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Wage & Hour Update: A Resurgence in Litigation Over Employees. Exempt/Non-Exempt Status Under the FLSA

December 31, 2001

One of the more startling legal developments in the American workplace over the past year is the precipitous rise in litigation under the Fair Labor Standards Act ("FLSA") and similar state wage laws governing overtime. As several recent multi-million dollar settlements and judgments have demonstrated, determining whether to classify employees as exempt or non-exempt is no longer a routine decision to be left to payroll clerks. The increase in these types of wage claims serves as a warning to all employers that the classification of employees as exempt from overtime pay is an important strategic and legal decision where errors in judgment can have dire financial consequences.

The overtime litigation explosion

A number of large companies have recently settled highly publicized complaints alleging wrongful withholding of overtime pay:

Employers that have opted to vigorously defend such claims rather than settling have, in many cases, fared no better. In July 2001, for example, a California jury returned a $90 million verdict against Farmers Insurance Exchange in a case alleging failure to pay overtime wages under state law. The jury found that 2,400 claims adjusters and examiners had been misclassified by their employer as exempt employees, and were entitled to overtime pay. Industry analysts have predicted that the judgment may cost the company upwards of $130 million after interest and attorneys fees are factored in.

Similarly, in August 2001, a federal judge in Tennessee awarded almost $2.9 million in overtime pay, plus interest, to a plaintiff class consisting of 125 managers at Waffle House restaurants. The court found that the plaintiffs regularly performed non-supervisory tasks - despite their title of "manager" - and were therefore non-exempt employees entitled to overtime pay.

These cases are only the most recent examples of a trend that has been developing over the last few years. According to the federal government, the number of FLSA claims filed in federal court increased by nearly 25% between 1998 and 2000. Similar increases have been seen in the number of wage and hour cases filed in state courts. Because wage and hour claims are often filed as class actions, they are particularly expensive for employers to defend, and they tend to attract significant unwanted publicity.

Why now?

An employee's right to premium pay for overtime work was created in 1938 by the federal Fair Labor Standards Act. This depression-era legislation was originally designed to protect the industrial employees of the day from exploitation. Following the passage of the FLSA, most states passed similar legislation regulating overtime and wages.

In essence, the FLSA guarantees time-and-a-half pay for all hours worked beyond 40 in a workweek, unless an employee is salaried and falls into one of three main categories exempted from the overtime requirement: "professional" (one whose primary duties include using his/her own discretion and judgment in work requiring scientific or specialized study; teaching; or performing original and creative work), "executive" (one whose primary duty is the management of the company or a part thereof, and who regularly supervises two or more employees, and who has the authority to hire and fire) or "administrative" (one whose primary duty is to perform nonmanual work directly related to the employer's business operations or management policies, and who customarily and regularly exercises discretion and independent judgment in performing his/her job duties). Another exemption applies to certain "outside sales" employees (employees who are regularly engaged in sales activity away from the employer's premises).

There are a host of possible explanations for the recent jump in the number of federal and state overtime claims. Many experts have theorized that the recent weakening of the economy has led employers who have reduced their workforces to push their remaining employees to work longer hours. As a result, employees have begun to realize that being classified as non-exempt could be more lucrative than staying in a salaried "white-collar" position. Another possibility is that the so-called "new economy" has led to a blurring of the traditional lines between exempt and non-exempt job classifications. Federal and state overtime laws were formulated with factory employees in mind, not the employees engaged in today's service and information sectors. As a result, employers in the new millennium are faced with much more difficult choices regarding how to classify employees for purposes of FLSA and similar state laws. Boundaries that were once clearly defined - between managerial employees and those who work under them - are now often based more on perception than reality. Furthermore, many human resource professionals fall victim to the often complicated regulations attached to federal and state overtime law, and rather than make tough decisions based on new workplace realities, they misclassify employees because "that's the way it's always been done." Add to this the sheer momentum of recent headline-grabbing million dollar settlements, and it is not surprising that employers are now facing an onslaught of overtime claims.

Ensuring that your organization is following the rules

Know the tests for each FLSA exemption

In order to ensure that its employees are accurately classified as exempt or non-exempt, the employer should first confirm that each of its exempt employees has been properly placed in one of the exempt categories. In doing so, it is important to ensure that each class of exempted employees is classified as such based on these workers' actual job duties, not on their job titles. The Waffle House case is a classic example of what happens to employers who fail to heed this advice.

Beware the mid-level employee

In reviewing job classifications for purposes of FLSA compliance, the employer should be especially wary of mid-level employees – those at the bottom of the salaried category of employees within the employer's ranks. This is the group of employees most likely to be misclassified as exempt; these employees often perform both exempt and non-exempt job duties, making proper classification difficult.

Re-examine any policy docking the pay of salaried employees

Another common pitfall the employer faces relates to the practice of docking employees' pay for short-term absences from work. To qualify as exempt under the FLSA, an employee must not only perform functions that fall within one of the exemptions, but must be paid on a salaried (as opposed to hourly) basis. Generally, this means that an exempt employee must receive his full salary for any workweek in which he performs any work without regard to the number of days or hours worked. By erroneously applying to exempt employees a policy of docking pay for missed work, the employer may have unwittingly converted those workers to non-exempt status - making them eligible for overtime pay.

Comply with applicable state law as well as with the FLSA

It is imperative that the employer understands and complies with the requirements of applicable state wage and hour law. Certain state wage and hour laws provide greater protections to employees than those afforded under the FLSA. Under California state law, for example, employers must treat an employee as non-exempt and entitled to overtime unless, among other things, that employee spends more than half of his or her time on management duties. California law also requires that most non-exempt employees be paid time and one-half after eight hours in a day (unlike the FLSA, which has no daily overtime requirement and requires premium pay only after 40 hours in a week).

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It should be abundantly clear to employers that the Fair Labor Standards Act is not an anachronistic, irrelevant piece of legislation from a bygone era. Changes in the composition of America's workforce, employer ignorance and a weakened economy have spurred plaintiff's lawyers to breathe new life into the FLSA and related state laws, using wage and hour legislation in ever more creative ways to consistently win multi-million dollar settlements and judgments. Employers should take proactive steps to ensure that their current employee classifications are accurate. Neglecting to do so could force an employer to learn the hard way just how costly wage and hour violations can be.