Wage & Hour Defense Blog : Wage & Hour Lawyer & Attorney : Epstein Becker Green Law Firm : DOL Enforcement, FLSA Coverage

By Betsy Johnson

On August 19, 2009, the Chief Counsel of the California Division of Labor Standards Enforcement ("DLSE") issued an Opinion Letter on behalf of the Labor Commissioner, Angela Bradstreet, in which the DLSE reversed its enforcement stance on the issue of shortened workweeks with reduced salaries for exempt employees. In the Opinion Letter, the DLSE opined that there is nothing in California law that would prevent an employer from implementing a reduction in exempt employee salaries that is directly proportional to a reduction in the number of days worked per week.

This change in the DLSE enforcement policy brings California law more in line with the federal Fair Labor Standards Act ("FLSA") regarding "furloughs" and salary reductions for exempt employees. For more information regarding the FLSA rules regarding furloughs, please see our March 2009 Client Alert.

Question Presented to the DLSE

The employer sought to reduce the work schedule of its exempt employees and implement a corresponding reduction of their salaries as an alternative to layoffs. Specifically, the employer proposed reducing the number of workdays from five (5) days to four (4) days per week and making a proportionate reduction in the salaries of the exempt employees by 20 percent. The employer represented to the DLSE that the reduction in workdays and salaries would be a temporary measure to assist the employer in weathering the current economic downturn. The employer intends to restore both the full five-day work schedule and the full salaries of its exempt employees.

The question presented to the DLSE was whether the employer's planned salary reduction is consistent with the "salary basis test" for exempt employees under California law.

The DLSE's Analysis

In order to qualify for an exemption from the overtime and minimum wage requirements of California law, an employee must meet both the "duties test" and the "salary basis test." For the purposes of the Opinion Letter, the DLSE assumed that the employees in question met the "duties test" for the "white collar" (executive, administrative and professional) exemptions described in the California Wage Orders.

At issue was whether the planned change ran afoul of the "salary basis test" as set forth in Labor Code § 515(a) and the Wage Orders. The Wage Orders provide that, in order for employees to meet the "salary basis test" portion of the exemption, the employees "… must also earn a monthly salary equivalent to no less than two (2) times the state minimum wage for full-time employment. Full-time employment is defined in Labor Code Section 515(c) as 40 hours per week." At present, the California minimum wage is $8.00 per hour, which equates to a minimum salary of $2,733.33 per month for exempt employees.

The DLSE concluded that there is no express provision in the California Labor Code, the Wage Orders or in any California cases that would restrict or prevent and employer from implementing a fixed reduction in exempt employee salaries during a period when the employer operates a shortened workweek due to economic conditions. Since the DLSE found no precedent in California law, the DLSE looked to the federal interpretations under the FLSA for guidance.

The DLSE found that the applicable federal regulations and interpretations by the federal Department of Labor ("DOL") support the conclusion that an employer may reduce its exempt employees' work schedule and salary without violating the salary basis test. Specifically, the DLSE looked at 29 CFR § 541.602, which sets forth the general rule that exempt employees must be paid their pre-determined salary in any week in which they perform work, and the series of DOL opinion letters interpreting this regulation.

The DLSE reviewed DOL opinion letters, dating as far back to 1970, in which the DOL consistently concluded that the salary basis test does not preclude a bona fide fixed reduction in the salary of exempt employees to correspond with a reduction in the normal workweek, so long as the reduction is not designed to circumvent the requirement that the employees be paid their full salary, and in no event less than the legal minimum salary, in any week in which they perform work.

The DLSE cited, with approval, several federal decisions which address this issue (see Archuleta v. Wal-Mart Stores, Inc., 543 F.3d 1226 (10th Cir. 2008); In re Wal-Mart Stores, Inc., 395 F.3d 1177 (10th Cir. 2005); and Caperci v. Rite Aid Corporation, 43 F.Supp.2d 83 (Dist. Mass 1999)). These decisions support the conclusion that the employer's proposal to reduce simultaneously its exempt employees' work schedule and salary for the specific reasons described above does not violate the salary basis test.

Finally, the DLSE addressed its previous enforcement position, which is found in an e-mail Opinion Letter issued by the DLSE in 2002 (see DLSE Opinion Letter 2002.03.12). In that opinion, the DLSE concluded that the federal and state regulations preclude an employer from reducing the salary of an exempt employee during a period in which the company operates a shortened workweek due to economic conditions. This conclusion relied in part upon the federal trial court decision in Dingwall v. Friedman Fisher Associates, P.C., 3 F.Supp.2d 215 (N.D. NY 1998). In Dingwall, the defendant employer reduced the workweek of its staff from five days to four and simultaneously reduced their salaries by 20 percent.

The DLSE analyzed the decision in Dingwall in relation to the more recent federal precedent and determined that Dingwall is not well reasoned and should not form the basis of the DLSE's enforcement position. Although the DLSE did not withdraw Opinion Letter 2002.03.12, the DLSE determined that the employer was not prohibited under California law from implementing the proposed reduction in the work schedule and salary of the exempt employees.

The DLSE's Conclusion

The DLSE concluded that, while there are differences between the federal and state salary requirements (e.g., minimum dollar amounts), the DLSE will follow the interpretation under the FLSA regarding the validity of a reduction in the work schedule and salary of exempt employees. The DLSE stressed that the exempt employees must still meet the salary basis test by earning a monthly salary of at least $2,733.33 (the equivalent of two times the state minimum wage for a 40-hour week), as provided in Labor Code §§ 515 and the Wage Orders.

The DLSE cautioned that its conclusion is based on the employer's representations that: 1) the "proposal to reduce the number of its employees' scheduled work days from five days to four days per week, with a corresponding reduction in salary, is based upon the employer having experienced significant economic difficulties due to the present severe economic downturn"; and 2) "as soon as the business conditions permit, the employer intends to restore both the full five-day work schedule and the full salaries of its exempt employees."

What the DLSE Opinion Letter Means To Employers

While the DLSE Opinion Letter is not legally binding precedent in civil litigation, it should be given significant weight by the California courts. However, the Opinion Letter is binding precedent in any DLSE proceeding and signifies a favorable shift in the DLSE's enforcement policy in favor of giving employers more flexibility in implementing cost-cutting measures to address changing economic conditions. By implementing reductions in exempt employees' salaries and work schedules, an employer may be able to avoid layoffs and be in a better position to adjust to changes in the economy.

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The U.S. Department of Labor's Wage & Hour Division has issued two new opinion letters addressing circumstances under which employers may not reduce the hours of exempt employees without running afoul of the "salary basis" test and risking loss of the employees' exempt status.  

First, some background.  Employees exempt from the FLSA's minimum wage and overtime requirements as professional, executive, or administrative employees must be paid a salary of at least $455 per week. Under 29 C.F.R. § 541.602(a),

[a]n employee will be considered to be paid on a "salary basis" . . . if the employee regularly receives each pay period . . . a predetermined amount constituting all or part of the employee’s compensation, which amount is not subject to reduction because of variations in the quality or quantity of the work performed. . . . An employee is not paid on a salary basis if deductions from the employee’s predetermined compensation are made for absences occasioned by the employer or by the operating requirements of the business. If the employee is ready, willing and able to work, deductions may not be made for time when work is not available.

In the first opinion letter, the employer sought to reduce the hours worked by employees using the following system:

Your client proposes occasionally reducing the hours worked by exempt employees due to short-term business needs (e.g., low patient census). In such cases, the employer offers “voluntary time off” (VTO), where employees may, at their option, use paid annual, personal, or vacation leave, but continue to accrue employment benefits. The employer approves VTO on a first-come, first-served basis. If there are insufficient volunteers for VTO, the employer requires “mandatory time off” (MTO) under a seniority-based rotational method. Exempt employees required to take MTO may use accrued paid leave or take unpaid MTO. If the employee elects not to use accrued paid leave or does not have sufficient accrued paid leave to cover the VTO or MTO, the employer deducts the amount equal to the VTO or MTO from the employee’s salary, if it is shorter than one workweek. For unpaid VTO or MTO lasting an entire workweek, the employer does not pay the salary for that pay period. Salaried exempt employees may take VTO or be assigned MTO in one-day increments.

The DOL opined that salary deductions due to MTO lasting less than a workweek violate the salary basis requirement and may cause the loss of exempt status.  "Deductions from salary due to day-to-day or week-to-week determinations of the operating requirements of the business are precisely the circumstances the salary basis requirement is intended to preclude." 

In the second opinion letter, the employer proposed requiring salaried exempt employees to stay home or leave work early during periods of insufficient work.  The employer would deduct the non-work time from the employees’ accrued paid time-off accounts. The employees would receive their regular salaries so long as they had sufficient hours in their PTO accounts to cover the non-work periods. If an employee’s accrued PTO was exhausted, the employee’s salary would be reduced in full-day increments, except that in no event would an employee’s salary be reduced below the $455 per week.

The DOL opined that this proposal would also run afoul of the salary basis test. 

If an employer requires that an exempt employee work less than a full workweek, the employer must pay the employee’s full salary even if: (1) the employer does not have a bona-fide benefits plan; (2) the employee has no accrued benefits in the leave bank; (3) the employee has limited accrued leave benefits, and reducing that accrued leave will result in a negative balance; or (4) the employee already has a negative balance in the accrued leave bank. 

The DOL also opined that if an exempt employee’s accrued PTO is exhausted and the periods of insufficient work continued, the employer would not be permitted to send the employee home and pay him a reduced salary for the week.  The DOL distinguished this situation from the scenario discussed in a 1970 opinion letter, in which the employer was considering a permanent change in the work schedule from 52 five-day workweeks to 47 five-day workweeks and 5 four-day workweeks. "In that case," the DOL noted, "the salary basis requirement was not circumvented because all the exempt employees were to be paid according to a bona fide reduction of one-fifth of their salaries for a fixed schedule of five annually recurring four-day workweeks."

The distinguishing principle was stated in a 1995 DOL opinion letter:

... a fixed reduction in salary effective during a period when a company operates a shortened workweek due to economic conditions would be a bona fide reduction not designed to circumvent the salary basis payment. Therefore, the exemption would remain in effect as long as the employee receives the minimum salary required by the regulations and meets all the other requirements for the exemption.

My takeaway from these opinion letters is this:  Employers that are considering reducing their exempt employees' hours due to insufficient work must proceed very carefully.  Reducing exempt employees' hours of work, and reducing their pay correspondingly, may be permissible if the changes are carried out in accordance with a fixed schedule over an extended period of time.  An employer may not make reductions in work hours and pay based on day-to-day or week-to-week determinations of how much work is available.  Such reductions will run afoul of the salary basis test, risk forfeiture of the employees' exempt status, and expose the employer to overtime claims from the employees when their workload increases.     

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The following is a reprint of a client alert authored by EBG attorneys Doug Weiner and Frank Morris, Jr.  It should be of interest to all Florida employers that are considering a reduction in force.

For many employers, these are desperate economic times. Every entity facing diminished revenue must consider cost cuts to survive. As news reports show, reductions in force (RIFs) are being used daily to achieve cost savings, and for some employers they may be the best solution. In some cases, however, the savings are not immediate as a result of statutorily required or voluntary notice periods, as well as costs of severance pay.

A different approach may be a furlough strategy, customized to fit each employer’s needs, which may also achieve a significant cost-savings benefit. Implementing a furlough can help retain the employer’s experienced workforce at a reduced cost, to help the enterprise weather the economic crisis. Most employees faced with, for example, the choice of a 20 percent annual pay reduction or the loss of their job would not hesitate to choose a reduction in pay. Further, both employers and employees taking advantage of a furlough program are well-positioned to take advantage of any increase in business activity in the inevitable economic recovery, whether it be this year or next. Furloughs are often viewed by the workforce more favorably than layoffs, thus preserving morale in the organization as well.

The Fair Labor Standards Act (“FLSA”) requires hourly and non-exempt salaried employees to be paid time-and-one-half their regular rate for weekly hours worked over forty. Accordingly, the first place to look for cuts in employee payroll costs is in non-exempt employee overtime pay. The FLSA was designed to give employers an incentive to spread employment from employees who work over forty weekly hours to other workers who are working fewer hours. In an environment where costs are critical, it is generally an inefficient use of payroll dollars to pay the additional wage premium required for overtime work.

Eliminating non-exempt overtime work is only the first step in reducing payroll costs among hourly non-exempt employees, salaried non-exempt employees and salaried exempt employees. Take an example in which it has been decided that in a department of 100 employees, where all three categories of employees work, that payroll expenses must be cut by 20 percent. One possibility is to reduce the department headcount by 20 percent, eliminating 20 jobs and the costs associated with them. Another possibility is to implement a mandatory furlough period with 20 percent pay cuts for all 100 employees. The furlough strategy takes more administrative time to manage properly, but it potentially saves 20 jobs while achieving the necessary cost-saving objective.

The FLSA allows employers to implement a variety of options to impose salary reductions and pay cuts, as do most state laws. A salary may be prospectively reduced without violating the “salary-basis” test of the FLSA for exempt employees, including a reduction in pay proportionate to a reduction in the number of days worked. Managers may implement furloughs and RIFs simultaneously or in a phased sequence. As with all such strategies, any applicable state and local requirements need to be determined, as federal law will defer to a state or local standard that provides a greater protection to the employee. California, as shown by the state’s decision to furlough state employees, allows furloughs to be implemented in accord with particular wage-hour requirements that must be considered.

The FLSA permits prospective adjustments to an exempt employee’s salary, including revisions to commission agreements or bonus compensation plans based on the quantity or quality of work, which do not reduce the “predetermined amount” of the employee’s salary (of course, the terms of the plans also need to be checked before changes are made). In concept, if the duties test for exemption is satisfied, the predetermined salary of, e.g., an exempt Sales Manager, could be as low as $455 per week, while the compensation the employee actually receives could be substantially higher (based upon commissions for meeting sales goals or bonuses for meeting other performance criteria). To preserve the salary basis of the exempt employee, the predetermined amount of salary would have to be paid for workweeks in which there were no commissions, or for which no bonus payments were made.

Careful strategic planning is required before implementing a furlough. Considerations include:

• Exempt salaried employees may have their salaries prospectively reduced to a lower predetermined amount so long as they stay above $455 per week. Salary adjustments may not be designed to circumvent the requirements of the FLSA.

• Hourly workers must be paid for every hour they are directed or permitted to work. Permitting “extra” work as, for example, spending more than de minimus time checking a Blackberry®, even when unauthorized, may well give rise to the obligation to pay for the time. Accordingly, managers must take the necessary steps to ensure the furlough plan realizes the necessary cost savings.

• It is a good practice to give employees clear notice specifying that no “volunteer work” is permissible and no work is to be performed unless specifically authorized by a predetermined schedule or authorization by an appropriate manager. Implementing a strict policy of prohibiting unscheduled work and having an administrative procedure to uniformly enforce the policy is well advised.

• Managers may consider asking hourly and salaried non-exempt employees for the return of employer-owned remote access devices during a furlough. Employees who access their work email accounts while on their “time off” may be working, or may start working. If they are working, even though advised not to do so, the employer may well incur wage liability, defeating the purpose of the furlough. Unauthorized work by non-exempt employees in violation of the employer’s furlough policy may generate exposure to significant wage claims. Violations of the furlough policy should be considered a serious disciplinary issue, warranting sanctions, including suspension and discharge. Withholding pay for hours actually worked, however, is not a legal option, even when the hours worked were not authorized.

• Salaries for exempt and non-exempt employees may be prospectively reduced so long as those adjustments are not so frequent as to appear designed to circumvent the requirements of the FLSA. Quarterly adjustments have been found by the U.S. Court of Appeals for the Second Circuit to be in compliance with the FLSA. Adjustments to the predetermined amounts of salary should be implemented as infrequently as feasible so as not to raise an argument that the adjustments are a pretext to avoid compliance with the FLSA.

In sum, properly implemented salary reductions should comply with the salary requirements of the FLSA. Although it requires strategic planning and careful implementation, employers may find many benefits by implementing an effective cost-savings furlough plan that saves money and jobs, versus the RIFs dominating the news.

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