Outside Sales Exemption

By David Garland and Douglas Weiner

In February 2011, the U.S. Court of Appeals for the Ninth Circuit gave a resounding victory to employers in the pharmaceutical industry by finding that pharmaceutical sales representatives are covered by the outside sales exemption of the Fair Labor Standards Act (“FLSA”). Christopher v. SmithKline Beecham, No. 10-15257 (9th Cir. Feb. 14, 2011). Plaintiffs, and the U.S. Department of Labor (“DOL”) in an amicus brief, had argued the exemption did not apply because sales reps are prohibited from making the final sale. Prescription medicine in the heavily regulated pharmaceutical industry can only be sold to the ultimate consumer with the authorization of a licensed physician. Sales reps use their “selling skills” to persuade doctors to prescribe their employer’s products when the doctor’s patients have a medical need for them. Sales reps do not transfer title to the medicine themselves.

Previously the Second Circuit, in In Re Novartis, took a contrary view and adopted the Secretary of Labor’s position that the outside sales exemption did not apply to pharmaceutical sales representatives specifically because they were prohibited by regulation from making direct sales. The Ninth Circuit rejected the plaintiffs’ and DOL’s “rigid, formalistic interpretation” of the FLSA’s definition of “sale,” which provides that “Sale” … includes any “sale … or other disposition.” 29 U.S.C. 203(k). Because of the uncertainty in this unsettled area of law, both the employee plaintiffs and the employer asked the U.S. Supreme Court to review the Ninth Circuit’s decision.

Pertinent to the aggressive approach the DOL has recently taken in submitting unsolicited amicus briefs in significant cases, another issue the Supreme Court may review is the degree of deference, if any, the court owes to an amicus brief submitted by the DOL. Again in stark contrast, the Second Circuit gave the DOL’s amicus brief “controlling deference” to interpret the DOL’s own regulations while the Ninth Circuit gave the DOL’s amicus brief “no deference” finding it was a departure from established industry norm that the DOL used to short-cut the public notice – and – comment rule making procedures.       

It would be a most welcome development for the Supreme Court to affirm the Ninth Circuit and resolve this dramatic split in the circuit courts. However, even if the Second Circuit’s view of the “outside salesman” exemption is upheld, there are circumstances when sales reps may be exempt by virtue of the administrative exemption. Employers need clarity to structure employment practices without the ever-present threat of class action litigation.

By Michael S. Kun, David W. Garland, Douglas Weiner

The Ninth Circuit Court of Appeals has become the latest Circuit Court to weigh in on the subject of whether pharmaceutical sales representatives are covered by the FLSA outside sales exemption.  The result, in Christopher v. SmithKline Beecham, No. 10-15257 (9th Cir. Feb. 14, 2011), is a resounding victory for employers in the pharmaceutical industry.

The plaintiffs and the Secretary of Labor argued, among other things, that sales representatives in fact do not make sales at all, which places them outside the bounds of the outside sales exemption.  Although other courts have agreed, in unmistakably clear language the Ninth Circuit rejected this argument.   The Court explained that the plaintiffs’ contention “that they do not ‘sell’ to doctors “ignores the structure and realities of the heavily regulated pharmaceutical sales industry.”  Although pharmaceutical sales representatives are prohibited by federal law from consummating direct sales to physicians and patients, the Court held that a “common sense” interpretation of the duties of pharmaceutical sales representatives shows that they fall plainly within the terms of the outside sales exemption.

Recognizing the reality of what pharmaceutical sales representatives do, the Court observed that they secure the most that they can achieve under the law from physicians — a non-binding commitment to prescribe the assigned product when medically appropriate.  This commitment is valued enough that the manufacturer rewards the representative with increased commissions when “a physician increases his or her use of a drug in the PSR’s bag.”

Unlike the Second Circuit in In Re Novartis, which adopted the Secretary of Labor’s position that the outside sales exemption did not apply to pharmaceutical sales representatives, the Ninth Court refused to give deference to the Secretary’s amicus brief in support of the plaintiffs’ claims.  In strong language, the Court questioned why the DOL had changed its position on an exemption that has existed since 1938, noting that until the Secretary’s appearance in In Re Novartis, it had not “challenged the conventional wisdom that detailing is the functional equivalent of selling pharmaceutical products.”  

Although welcome, the Ninth Circuit’s opinion is unlikely to be the final word on this important issue.  Novartis has filed a petition for certiorari to the U.S. Supreme Court.  Given the split among the circuits, it would not be surprising for the Supreme Court to take an interest in this issue.

In an important decision that explains the distinction between promoting and making sales, the Eleventh Circuit held recently that a marketing executive was exempt from the overtime and minimum wage provisions of the Fair Labor Standards Act as an outside salesperson. The case is Gregory v. First Title of America, Inc., Case No. 08-10737 (11th Cir., January 27, 2009).

Before addressing the facts of the case and the Eleventh Circuit’s holding, let’s review the applicable statute and regulations. The FLSA includes several exemptions from its minimum wage and overtime requirements, including any employee employed in the capacity of an outside salesperson, as defined by the Secretary of Labor. See 29 U.S.C. § 213(a)(1).

The Department of Labor defines “outside sales employee” as any employee whose primary duty is (i) making sales within the meaning of section 3(k) of the Act, or (ii) obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer; and (2) Who is customarily and regularly engaged away from the employer’s place or places of business in performing such primary duty. 29 C.F.R. § 541.500(a).

29 C.F.R. section 541.501 defines “making sales or obtaining orders” as follows:

(b) Sales within the meaning of section 3(k) of the Act include the
transfer of title to tangible property, and in certain cases, of tangible
and valuable evidences of intangible property. Section 3(k) of the Act
states that ‘sale’ or ‘sell’ includes any sale, exchange, contract to sell,
consignment for sale, shipment for sale, or other disposition.

(c) Exempt outside sales work includes not only the sales of
commodities, but also ‘obtaining orders or contracts for services or for
the use of facilities for which a consideration will be paid by the client
or customer.’ Obtaining orders for ‘the use of facilities’ includes the
selling of time on radio or television, the solicitation of advertising for
newspapers and other periodicals, and the solicitation of freight for
railroads and other transportation agencies.

(d) The word ‘services’ extends the outside sales exemption to
employees who sell or take orders for a service, which may be
performed for the customer by someone other than the person taking
the order.

Promotional work is addressed in 29 C.F.R. § 541.503. Promotional work may or may not be exempt outside sales work, depending on the circumstances under which it is performed. “Promotional work that is actually performed incidental to and in conjunction with an employee’s own outside sales or solicitations is exempt work” whereas “promotional work that is incidental to sales made, or to be made, by someone else is not exempt outside sales work.” 29 C.F.R. § 541.503(a).

Now for the facts and the Eleventh Circuit’s holding. First Title of America, Inc. (“First Title”) is a title marketing company based in Lake Mary, Florida. The plaintiff, Nelda Gregory, was a “marketing executive” for First Title who was hired due, in large part, to her prior experience in selling insurance. According to the Employment Agreement executed between the parties, her job description was to “provide the services for referring and closing title insurance companies.”

Under the terms of the Employment Agreement, Gregory initially was paid $1000 per week. At Gregory’s suggestion, she later began to be paid on a commission basis and received a fifty percent commission on all orders for title insurance from her clients that closed with First Title. Gregory claimed that although she often worked more than forty hours per week, she was never compensated for her overtime.

Gregory argued that she did not fall within the FLSA’s outside sales exemption because she was employed by First Title as a marketing representative and she never actually consummated a sale during her employment. Gregory contended that she was tasked only with inducing realtors, brokers and lenders to begin referring their customers – the end user – on to First Title for title insurance services. She maintained that she never directly sold title insurance or title insurance services to anyone because she was not licensed to do so. In short, Gregory asserted that she was employed only to promote First Title’s services and to stimulate sales and was never involved in the actual sale of title insurance to the realtors, brokers and lenders, or to the end users.

First Title argued that Gregory’s primary duty was bringing in or obtaining orders for First Title and that her compensation was tied directly to orders for title services that ultimately closed. First Title cited to language from the Preamble to 29 C.F.R. Part 541 discussing recent modifications to § 541.403 (Promotion Work), in which the DOL remarked that:

[T]he Department agrees that technological changes in how orders are taken and processed should not preclude the exemption for employees who in some sense make the sales. Employees have a primary duty of making sales if they ‘obtain a commitment to buy’ from the customer and are credited with the sale.. . . . Exempt status should not depend on whether it is the sales employee or the customer who types the order into a computer system and hits the return button. The changes to proposed section 541.503(c) are intended to avoid such a result.

Thus, First Title argued that that how the order is placed is immaterial – the inquiry should focus on the efforts of the salesperson. If those efforts were directed toward the consummation of her own sales as opposed to stimulating the sales of the company in general, then the employee is exempt.

Agreeing with First Title, the Eleventh Circuit concluded that Gregory’s primary duty was to obtain orders for First Title’s title insurance services, i.e., bring in orders. The court noted that the bulk of Gregory’s time was spent away from the office, free from direct supervision and performing work that could not be conclusively characterized as nonexempt.

Addressing Gregory’s argument that her work was “stimulating sales” as opposed to “obtaining orders for services,” the court concluded that “Gregory did, indeed, make a sale in some sense.”

She obtained commitments to buy orders for First Title’s title insurance service and, most importantly, was credited with the sale. She was hired for her prior sales experience and brought a book of clients with her to First Title. Not long after being hired, Gregory’s sole source of income was directly tied to the number of orders that she brought in. She listed her clients for the Appellees and received credit (and payment) only for those orders placed by her clients that closed. All of her efforts were directed towards the consummation of her own sales and not towards stimulating sales for First Title in general.

The court also noted that Gregory did not merely “pave the way” for other salespeople. “Gregory did not collect orders and turn them over to another salesperson nor does the record contain evidence of any other intervening sales effort between Gregory and orders placed with First Title[,]” the court noted. “As opposed to conceiving of Gregory as “paving the way” for others to consummate the sale, we view her as acting more as a conduit through which orders for services flowed. Gregory received credit and payment for those orders that flowed through her to First Title.”

The Gregory decision is significant, as there are undoubtedly thousands of sales and marketing employees within the Eleventh Circuit (Florida, Georgia and Alabama) who “obtain a commitment to buy” from the customer and are credited with the sale, but who do not actually place the order for the sale. Gregory makes clear that such facts do not necessarily preclude the application of the outside sales exemption.

A caveat: Employers should keep in mind that courts generally construe exemptions to the FLSA narrowly. Before classifying any employee as exempt under one of the “white collar” exemptions, careful attention must be paid to the employee’s actual job duties and the tests set forth by the DOL.