By John F. Fullerton III, Douglas Weiner and Meg Thering¹ 

(John F. Fullerton III is a Member of Epstein Becker & Green in New York City. Douglas Weiner is Senior Trial Counsel and Meg Thering is an Associate at that firm.)   

The plague of lawsuits for unpaid overtime compensation by employees who claim that they were misclassified by their current or former employer as “exempt” from overtime under the “administrative” exemption of the Fair Labor Standards Act shows no signs of receding.  These lawsuits continue to present challenges to employers, not just in terms of the burdens and costs of defending the cases, but in the uncertainty of the potential financial exposure.

Rather than making sure that all elements of the administrative exemption have been satisfied for each job title or position, employers sometimes simply treat employees who perform office work and are paid reasonably well as exempt from overtime.

Unfortunately for these employers, the U.S. Department of Labor and plaintiffs’ attorneys are paying attention.  In fact, as was announced in 2010, they are working together – the Department of Labor refers potential plaintiffs to lawyers, and provides employees with iPhone apps to track their work hours.   

Misclassification litigation has lead to some very large, public settlements and judgments against employers.  Just as an example, in recent years several large institutions in the financial sector have paid between hundreds of thousands to tens of millions of dollars to settle class actions and Department of Labor investigations where employees with job titles such as “financial advisor,” “senior specialist” and “financial analyst” have allegedly been misclassified under the administrative exemption.   

Employers are left asking:  Is there a cure?

WHAT IS THE ADMINISTRATIVE EXEMPTION?

The FLSA provides a minimum wage and overtime pay exemption for any employee employed in a bona fide administrative capacity as defined in the FLSA’s regulations. An employee may qualify for the exemption if both the “salary” and “duties” tests are met.

Under the regulations an “employee employed in a bona fide administrative capacity” means “any employee”:
        (1) Compensated on a salary or fee basis at a rate of not less than $455 per week;
        (2) Whose primary duty is the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
        (3) Whose primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.   

The phrase “work directly related to the management or general business operations of the employer or the employer’s customers”  can refer to work in such functional areas as research, finance, legal, information technology, marketing, and human resources.  Further, the regulations provide several factors “to consider when determining whether an employee exercises discretion and independent judgment with respect to matters of significance,”including:  

whether the employee has authority to formulate, affect, interpret, or implement management policies or operating practices; whether the employee carries out major assignments in conducting the operations of the business; . . . whether the employee has authority to commit the employer in matters that have significant financial impact; . . . whether the employee provides consultation or expert advice to management; . . . [and] whether the employee investigates and resolves matters of significance on behalf of management. 29 C.F.R. § 541.202.   

Notwithstanding this regulatory guidance and some helpful case law, the bottom line is that “discretion,” “independent judgment,” “general business operations,” and “matters of significance” have no single, easily applied definition.  Thus, because these terms have no precise definitions, they are often difficult to apply with a high degree of confidence.

Although the other so-called “White Collar” exemptions that are applicable to “executive” and “professional” employees have their own ambiguities, they do have more precise definitions, and thus, can usually be applied with more certainty.

For example, to qualify for the executive exemption, an employee must, among other things, supervise two or more full time employees.  Without much ambiguity, that element of the test is satisfied by a digital count.  Generally speaking, if the person is indeed a supervisor, either she does, or does not, supervise at least two employees.

Likewise, the professional exemption generally turns on whether the employee in question has the requisite academic degree.   

Of course, applying FLSA exemptions is rarely “easy,” but because the administrative exemption is defined in such soft terms, the challenge of correct application is greatly increased.  In addition, because the applicability of the administrative exemption is fact-specific, it is generally difficult to obtain pre-trial dismissal of such cases.  Thus, even an employer who is ultimately found to have had classified its employees properly may incur great expense and spend significant time and resources in defending such suits.   

WHAT CAN EMPLOYERS DO TO MINIMIZE THEIR RISK OF CATCHING THE MISCLASSIFICATION BUG?

Recognizing how tricky the administrative exemption can be, what affirmative steps can employers take to help minimize the risk and reduce the potential liability?  The best strategy, of course, is making sure that employees are correctly classified in the first place.  This is often easier said than done.

One possible starting point is ensuring that exempt administrative employees have accurate job descriptions.  Sometimes all the person responsible for classifying classify a job title or position has to rely upon is the written job description, and sometimes nothing more than the hiring manager’s brief summary of what the position entails.

In addition, a written job description may be the first thing a plaintiff’s lawyer or the Department of Labor examines when investigating a potential misclassification claim.  Thus, for both reasons, review that description to make sure that the position described jumps off the page as being exempt.

Review and revise the job descriptions with the statutory definitions and regulatory guidelines on hand, so that the description matches to the greatest extent possible the language of the standard that will be applied if the exempt classification ever comes under scrutiny.

Also, be aware that an employee’s failure to exercise the independent judgment and discretion that the position requires does not relieve him of his exempt status.  However,  it does require proactive management of the employee’s performance, so that he cannot later argue that his job description did not match the actual duties, as plaintiffs often claim.

Rather than condoning the failure to exercise independent judgment, the employer should take steps to address this shortcoming in periodic evaluations and make clear the expectation that his performance will match the job description.

In addition, jobs change over time, so job descriptions should not be drafted once and then forgotten.   

Another strategy for ensuring correct classification from the outset is to use the “highly compensated” employee exemption whenever possible.   Under that exemption, a highly compensated employee is deemed exempt if:
        (i)   the employee earns total annual non-discretionary compensation of $100,000 or more (including at least $455 per week paid on a salary basis);
        (ii)  the employee’s primary duty includes performing office or non-manual work; and
        (iii) the employee customarily and regularly performs at least one of the exempt duties or responsibilities of an exempt executive, administrative or professional employee.

For example, an employee may qualify as an exempt highly-compensated administrative employee if she customarily and regularly performs office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers – in other words, works in a department and role typically considered “administrative” – even if she does not exercise any independent judgment.   

Thus, employers should at least give consideration, especially in borderline cases, to raising the base salary of an employee who is close to the $100,000 threshold to that level.  Doing so will make it considerably easier to establish that the employee is exempt if the classification is challenged, and the money saved may be well worth the relative increase in base salary.

WHAT CAN EMPLOYERS DO TO MINIMIZE THE FINANCIAL EXPOSURE TO MISCLASSIFICATION?

In terms of reducing potential liability under the FLSA, there are a few strategies that can be employed.  One is to make sure the employer is in a position to argue that any overtime owed should be calculated according to the “fluctuating work-week” or “half-time” method, rather than the better known time-and-one-half method.

Make sure that the employees being classified as exempt understand from the outset that they will receive the same weekly salary regardless of the number of hours they actually work from week to week (and that this in fact happens).

While not required, it is advisable to put this agreement in writing.  This method of calculation can dramatically decrease the potential damages in a misclassification case.

Instead of dividing the weekly salary by 40 to determine the regular rate of pay and paying one-and-a-half times that rate for every hour worked in excess of 40, the weekly salary is instead divided by the actual number of hours the employee worked each week.  Thus, the more overtime an employee worked, the lower the regular rate.  The employee is then paid an additional one-half of that rate for every hour worked in excess of 40 in a week, rather than one-and-a-half times that rate.

Conceptually, the salary pays straight time for all weekly hours, and only additional half-time is due for weekly hours over 40 to pay the time-and-one-half required by law.   

Although a split in authority has arisen among the districts courts regarding whether this method can apply retroactively, five federal circuit courts have now approved the use of the half-time method in misclassification cases.

Thus, employers who are sued or threatened with legal action for unpaid overtime should continue to argue for the half-time method of calculating damages, in litigation or during settlement discussions, in any case in which the employees were clearly paid a fixed salary, regardless of the number of hours actually worked each week.

The key to satisfying the salary basis necessary for reliance on any of the “White Collar” exemptions, and for reliance on the “half-time” method, is making sure that a consistent salary is maintained, without improper deductions in weeks in which the hours worked dip below 40, or for any other reason that would taint the salary basis.

Nevertheless, some deductions from exempt employees are permissible without putting the salary basis at risk.  Some examples include: employee absences from work for one or more full days for personal reasons other than sickness or disability; absences of one or more full days due to sickness or disability if the deduction is made in accordance with a bona fide plan, policy or practice of providing compensation for salary lost due to illness; offsets for amounts employees receive as jury or witness fees, or for military pay; penalties imposed in good faith for infractions of safety rules of major significance; unpaid disciplinary suspensions of one or more full days imposed in good faith for workplace conduct rule infractions; and amounts for weeks in which an exempt employee takes unpaid leave under the Family and Medical Leave Act. 

If an employer makes an error by making impermissible deductions from an exempt employee’s salary, it may be able to rely on the “safe harbor” rule.  Employers can seek refuge under this rule if they:
        (i)   have a clearly communicated policy prohibiting improper deductions and including a complaint mechanism;
        (ii)  reimburse employees for any improper deductions; and
        (iii) make a good faith commitment to comply in the future. 

If these factors are met, the “safe harbor” will apply and the employer will not lose the exemption for any affected employees – unless the employer willfully violates the policy by continuing to make improper deductions after receiving complaints. 

A FINAL PRESCRIPTION 

This article has focused on the FLSA, but it is important to remember that most states have their own wage-and-hour laws that are in some instances stricter than federal law.  Not only should employers make sure that employees are properly classified under both state and federal law, but they should understand that not all of the antidotes described above may be available under state law.

At the end of the day, a carefully planned and implemented process for making initial overtime classification decisions, with periodic internal audits to ensure the continuing accuracy of those classifications, is likely the best way to ensure that the plague of administrative exemption litigation passes you by.

Notes 

¹    John F. Fullerton III is a Member of Epstein Becker Green’s Labor and Employment practice, in the Firm's New York office. He has substantial experience serving clients in the financial, health care, real estate, and building service industries. He can be reached at jfullerton@ebglaw.com.  Douglas Weiner is a Senior Trial Counsel in Epstein Becker Green’s Labor and Employment practice, in the Firm's New York office.  He has 30 years of federal wage and hour litigation experience. He can be reached at dweiner@ebglaw.com.  Meg Thering is an Associate in Epstein Becker Green’s Labor and Employment practice, in the firm's New York office. She can be reached at mthering@ebglaw.com.