Add One Line in Your Employment Contracts and Policies to Reduce Exposure to Misclassification Liability

Employers, even with the most robust and well-intentioned human resources departments, can still face the dreaded misclassification lawsuit for their salaried employers. In many cases, exempt employees are properly classified as executive or administrative employees. A misclassification lawsuit, however, is difficult to dismiss early because plaintiffs are afforded great latitude in crafting factual disputes that can only be resolved at trial. On top of that, plaintiffs generally bring such claims as class or collective actions – making litigation costly as well. Further compounding the problem, settlement of wage and hour misclassification cases is the preferred mode of resolution – but only after a range of damages can be made with some degree of certainty.

What if I told you that if you included one simple sentence in your employment contracts, handbooks and policies for salaried employees, it would likely reduce your exposure by approximately two-thirds in FLSA cases? For starters, it would make it easier to settle at the right amount by avoiding unnecessarily inflated ceiling for damage calculations by plaintiffs. So what are the “magic words” in this simple sentence?

For exempt employees, your salary is intended to pay for all hours worked during each pay period, regardless of your scheduled or tracked hours.

An employer’s first response is: well, isn’t that assumed for salaried employees since common sense dictates that a salaried employee means that an employee is not paid on a time basis and would be paid for all hours worked? No. This isn’t the case as more courts have presumed that, absent an express understanding, an employee’s salary only applies to the first 40 hours of a workweek as a default. This is because U.S. Department of Labor regulations are vague on how to calculate damages for misclassification cases, and courts have growingly interpreted guidance on what is called the Fluctuating Workweek (“FWW”) method of calculation for non-exempt employees – that is, counting a weekly salary to count as pay for all hours worked at a regular rate, even “overtime.”

Wait, what? In short, many courts would treat any overtime hours as unpaid as a default for calculations. Damages, therefore, would be 1.5 times the regular rate based on 40 hours (salary divided by 40 hours) for the overtime hours. See Ramos v. Telgian Corp., 176 F. Supp. 3d 181, 193, 2016 U.S. Dist. LEXIS 44321 (E.D.N.Y. 2016) (explaining that “[i]n the case of salaried, rather than hourly, employees, … the FLSA … ‘presum[es] that [] a weekly salary covers only the first forty hours, unless the parties intend and understand the weekly salary to include overtime hours at the premium rate’”).

If the “magic words” are properly inserted, a salary will cover all hours worked at the non-overtime, regular rate of pay (salary divided by all hours worked in a week). In these cases, damages will only be limited to the “overtime premium” for overtime hours – or just 0.5 more than the regular rate of pay. The impact of this one simple sentence in wage & hour claims was recently highlighted in a recent decision by the Southern District of New York. District Judge Paul Engelmeyer held in Thomas v. Bed Bath & Beyond, 2018 U.S. Dis. LEXIS 27904 (S.D.N.Y. Feb. 21, 2018) that a signed acknowledgment by an employee stating “I understand that my base weekly salary is compensation for all hours I work in a week” was sufficient to merit damages at just 0.5 times the regular rate.

To illustrate the financial impact and disparity of the two calculation methods, take a look at the difference:

Example: Salaried employee earns $900 per week and alleges 45 hours of work per week

FWW Method Without The “Magic Words”:

Regular rate of pay: $900 divided by 40 hours = $22.50

Overtime rate of pay: 1.5 times $22.50 (regular rate of pay) = $33.75

Unpaid wages: 5 hours x $33.75 (overtime) = $167.75

With the “Magic Words”:

Regular rate of pay: $900 divided by 45 hours = $20

Overtime rate of pay: 1.5 times $20 (regular rate of pay) = $30

Overtime premium: $30 (overtime rate) minus $20 (regular rate of pay) = $10

Unpaid wages: 5 hours x $10 (overtime premium) = $50

The disparity in damages is not due to the actual overtime rate difference which is fairly small. Rather, the stark difference is because the FWW method assumes that no wages are paid for overtime hours while the other method assumes that wages were paid, but only at the regular rate. Assuming a class or collective action size of 40 and three years statute of limitations, total damages would be over $2,000,000 for the FWW Method. If an “express understanding” between an employer and employee is made, the damages are approximately $624,000.

Now, the requirement of an “express understanding” may, as a gut reaction, seem asinine. Applying a time based damages formula would be seem paradoxical to common sense and needlessly cruel based on the impact on damages. There are fair, but wonky arguments that the default calculation methods is improper as a matter of law. This is, however, a situation where litigation to challenge this assumption, or awaiting definitive regulatory guidance is impractical. Rather, this risk can easily be mitigated by habitually including the one simple sentence into all your employment contracts, handbooks and policies for salaried employees. Taking such steps requires little effort or thought, and as demonstrated above, could mitigate financial liability by significant amounts.

As a caveat, this suggestion applies to wage & hour rules governed by the FLSA. Some state laws have not adopted the FLSA’s rules and may have their own methods on calculating overtime rates and damages for misclassified employees. However, it is unlikely that inclusion of the recommended terms would create greater risk of liability – such terms would likely be set aside in such limited jurisdictions.

Employers should feel free to adopt the above recommendations or use their own language as they see fit. If you need strategic assistance regarding the above, Mark Konkel of Kelley Drye & Warren LLP is available to discuss your wage & hour practices.