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Employers Who Take Deductions From Salaried Employees' Pay May Be Liable for Overtime Compensation, According to Second Circuit

October 31, 2000

In a case that had been remanded previously by the United States Supreme Court, the U.S. Court of Appeals for the Second Circuit in New York recently ruled that a class of salaried New York City employees might be entitled to overtime compensation under the Fair Labor Standards Act (the "FLSA"), because their employer maintained policies permitting deductions from employee compensation for certain disciplinary infractions. Yourman v Giuliani, 2000 U.S. App. Lexis 24762 (October 3, 2000).

Under the FLSA, employees who work more than 40 hours per week must be paid time-and-a-half for those overtime hours. 29 U.S.C. §207(a)(1). Employees employed in a bona fide executive, administrative, or professional capacity are exempt from these overtime requirements. 29 U.S.C. §213(a)(1). To qualify for any of these exemptions, the employee must be compensated on a "salary basis." Deductions from pay in less than one week increments for disciplinary violations are inconsistent with compensation on a salary basis. Auer v Robbins, 519 U.S. 452, 456 (1997). However, when a deduction is "inadvertent, or is made for reasons other than lack of work, the exemption will not be considered to have been lost if the employer reimburses the employee for such deductions and promises to comply in the future." 29 C.F.R. § 541.118(a)(6). A deduction is not considered inadvertent if an employer "engages in a practice of making impermissible deductions in its employees' pay, or has a policy that effectively communicates to its employees that such deductions will be made." Yourman (quoting Klem v. County of Santa Clara, 208 F.3d 1085, 1091 (9th Cir. 2000)).

The issue presented in Yourman was whether the City of New York has such a practice or policy of taking improper deductions from its salaried employees' pay. The plaintiffs represent a class of salaried employees who are subject to written policies permitting deductions from employee compensation for a variety of disciplinary infractions. The employees filed suit, seeking unpaid overtime compensation as provided for under the FLSA. The United States District Court for the Southern District of New York concluded that the employees were not compensated on a salary basis and granted summary judgment to the plaintiffs; the Second Circuit affirmed. The Supreme Court vacated the judgment and remanded the case in light of its holding in Auer that salaried employees are, in reality, non-exempt employees eligible for overtime pay if their employer has an actual practice of making pay deductions or an employment policy that creates a significant likelihood of pay deductions. On remand, the District Court granted summary judgment to the City, holding that the plaintiffs were not entitled to receive overtime compensation because the City had no actual practice of taking impermissible pay deductions from salaried employees' pay, nor did it have a policy that created a significant likelihood of such pay deductions.

In its October 2, 2000 decision, the Second Circuit agreed with the District Court's ruling that the City had no employment policy which created a significant likelihood of deductions from salaried employees' compensation. Both courts reached this conclusion after finding that the relevant City policies did not contain rules only applicable to salaried employees, and did not "effectively communicate that [pay] deductions 'would in fact be made in specified circumstances.'" However, the Second Circuit also vacated the lower court's ruling that the City did not have "an actual practice" of pay deductions, and remanded the case for further proceedings. The Court described several errors in the lower court's analysis of this issue, most significant among which was its determination that no "actual practice" of impermissible deductions existed because the number of impermissible deductions taken from salaried employees' pay was relatively small by comparison to the number of salaried City employees. The Second Circuit explained that, in determining what constitutes an "actual practice" on remand, the District Court should focus its inquiry on whether the City's practices reflect an "objective intention" to pay its employees on a salaried basis. In making such an inquiry, the Court should consider a number of factors, including the number of times other discipline was imposed, the number of infractions warranting discipline, the existence of policies favoring or disfavoring pay deductions, the process by which sanctions are determined, and the degree of discretion held by the disciplining authority.

In light of the Second Circuit's most recent decision in Yourman, employers should seek counsel before taking deductions from salaried employees' pay, as such deductions may have the undesirable effect of converting otherwise exempt employees to non-exempt status (thereby requiring the employer to pay overtime to those employees in applicable circumstances).