budgetary figure set for the store, the manager’s compensation was recalculated pursuant to a detailed formula which considered monthly fluctuations in store performance, labor costs and controllable expenses.  In addition, the Company provided managers with a weekly guaranteed draw, designed to ensure continuity in their compensation, which was reconciled when calculating commissions earned.  The court rejected arguments that: (i) the draw negated the Company’s assertion that the commission plan was “bona fide”; (ii) tying the commission rate to store profits as opposed to store sales rendered the payments non-bona fide commissions; and (iii) the managers’ frequent failure to exceed the guaranteed draw affected the analysis.  Since the question of whether the payments based on the percentage of controllable profit consisted “bona fide commissions” was the sole prong of the 7(i) exemption (requiring also payment of time and one-half the minimum wage for all hours worked and employment at a “retail or service” establishment) raised by plaintiffs, summary judgment for defendants was appropriate. 

Use of commission and other forms of incentive compensation continues to be widespread among employers across all industries.  Employers contemplating implementation of a 7(i) compliant commission plan should consult with counsel and closely scrutinize applicable federal and state law.

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As we have previously discussed, the FLSA contains an exemption for commissioned employees in the retail or service industry who meet certain parameters: colloquially referred to as the “7(i)” exemption. California has a similar exemption which the California Court of Appeal, Second Appellate District recently applied to a sales consultant, holding that Defendant’s payments qualified as “commissions.” Areso v. Carmax, Inc., 195 Cal. App. 4th 996 (Cal. App. 2d Dist. 2011). 

Plaintiff Areso was engaged in selling defendant’s “used vehicles, warranty plans, used vehicle appraisals and vehicle accessories,” and received payments based on the products and services she sold. At issue were two different versions of Carmax’s sales consultant pay plan for California employees.  Under both, plaintiff was eligible to receive a fixed amount per sale of a car, and then a percentage of the purchase price of accessories sold. The trial court ruled both of these “per vehicle” pay plans were “a performance-based incentive system and thus, fairly understood to be a commission structure under Labor Code § 204.1.” Id. at 1000.

Areso appealed. The Court of Appeal began its analysis by noting that Wage Order 7-2001 exempts from California Labor Code overtime requirements “any employee whose earnings exceed one and one-half times the minimum wage if more than half of that employee’s compensation represents commissions.” Id. at 1002-3. This exemption mirrors 7(i), but without the requirement that the employee be in a “retail or service” industry. The court observed that the Cal. Labor Code also contains a definition of commission wages, namely “compensation paid to any person for services rendered in the sale of such employer’s property or services and based proportionately upon the amount or value thereof.” Id. citing Labor Code § 204.1 (emphasis in original). 

The Court then analyzed previous California appellate authority addressing other types of incentive compensation, such as a percentage of the hourly rate charged to a customer, and “point” systems based on the items sold, but not tied to the price of those items. The Court observed that “none of the[se] cases interpreting § 204.1 has involved the compensation system which, like Carmax’s, compensate sales people with a uniform payment for each item or service sold and as a result, no cases construed the word ‘amount’ in the statute. This is an issue of first impression, and new facts require new law.” Id. at 1007. Rejecting plaintiff’s contention that in order to be “proportionate”, the percentage of the items sold payable to the commission employee must fluctuate, the Court observed that “paying sales people a uniform fee for each vehicle is proportionate—a one-to-one proportion. The compensation will rise and fall in direct proportion to the number of vehicles sold.” Id. at 1008. 

The Carmax decision represents a welcome victory for California employers seeking to apply this overtime exemption. Observes Jackson Lewis Partner JoAnna Brooks, who regularly handles wage and hour litigation in California, “The decision is surprising because it rejects the Division of Labor Standards Enforcement’s traditional guidance that a commission must be a percentage of the actual sales price. Other forms of fixed incentives are typically deemed bonuses or piece rates. Thus, it may be lawful to pay a fixed commission, but calculating a fixed payment based on anticipated “profit” after deducting expenses, such as overhead costs, may still be deemed a bonus. The consequences are significant, because it can result in mis-classification of an inside sales worker.”

Despite this decision, California wage and hour laws remain full of pitfalls for employers. Employers should proceed with caution. As Brooks notes, “Even employers who meet California’s commission exemption must take additional steps to ensure they have a properly drafted commission plan explaining when commissions are earned, the applicable rates paid, calculation of overtime and the impact of separation from employment.” 

California employers must continue to stay in the vanguard of wage and hour compliance to avoid costly litigation. 

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The “retail or service exemption” to the FLSA, sometimes referred to as the “7(i) exemption”, noting the location where it is codified, 29 U.S.C. Section 207(i), has three requirements. While the first requirement, to pay time and one-half the minimum wage for all hours of work, is straightforward, the other two prongs—that an employee receive 50% of his or her income in the form of “bona fide commissions” and that the individual be employed by a “retail or service establishment”—sometimes lead to litigation. Recently, a district court in Vermont addressed these two prongs as applied to a cable installer. 

In Owopetu v. Nationwide CATV Auditing Servs., Inc., 2011 U.S. Dist. LEXIS 24948 (D. Vt. Mar. 11, 2011), the court held that a cable installer working for a subcontractor of the cable provider who was paid a percentage of the amount billed to the provider by the subconstractor received bona fide commissions. The court held a bona fide commission existed because his “ability to earn income fluctuated based upon the volume of customer work orders, he was paid a percentage of the value of each service performed, and he was provided performance-based incentives to increase his income.”   The court relied on several cases that have held a compensation system that creates an incentive to work faster and more efficiently is consistent with the existence of a bona fide commission. It was immaterial that the individual was not engaged in sales.

Nevertheless, the court denied summary judgment because the defendant had not produced evidence regarding whether the plaintiff was employed by a “retail or service” establishment. While the company established that it provided services that are not for resale (installation of cable at customer’s homes), which is one requirement need to satisfy the definition of a “retail or service establishment”, no evidence was presented regarding whether the services are “recognized as retail in the industry,” the other requirement.   The Defendant will have to establish that evidence at trial or seek permission to move for summary judgment on a fuller record.

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The 7(i) exemption from overtime is not limited to “local” retail or service establishments, and applies to employers who sell nationwide via phone or the internet, a Utah district court has held, rejecting DOL regulations, and finding them antiquated. See Selz v. Invest Tools, Inc., 2011 U.S. Dist. LEXIS 93604 (D. Utah, Jan. 27, 2011). 

Plaintiffs were employed as sales representatives at a call center and were responsible for selling, via phone, products and services to educate individual investors on how to personally invest in exchange markets on-line. In response to a suit for alleged unpaid overtime initiated by sales representatives, the employer moved for summary judgment based on the 7(i) exemption, which applies to employees who earn than 1.5 times the minimum wage, make over 50% of their income in commissions and are employed in a “retail or service establishment.” The court rejected plaintiff’s argument that the exemption could not apply because defendant sold their products nationally, not locally, finding the persuasive value of the DOL’s regulations defining a retail or service establishment to be “minimal,” noting they were drafted for the repealed 13(a)(2) exemption formerly applicable to all retail and service employees. The court further noted the regulations have not been updated to reflect the impact of the Internet. “The internet has fundamentally changed what is considered a retail or service establishment and insofar as the Department of Labor regulations do not take this into account, they are not a persuasive interpretation of the FLSA,” the court held.

In evaluating whether the call center was a “retail or service establishment,” the court examined whether the establishment sold goods to the general public, served the everyday needs of the community, was at the end of stream of distribution, and whether it took part in the manufacturing process, all of which the court held were satisfied. Further, the court held even though the employer did not have a physical location accessible by the public, it was accessible via phone and internet and thus, had an establishment available to the public that met its everyday needs. 

While the court granted summary judgment to the employer regarding its status as a “retail or service establishment,” the court denied summary judgment as the applicability of the exemption, finding a fact issue whether the employees earn 1.5 times minimum wage for each hour worked, one of the other requirements needed to establish the exemption.

The case reflects a growing trend of district courts recognizing that Department of Labor regulations defining a “retail or service establishment” are antiquated and are of limited use in interpreting the 7(i) exemption, given the changes in how business is now conducted, particularly through phone sales and the internet. Employees who sell via phone or internet should evaluate the applicability of the 7(i) exemption in light of this decision. Of course, state law also must be consulted.

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As discussed here and here, the FLSA provides an exemption for employees who 1) are employed by a “retail or service establishment”; 2) earn at least 1.5 the minimum wage for all hours worked; and, 3) earn more than 50% of their compensation in a representative period from commissions. In July 2009, a federal district court in Pennsylvania applied this “7(i)” exemption and found that commission-compensated sales associates of NutriSystem’s weight loss and weight management products were not entitled to overtime under the FLSA. Parker v. NutriSystem, Inc., 2009 U.S. Dist. LEXIS 66597 (E.D. Pa., July 30, 2009). This week, the Court of Appeals for the Third Circuit upheld this decision. Parker v. NutriSystem, Inc., 2010 U.S. App. LEXIS 18691 (3d Cir. Sept. 7, 2010).

On appeal, Plaintiff challenged the district court’s ruling that NutriSystem’s compensation plan established a "bona fide commission rate" and was therefore a "commission" within the meaning of the FLSA and the 7(i) exemption. In upholding the payments in question as commissions, the Third Circuit first noted the paucity of appellate case law defining a commission for purposes of the FLSA. Relying on Judge Posner’s opinion in Yi v. Sterling Collision Centers, 480 F.3d 505 (7th Cir. 2007), the Third Circuit concluded that the NutriSystem compensation plan, wherein “a flat rate fee is not paid unless a sales associate completes a sale . . . [and the fee is] is tied to both the time the sale is made and whether it is based on an incoming or outgoing call”, constituted the payment of bona fide commissions, even though the commission was not calculated as a flat percentage of customer costs. The Court observed that this method of compensation both incentivized the sales associates to make more sales calls, and, importantly, "decoupled [compensation] from actual time worked."

Employers utilizing piece rates, job rates, sales commissions or other forms of incentive pay should be aware of the potential applicability of this exemption. Of course, applicable state law also must be reviewed.

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The Fair Labor Standards Act contains an exemption from overtime for employees of a “retail or service establishment” who earn at least 1.5 the minimum wage for all hours worked and more than 50% of their compensation from commissions. This exemption is often referred to as the “retail sales exemption” or “7(i) exemption,” referencing the section in which it is codified. Often the difficulty in applying the exemption lies with determining which establishments fall within the definition of a “retail or service establishment” and which do not. Department of Labor regulations provide a long list of retail non-retail establishments, but several courts have noted the list does not provide any rationale for distinguishing retail and non-retail and is of limited assistance. See e.g., Martin v. The Refrigeration School, Inc., 968 F.2d 3, 7 n. 2 (9th Cir. 1992). 

Recently, a California District Court was faced with the question of whether account executives responsible for selling precious metals (e.g., gold and platinum) to customers via phone were employed by a “retail or service establishment,” and thus exempt from overtime under the 7(i) exemption.  Parne v. Monex Deposit Co., 2010 U.S. Dist. Lexis 59768.  Relying on the definition of a “retail or service establishment” contained in the 13(a)(2) retail and service exemption [now repealed], the Court explained a retail or service establishment is one that (1) does not earn more than 75% of its revenue from goods or services that are provided for resale; and (2) is recognized as retail in the particular industry. 

In applying this definition, the Court first held that even though customers typically bought metals for investment purposes with the ultimate goal of reselling them for a profit (some customers did not even take possession of the metal), the precious metals were not goods provided for “resale,” as contemplated by the statute, because the metals were not sold with the understanding the metals would be immediately resold. Second, despite competing evidence regarding whether the industry viewed the Defendant as a retail seller (plaintiffs argued the Defendant was similar to a brokerage house), the Court held that summary judgment was still proper because the Defendant satisfied the standard courts have used in determining whether a particular establishment is “recognized as retail”—it sold goods to the general public; it did not take part in the manufacturing process; it provided a product that served the everyday needs of the community; and, it sold goods at the end of the stream of distribution. The factor that presented a “close[] question,” according to the Court, was whether selling precious metals served the “everyday needs of the community”. After noting that cases lack a unified approach in answering this question, the Court held “everyday needs” means “basic” or “integral” needs of members in the community, and collecting and investing metals fell within this standard.

As wage and hour cases continue to be an active area of litigation, the different prerequisites for application of the 7(i) exemption, including which services and goods also meet the “basic” or “integral” needs of the community, will likely continue to be litigated.  Before utilizing the exemptions, employers relying on the 7(i) exemption, should review the relevant regulations and case law to ensure that their business qualifies as a “retail or service establishment”.

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