by Shane Sagheb

For years, employers in California have been cautioned about deducting debts from employees’ final paychecks. On January 9, 2014, the Ninth Circuit Court of Appeals issued an unpublished opinion in Ward v. Costco Wholesale Corp., No. 11-56757 (9th Cir. Jan. 9, 2014), holding that under certain limited circumstances, such deductions do not run afoul of federal law or the California Labor Code. In light of the fact that this decision is not published and no state court opinion has adopted its holding, however, employers should remain cautious about making such deductions.

During their employment with Costco, the plaintiffs in Ward signed an agreement authorizing the company to deduct from their final paychecks, upon separation of employment, any balance due on their company-issued credit card. When Costco deducted unpaid credit card balances from the plaintiffs’ final paychecks, applying those balances against their accrued vacation and sick pay, the plaintiffs sued, alleging violations of the Fair Labor Standards Act (“FLSA”) and the California Labor Code.

The trial court rejected the plaintiffs’ claims following a bench trial, and the Ninth Circuit affirmed. With respect to the FLSA claims, the court observed that federal law did not require employers to pay accrued vacation and sick pay upon discharge and thus evaluated whether such deductions violated federal overtime and minimum wage requirements. It concluded that because the amount of the deductions exceeded the employees’ accrued vacation and sick pay, “the district court correctly found that the credit card deductions did not effect a violation of the overtime and minimum wage requirements.”

The court also concluded that the plaintiffs in Ward failed to prove a violation of California Labor Code Sections 201 or 203, which require the payment of all earned wages at termination. The Ninth Circuit relied on and analogized the decision in Schachter v. Citigroup, Inc., 47 Cal. 3d 610 (2009), in which the California Supreme Court enforced vesting and forfeiture provisions contained in an incentive plan. The incentive compensation plan in Schachter provided employees with shares of restricted company stock at a reduced price in lieu of a portion of their annual salaries. The plan included vesting requirements and provided that the employees would forfeit any such stock, as well as the cash compensation they directed to be paid in the form of stock, if their employment ended before the entitlement to the stock vested. The Court in Schachter held that the forfeiture provision was enforceable, at least as to employees who were discharged with cause or who resigned, because the rights under the incentive plan had not yet vested and, therefore, had not been earned.

Without analyzing the differences between the incentive plan in Schachter and the credit card expense agreement before it, the Ninth Circuit in Ward simply paraphrased Schachter as follows: “Having elected to receive some of [their] compensation in the form of [credit card balances], … [Plaintiffs] cannot now assert that [they] should have been paid in cash that portion of [their] compensation [that Plaintiffs] elected to receive [in the form of credit card balances].” Thus, the court equated the credit card balance agreement and incentive plan and concluded that “Costco did ‘not run afoul of the Labor Code because no earned, unpaid wages remain outstanding upon termination according to the terms of” Plaintiffs’ agreements with Costco” (quoting Schachter).

State courts in California are not obligated to abide by the conclusion reached by the Ninth Circuit in Ward. Moreover, it is unclear from the Ninth Circuit’s opinion in Ward why the court concluded that the credit card agreement signed by the plaintiff in that case was analogous to the vesting and forfeiture provisions in the incentive plan at issue in Schachter. Employers thus are well-advised to continue to proceed with caution when considering whether to make deductions from employees’ final paychecks.