California Court of Appeal Analyzes ‘Salary’ Test Under Administrative Exemption

Under California law, an employee is exempt from California’s overtime requirements and other wage and hour laws if the person is employed in an administrative capacity. To meet this exemption, California’s wage orders and the California Labor Code provide that an employee must perform certain job duties and be paid a monthly salary equivalent to at least twice the state minimum wage for full-time employment. Neither the Labor Code nor the wage orders define what constitutes a “salary” or what it means for an employee to be paid on a salary basis for the purposes of the exemption. A recent California Court of Appeal decision, however, sheds some light on the issue.

In Semprini v. Wedbush Securities, Inc., No. G057740 (November 9, 2020), the court found that a commissions-only pay structure did not meet the administrative exemption’s salary basis test, which requires the payment of at least twice the minimum wage and which is a “predetermined amount” that is “not subject to reduction because of variations in the quality or quantity of the work performed.” It was not enough that the employer would advance any shortfall for the month because such payment was not a predetermined amount and the advance had to be repaid. Despite the court’s decision, its ruling may be of particular interest to employers that utilize nondiscretionary bonuses and commissions to meet the “twice the state minimum wage” salary threshold.

Background

The employer in this case, Wedbush Securities, Inc., classified its financial advisors as exempt from overtime requirements and other wage and hour rules purportedly in accordance with California’s administrative exemption. Wedbush paid its financial advisors on a commissions-only basis, in which the advisors received compensation based on the number of trades or sales they made in a given month. This pay structure routinely resulted in financial advisors earning more than twice the minimum wage, but when a shortfall occurred, Wedbush would pay its financial advisors the commissions earned plus a draw (or advance) against future commissions. In doing so, Wedbush ensured that its financial advisors earned at least twice the minimum wage each month and Wedbush only clawed back the previously issued advances on commissions in months when the financial advisors earned more than twice the minimum wage.

Two of Wedbush’s financial advisors who were paid according to this pay structure filed a class action complaint against Wedbush alleging various wage-and-hour claims on behalf of themselves and all other financial advisors Wedbush employed in California. Wedbush asserted the administrative exemption as one of its affirmative defenses, and the case proceeded to an early bench trial to determine whether the administrative exemption applied. The trial court concluded that it did, finding that Wedbush’s compensation plan satisfied the salary basis test by ensuring that the putative class members received at least twice the minimum wage each month, and therefore it provided a complete defense to all claims. The trial court entered judgment for Wedbush, and the advisors appealed.

The Court of Appeal’s Reasoning on Commissions-Only Compensation Plans

The question presented on appeal was “whether a compensation plan based solely on commissions, with recoverable advances on future commissions, qualifie[d] as a ‘salary’ for purposes of [the administrative] exemption.” The court of appeal concluded that it did not. In reaching this decision, the court explained that it would need to turn to the federal salary basis test under the Fair Labor Standards Act (FLSA) for guidance because neither the California Labor Code nor wage orders defined what constitutes a “salary.” The court referred to 29 C.F.R. § 541.602(a), which provides that an employee is paid on a salary basis if the employee “‘regularly receives each pay period on a weekly, or less frequent basis, 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.’” (Emphasis added by the court.)

Wedbush argued that its financial advisors received the required predetermined amount when it advanced wages to financial advisors who earned less than the minimum wage, but the court of appeal disagreed. “An advance is not a wage,” the court stated. “Wedbush therefore cannot rely on its advances to satisfy the salary basis test. The salary basis test requires employers to pay employees at least double the minimum wage, not loan them that amount. Since Wedbush recoups the advances from future commissions, it does not pay wages (much less a salary) equivalent to twice the minimum wage,” the court ruled.

The court further explained that because the financial advisors’ commissions were dependent on the “performance and the quantity of their sales,” the commissions-only pay structure would not constitute a “salary.” The court found support for this position in the 2020 amendment to 29 C.F.R. § 541.602(a)(3), which provides that “[u]p to ten percent of the salary amount required by § 541.600(a) may be satisfied by the payment of nondiscretionary bonuses, incentives and commissions, that are paid annually or more frequently.” Therefore, the court concluded, “a commission-only compensation plan–i.e., a compensation plan based 100 percent on commissions–does not satisfy the federal salary basis test.” Since California law follows the federal salary basis test to a substantial degree, the court of appeal held that a commission-only plan could not pass California’s salary basis test and that the administrative exemption did not apply.

Key Takeaways

Employers that are currently attempting to meet the “salary basis” test by paying their employees on a commission-basis only may want to reexamine their compensation plans in light of the Semprini case. Significantly, however, as discussed above, the court of appeal did favorably cite 29 C.F.R. § 541.602, which provides that up to 10 percent of the salary can be paid by nondiscretionary bonuses and commissions. Because of the recent amendment to the federal regulations, this decision was the first by a California appellate court to address the use of nondiscretionary bonuses and commissions to meet the salary basis. Although it did not squarely address the issue, this decision may provide support to employers that look to utilize up to 10 percent of the salary amount from nondiscretionary bonuses and commissions to satisfy the administrative exemption.