Employment Law Advisory Bulletin
California Court of Appeal Rules Against Certain
Expense Deductions From Employee Compensation Plans
By Stuart
W. Miller and Robyn Todd
[May 2004]
Summary
The California Court of Appeal, Second District, has held that
employers must not include in employee bonus calculations, commissions
or other incentive compensation plans any deductions which are not
permitted by law or regulation to be charged to employees. Ralphs
Grocery Co. v. Superior Court of Los Angeles County, 112 Cal.
App. 4th 1090 (2003). Such expenses include costs of workers’
compensation claims and, for non-exempt employees, any cash or inventory
shortage, or expenses for breakage or loss of equipment (unless
caused by the particular non-exempt employee’s gross negligence,
willful act or dishonesty). The California Supreme Court has declined
to review this decision.
Case Analysis
Ralphs Grocery Company provided a bonus program for its employees
based on the net earnings of a particular grocery store.
To calculate net earnings, Ralphs deducted expenses and losses due
to cash shortages, inventory shortages and shrinkage, and workers’
compensation. However, California Labor Code § 3751 prohibits
employers from deducting any amount from an employee’s earnings
to cover any part of the cost of workers’ compensation. Since
a bonus is part of an employee’s earnings (as are commissions
and other incentive compensation schemes), the court of appeal held
it was unlawful to include workers’ compensation costs in
any bonus calculation for either exempt or non-exempt employees.
In addition, California Industrial Welfare Commission (IWC) Wage
Orders covering non-exempt employees prohibit employers
from making wage deductions for “any cash shortage, breakage,
or loss of equipment” not caused by the particular employee’s
gross negligence, willful act, or dishonesty. The court held that
Ralphs’ bonus calculation, which deducted expenses for cash
and inventory shortages and shrinkages, violated the Wage Order
by making impermissible deductions from employees’ wages.
Cash and inventory shortages and shrinkages were described as inevitable
consequences of business, to be borne as expenses of management;
Ralphs could not require its non-exempt employees to be “the
insurers of its business losses and expenses.”
However, the prohibition in the IWC’s Wage Orders on deductions
for “any cash shortage, breakage, or loss of equipment”
does not apply to exempt employees. Also, there is nothing in the
Labor Code that expressly prohibits deductions from wages of exempt
employees for cash or inventory shortages. Therefore, the court
held that an employer may legitimately require exempt employees
to bear some burden of business losses and expenses by basing a
part of their compensation such as a bonus on a formula which takes
into account cash and inventory shortages.
Effect on Employers
After Ralphs, California employers who offer bonuses,
commissions or any other incentive compensation plan must adhere
to the following rules:
- Exempt and non-exempt employees: Do not deduct any
amount for any workers’ compensation costs.
- Non-exempt employees only: The Wage Order in Ralphs
covered the mercantile industry. Similar provisions prohibiting
deductions for cash shortages, breakage or loss of equipment exist
in other IWC Wage Orders applicable to most other industries.
All such employers may not make such deductions. However, most
employers may make such deductions if the employer can show the
shortage, breakage or loss was caused by the particular employee’s
gross negligence, dishonesty or willful act.
- Exempt employees only: Employers may deduct
for cash or inventory shortages, breakage or loss of equipment.
The bonus plan in Ralphs was upheld partly because the
court found it did not resemble, in truth or in spirit, an unlawful
recapture of wages paid in violation of Labor Code § 221
or the unlawful exacting of a cash bond in violation of the Labor
Code. The court found there was “nothing unfair” in
basing part of exempt employees’ compensation on a formula
that rewarded them for effective supervision.
Employers should review their existing bonus, commission, and other
incentive compensation plans to ensure they do not include deductions
in violation of these rules.
For
further information about the Ralphs Grocery decision,
please contact:
This Employment Law Advisory is a
publication of the Employment Law Department of Davis Wright Tremaine
LLP. Our purpose in publishing this Advisory is to inform our clients
and friends of recent developments in employment law. It is not
intended, nor should it be used, as a substitute for specific legal
advice as legal counsel may only be given in response to inquiries
regarding particular situations.
Copyright © 2004, Davis Wright Tremaine
LLP.
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