The Overtime Classification Game: What Your Company Should Know About

The Exempt vs. Non-Exempt Debate

By: Ross E. Shanberg, Esq.

At first glance, the basic overtime classification rule is deceivingly simple. It states that workers who spend more than half of their work time "engaged in work which is primarily intellectual, managerial, or creative, and which requires exercise of discretion and independent judgment" are legally exempt from overtime requirements. After reading this seemingly clear cut rule taken from a recent California Court of Appeals decision, one can easily start playing the overtime classification game with friends and co-workers, using the people encountered in everyday life as the prompts; the waiter who served lunch was non-exempt, the conductor at the symphony was exempt, the telemarketer who interrupted dinner was non-exempt, the cop who gave me the speeding ticket was exempt, etc. This game starts out easy because many of the most obvious jobs (e.g. waiters, lawyers, bus drivers, doctors, sales managers, receptionists) fit neatly into either the exempt or non-exempt category. However, the game becomes difficult, the rules confusing, and the losses expensive when employers answer incorrectly and mis-classify their own employees who might arguably fit into either category.

Many large employers have recently found themselves in an unenviable position defending against overtime wage related class action lawsuits. The central issue in all of these cases is whether certain salaried employees, who are classified as exempt from overtime laws by their employers, are entitled to overtime because they perform work that more closely conforms with non-exempt status requirements. Many of these lawsuits have concluded with employers paying out multi-million dollar settlements in the interest of avoiding onerous legal costs as well as the risk of a costly final judgment against them.

Some of these lawsuits may well have been the result of companies knowingly mis-classifying employees in an attempt to save the cost of paying overtime. However, the majority of the employer-defendants were probably very surprised to find themselves on the wrong side of the overtime law. The lesson to be learned here is that a few hours taken reviewing current employee overtime classifications and classification policies might save millions in legal fees and settlements in the future. Employers must realize that there are three main categories of exempt employees: executive exempt, professional exempt and administrative exempt. Each of these categories has specific criteria and definitions, but generally speaking all require that an employee spend at least 50% of his/her time (1) exercising discretion and independent judgment, (2) making independent decisions that are binding on the company, and (3) managing at least 3-4 individuals. Specific requirements for inclusion in the various exemption classifications can also vary by industry and the type of work performed by the business. The Industrial Welfare Commission regularly issues wage orders that set forth specific regulations regarding wages, hours and working conditions within various industries. It is also recommended that all employers familiarize themselves with Labor Code Sections 510 and 511 that discuss what constitutes "overtime" and the appropriate rate of compensation for overtime hours.

In order to begin a general internal review of employee classifications, it is important to consider the following questions as a guideline:

1. What do these employees really do here? As mentioned above, unless employees are spending more than half of their work time being creative, managing other employees, thinking intellectually, or exercising independent judgment, they are non-exempt. Be very careful of classifying employees who work under the direct supervision of another as exempt. Bank of America learned the hard way when it settled for $22 million dollars with 6,000 personal assistants, who had been classified as administrative exempt when further investigation revealed that they fell within the non-exempt employee category. As such, they were all entitled to back pay of overdue overtime wages.

2. When is a manager not a manager? A manager is only a manager if he/she spends more than 50% of his/her time managing. Starbucks Corp. recently settled a lawsuit with its California store managers for $18 million. Even though managerial employees are generally considered executive exempt, the Starbucks claim reiterated that managerial staff must spend over half of their time performing managerial duties (i.e. not serving frappuccinos) to be considered exempt.

3. Are educated and/or highly trained employees always exempt employees? No. An employee's high level technical training or other education does not necessarily translate into an automatic exempt status. Pacific Bell learned this lesson when it paid 1,500 engineers $35 million for overtime wages that were due to them since they had been classified as professional exempt employees due to their education level and not classified as non-exempt employees based on their actual job duties. The exercise of independent judgment is one of the factors for classifying employees enumerated by the courts. Therefore, it is important to consider how much supervision and direction employees get when performing their job functions, regardless of their level of training or education.

While the horror stories of employers doling out millions of dollars to wrathful employees might fill many company heads with dread, the news regarding these types of lawsuits is not all bad for employers. The recent decision in Sav-On Drug Stores, Inc. v. Superior Court may make it more difficult for plaintiffs to litigate these actions by making it harder for them to get groups of employees certified by the court as a "class." In this type of lawsuit, class actions are the only practical way for plaintiffs to litigate because legal fees would quickly devour any recovery that individuals might be awarded on their own. However, the courts have made it clear that class action lawsuits are not appropriate when each proposed class member's right to recover depends on separate facts applicable only to that individual. The California Court of Appeals in Sav-On denied class certification to a group of approximately 1,400 Operating Managers and Assistant Managers at Sav-On's 300 retail stores citing insufficient uniformity among the retail locations' operations. Essentially, the court determined that because there were significant questions relating to how each store operated and how each employee divided time among exempt and non-exempt activities, each case would have to be decided individually. This decision is obviously extremely favorable for large employers with numerous locations. However, Sav-On may eventually prove to be easily distinguishable from subsequent cases because the employee job descriptions varied so significantly between store locations due to a variety of factors including size and type of store, hours of operation, and sales volume. Thus, firms who anticipate some exposure to this type of lawsuit might take the step of compiling information in advance, reflecting the non-uniformity of operations among company locations.

In conclusion, the best way for employers to protect against overtime class action lawsuits is to take a pro-active stance by conducting a review of current employee overtime classifications and related policies. After all, the best way to defend lawsuits is always to avoid them in the first place. If a lawsuit is threatened, the Sav-On decision certainly strengthens the employer's position at the bargaining table and might ultimately prove to be a potent weapon for inducing denial of class certification. In the end, the overtime classification game might not be anyone's idea of fun. However, by ensuring employee classifications are correct, companies can guarantee that the cost of playing the game remains economical.