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Legal Alert: Court Adopts Narrow Interpretation of “Commission” Under FLSA

Date   Oct 16, 2006
A federal court in Tennessee recently adopted a narrow interpretation of the term “commission” as that term is used in the Department of Labor (DOL) regulations interpreting the Fair Labor Standards Act (FLSA).

A federal court in Tennessee recently adopted a narrow interpretation of the term “commission” as that term is used in the Department of Labor (DOL) regulations interpreting the Fair Labor Standards Act (FLSA). See Wilks v. The Pep Boys (M.D. Tenn., Sep. 26, 2006). As a result of this interpretation, the court held that ten employees who filed a collective action against the employer for unpaid overtime compensation under the FLSA are not exempt from the FLSA’s overtime requirements under Section 7(i) of the Act. Accordingly, the employer must proceed to trial on their claims.

In Pep Boys, a group of current and former mechanics filed a nationwide collective action against Pep Boys, claiming, in part, that the employer failed to pay overtime compensation to employees who were paid pursuant to a complicated flat-rate system. The employer asked the court to throw out these claims, arguing that these employees were exempt from the FLSA’s overtime requirements under the retail commission exemption because they were paid on a commission basis.

The FLSA requires employers to pay covered employees an overtime premium of one and one-half times the employee’s regular rate of pay for any hours worked in excess of forty in one week. The overtime requirement is subject to a number of exceptions, one of which is the “retail commission” exemption in Section 7(i). This provision states that a retail establishment is not deemed to have violated the overtime requirement with regard to an employee: (1) who is paid a regular rate in excess of one and one-half times the minimum wage and (2) who receives more than half of his compensation for a representative period (not less than one month) in commissions on goods or services. 29 U.S.C. § 209(7)(i). The provision further states, “[i]n determining the proportion of compensation representing commissions, all earnings resulting from the application of a bona fide commission rate shall be deemed commissions on goods or services without regard to whether the computed commissions exceed the draw or guarantee.”

According to the court in Pep Boys, to claim this exemption, the employer must demonstrate the following three elements: (1) the employee worked in a retail or service establishment; (2) the employee was paid a regular rate of $7.73 per hour (which is one and one-half times the current minimum wage of $5.15 per hour) for every hour worked; and (3) the employee received more than half of his or her compensation for a representative period in the form of commissions earned from the sale of goods or services. Here, the court found that the employer failed to establish that the plaintiffs received more than half their compensation in the form of commissions.

In making this determination, the court held that to qualify as a “commission” under the exemption, the employer must compensate employees at a rate that is proportionally related to the amount it charges its customers. The court found that complaining employees were credited with a certain number of “labor hours” for each service job they performed. These labor hours were not based on how long an employee actually took to do the job, but instead were computed “according to predetermined standards as to how long each job should take to complete.” At the end of each week, the labor hours were multiplied by the employee’s rate, which ranged from $14.00 to $23.70, to determine the employee’s flat rate wages for that week.

The employer also used a Variable Benefit Rate (VBR), which was calculated by multiplying a varying percentage of the employee’s flat rate by the number of hours actually clocked. The VBR was based on the employee’s productivity over the preceding twelve weeks. The complaining employees claimed they were either paid their flat rate wage or VBR, depending on which was greater. The employer claimed the employees always received their flat rate wages and, when the VBR based wages exceeded the flat rate, received the difference in the form of Mechanics Supplemental pay “in addition to the commission.”

The court found that the price charged to the customer was not related to the number of hours the employee actually took to complete a particular task. The court held that evidence existed that undermined “any notion of a proportional relationship between employee compensation and customer price, either overall or for labor alone.” While the amount paid to each flat rate employee for each labor hour worked varied from $14.00 to $23.70, there was no evidence that customers were charged more for labor when the work done for them was performed by an employee on the high end of the scale.

The court did not determine whether proportionality must exist between the labor charge passed on to the customer and the flat-rate wages or between the overall price charged to the customer and the flat-rate wages, finding that the employer failed to demonstrate any proportionality at all. In finding no proportionality, the court noted that if the flat-rate wages and labor costs were actually correlated, the labor costs would fluctuate based on the amount paid to the flat rate employee tasked with completing the job. The court held, “it appears that the plaintiffs merely earn a predetermined amount for each task they complete and that this amount does not fluctuate in tandem with the amount charged to the customers.” Thus, the court held that the flat-rate employees were not exempt from the FLSA’s overtime requirements under the retail commission provision.

Employers’ Bottom Line:

The court’s narrow interpretation of the definition of commission under the retail commission exemption could impact employers who pay employees on any type of flat-rate basis. While this decision is not binding outside the court’s jurisdiction, there is little case law directly on point and other courts could find the reasoning in this case persuasive.

Automobile dealerships will still be able to rely upon the “mechanics” exemption from overtime found in Section 13(b)(10) of the FLSA for employees who qualify.

If you have a question about the decision in this case, or the validity of a claimed exemption under the FLSA, please contact the Ford & Harrison attorney with whom you usually work or Jerry Coker, jcoker@fordharrison.com, 404-888-3820 or Ben Fryer, bfryer@fordharrison.com, 404-888-3934.