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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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