Legal Update
Jan 30, 2012
Appellate Court Sheds Light On California Commissioned Employees Exemption
On January 24, 2012, the California Court of Appeal in Muldrow v. Surrex Solutions Corp. held that preliminary activities such as cold calling, searching for viable candidates, interviewing candidates, and inputting data are all essential sales duties, and therefore relevant to determining whether an employee is principally engaged in selling for purposes of the California commissioned employees exemption. In a matter of first impression, the court also ruled that a compensation system accounting for price and costs may still comply with the requirements of the exemption. Additionally, the court held that all employees in a given position, rather than selected members, are relevant to a determination of whether a commission-based compensation system is "bona fide" or not.
Background Facts
Tyrone Muldrow, a former "senior consulting services manager" who engaged in employment recruiting for Surrex, brought a class action alleging that Surrex improperly classified him as exempt under the California commissioned employees exemption. Muldrow recruited candidate-employees for client-employers. The clients would place job orders with Surrex, and Muldrow would search for potential candidates to fill the orders.
After placing an employee with a client, Surrex would bill the client at an hourly rate for the employee's services. In turn, a consulting services manager who successfully placed an employee would receive a percentage of the "adjusted gross profit" that Surrex earned from the client. The adjusted gross profit was generally defined as the rate that the client paid for the employee, less Surrex's costs in employing the employee.
Industrial Welfare Commission Wage Order 7-2001 exempts "commissioned employees" from overtime compensation if the employee's earnings exceed one and one-half times the minimum wage, and more than half of the employee's compensation represents commissions. Previously, in Keyes Motors, Inc. v. DLSE, the California Court of Appeal established two requirements for a compensation program to constitute "commission wages:" (1) the employee must be involved "principally in selling a product or service, not making the product or rendering the service," and (2) the employee's compensation "must be a percent of the price of the product or service."
The trial court in Surrex determined that the class member employees were subject to the commissioned employees exemption, and Muldrow appealed.
"Selling" a Product or Service
Muldrow argued on appeal that "searching on the computer, searching for candidates on the website, cold calling, interviewing candidates, inputting data, and submitting resumes," should not be characterized as sales activities. The court rejected this argument, adopting the trial court's holding that these activities are "essential prerequisites necessary to accomplishing the sale, " and thus, "sales-related activities." Therefore, the court held that plaintiffs were employed "principally in selling a product or service."
Commissions "Sufficiently Related" to Price
Muldrow also argued that Surrex's compensation program violated the "percent of the price of the product or service" requirement set forth in Keyes Motors because the compensation calculation contained cost-related factors. The court disagreed, holding that previous cases on this issue did not intend to limit employers to calculating commissions based strictly on a percentage of the price of the product or service.
Potential class members were responsible not only for negotiating the price that the client would pay Surrex, but also the amount that Surrex would pay the employee. Thus, the court noted that a commission system based solely on price would fail to reward employees who helped Surrex achieve greater profits by limiting costs. The court also stated that Surrex's commission system fully comports with the "essence of a commission" in that it is a payment based on sales, decoupled from actual time worked.
Therefore, the court held that plaintiffs' compensation constituted commissions for purposes of the commissioned employees exemption because it was sufficiently related to the price of services sold.
A Bona Fide Commission System
Senior consulting services managers received a monthly draw (advance on future commissions) ranging from $3,000 to $5,500 per month. Muldrow argued that this compensation plan did not constitute a bona fide commission system, citing the Division of Labor Standards Enforcement Policies and Interpretations Manual stating that "consistent commission earnings below, at, or near the draw are indicative of a commission plan that is not bona fide."
Muldrow attempted to limit the court's analysis on this point to only himself and nine other class members. The court refused, adopting the trial court's holding that "the test cannot be limited to whether any one or group of employees actually was able to realize income in excess of their draw. To so hold would be to reward the unmotivated or certainly the unproductive employee."
Accordingly, the court allowed evidence as to the compensation of all consulting service managers. Upon finding that many class members were paid in excess of their draws, the court rejected plaintiffs' contention that Surrex's commission system "was not bona fide as a matter of law."
What Surrex Means for Employers
Surrex clarifies that the term "sales" should not be interpreted "in a vacuum contrary to the job description of any salesman." Instead, when analyzing whether an employee is principally engaged in selling a product or service, the employer may account for all activities that are "essential prerequisites necessary to accomplishing the sale."
Surrex also confirms that a compensation system can comply with the "percent of the price of the product or service" requirement, even if it accounts for factors other than price. Thus, employers should continue to begin the compensation calculation with the price of the sale or service, but also may consider other profit-related factors in this calculation, such as costs.
Finally, employers should continue to ensure that a commission-based system results in many employees earning in excess of their draw. However, based on Surrex, employers do not need to be as concerned that a small number of unmotivated or unproductive employees will negate the "bona fide" nature of such a compensation system. Of course, employers desiring to rely on the California commissioned employees exemption also should make sure that they satisfy the commission pay exemption contained in the federal Fair Labor Standards Act.
Anthony DiBenedetto is an associate in the firm's Sacramento office. If you would like further information, please contact your Seyfarth Shaw LLP attorney or Anthony DiBenedetto at adibenedetto@seyfath.com.