By: Ruth Seroussi, Esq.

December 9, 2015

Apparel companies, beware, as there are a number of common errors employers make when paying employees commissions or piece rates. Unfortunately, recent decisions in California have complicated this area, and misapplication of the law can be costly. Being apprised of the common pitfalls can help minimize risk to your business.

Are You Paying Your Employee a Commission or Piece Rate?

The California Labor Code defines a commission as “compensation paid to any person for services rendered in the sale of the employer’s property or services and based proportionally on the amount or value thereof.” The employee must be employed principally in selling a product or service, and the commission must be “sufficiently related” to the price or the amount of items sold. This standard does not require the commission payment be a strict percentage of the employee’s sales. It can be based upon net profits or some other formula that takes into account the employee’s sales efforts.

The Labor Code specifically exempts from the definition of a commission temporary, variable incentive payments that increase but do not decrease payment, short-term productivity bonuses such as those paid to retail clerks, and, generally, bonus and profit-sharing plans unless the bonus is based on a fixed percentage of sales or profits.

Piece rate, or piecework, is defined as work paid for according to a set rate per unit. A piece rate must be based on an ascertainable figure paid for completing a particular task or making a particular piece of goods.

If you are paying employees a commission or piece rate, applicable law imposes certain obligations, some of which are discussed here. Employers should consult with legal counsel if they have any questions about whether or not a payment is a commission or piece rate.

The Commissioned Sales or Inside Sales Exemption

Some employers believe that if they pay their employees a commission an employee is automatically exempt from federal and state overtime requirements. This is not the case. In fact, the inside sales exemption—or commissioned sales exemption, as it is often called—is actually a narrow exemption under both federal and state law, exempting only certain commissioned employees from overtime requirements.

To qualify for this exemption, an employer must meet the requirements for the exemption under both the federal Fair Labor Standards Act and California law. Under both laws, an employee’s earnings must be more than one and a half times the minimum wage and more than half of the earnings must be in commissions. The federal and California inside sales exemptions differ substantially in their requirements from there.

Under the Fair Labor Standards Act, the inside sales exemption applies only to employees of “retail or service establishments” that sell goods or services to the general public (75 percent of whose annual dollar volume of the sale of such goods and/or services is not for resale) and that are recognized as retail sales or service establishments in that particular industry. There are detailed federal regulations analyzing which types of establishments do and do not qualify as retail or service establishments. It is construed relatively narrowly and does not apply to every employer covered under the California inside sales exemption.

In California, the inside sales exemption only applies to workers who are employed in the mercantile industry (i.e., wholesale, retail and rental businesses) covered by Wage Order 7 or in professional, technical, clerical, mechanical and similar occupations covered by Wage Order 4 (which applies when an “industry” wage order does not cover the employer). Thus, apparel manufacturers who pay sales employees a commission likely could not avail themselves of this exemption because Wage Order 1, which governs the manufacturing industry, does not contain the inside sales exemption.

Additionally, because California’s minimum wage is higher than the federal minimum wage, an employee’s compensation must be higher to meet the minimum earnings requirement for California’s inside sales exemption. For instance, under the Fair Labor Standards Act, the minimum wage for covered, nonexempt employees generally is $7.25 per hour, with limited exceptions. To satisfy the minimum earnings requirement of the inside sales exemption under the Fair Labor Standards Act, employees must earn more than $10.875 per hour. In contrast, California’s minimum wage is currently $9.00 per hour. It is set to increase to $10.00 per hour on Jan. 1, 2016. If an employer wants to argue that its commissioned employees are exempt from overtime in California under the inside sales exemption currently, they must earn more than $13.50 per hour. Come Jan. 1, 2016, commissioned employees must earn more than $15.00 per hour to satisfy the minimum-earnings requirement of California’s exemption. And, more than half of these earnings must be in commissions.

In further contrast to federal law, the California Supreme Court recently made clear that to satisfy the minimum earnings requirement for California’s inside sales exemption, a company may not average wages paid to an employee in one period with wages paid to the employee in another pay period. Instead, the earnings must exceed one and a half times the minimum wage for each hour worked during the pay period and must be made in each pay period. In short, the minimum earnings requirement must be satisfied in each workweek, with payments paid in each pay period. Employers need to ensure also that more than half of the employees’ earnings are in commissions earned in each workweek.

Employers should be aware that the inside sales exemption exempts employees from applicable overtime requirements only. It does not exempt them from recordkeeping requirements or from receiving meal periods and rest periods under California law or from tracking shift and meal period start and end times, for instance.

Because the inside sales exemption is complicated, because employers must meet the requirements under both federal and state law, and because federal and state law differ substantially, employers should not rely on these exemptions without first consulting with legal counsel. Many employers erroneously assume that the inside sales exemption is much broader than it is and that it is available when it is not. Commissioned employees who are not exempt inside sales employees must be paid overtime in accordance with applicable law.

California Commission Plans Must Be in Writing

Another common mistake that many companies make is that they do not realize that commission plans in California must be in writing, stating the method by which commissions will be computed and earned in clear and unambiguous terms. Employers must provide employees with a signed copy of the commission agreement and obtain a signed receipt of the agreement from the employee acknowledging both receipt of, and agreement with, the commission program before implementing it.

California employers should also be aware that the expiration date in a commission agreement is invalid under the new law, unless the agreement is immediately replaced by a new agreement or the employee is terminated. If not, then the terms of the expired agreement will remain in full force until the agreement is superseded or the employment is terminated.

Pure Piece-Rate or Pure Commission Payment Plans Are No Longer Viable in California

Finally, recent California decisions have taken issue with compensation structures whereby employees are paid purely on a piece-rate or commission basis. These decisions clarify that employers may not average piece-rate pay or commission pay over the course of a pay period to meet minimum-wage requirements. Rather, minimum-wage requirements affix for each hour worked. In other words, employers must pay employees for nonproductive time, including paid rest breaks, and for time where they are prevented from earning sales-related or production-based pay, such as in staff meetings, for instance. Otherwise, employers risk owing employees for unpaid wages and any attendant damages, penalties and interest.

Apparently in agreement with the courts, the California Legislature passed Assembly Bill 1513 (AB 1513), which takes effect Jan. 1, 2016. AB 1513 creates California Labor Code section 226.2, which provides for the payment of an hourly wage for “nonproductive” time worked by piece-rate employees separate from piece-rate compensation and a separate payment for rest and recovery periods, among other things. It also requires employers to include additional items on pay statements for piece-rate employees. Employers who have employees in California paid on a piece-rate or productivity basis should carefully review AB 1513 and discuss this new law with their legal counsel to confirm that they are in compliance with its requirements prior to the year-end, and, if applicable and advisable, avail themselves of AB 1513’s safe-harbor provision.

In short, employers should exercise caution when paying employees commissions and piece rates and consult legal counsel to help them navigate complex wage and hour requirements.

This article was featured in California Apparel News