The Impact of “Cash-in-Lieu of Benefits” Payments to Employees on Overtime Compensation Calculations

By: Zach P. Hutton and Justin M. Scott, Paul Hastings.

Introduction

In Flores v. City of San Gabriel,¹ the Ninth Circuit Court of Appeals considered an issue of first impression: whether “cash-inlieu of benefits” payments made directly to employees under a flexible benefits plan must be included in the regular rate of pay for overtime compensation. The court concluded that such payments do not qualify for exclusion from the regular rate under the Fair Labor Standards Act² (FLSA). Therefore, non-exempt employees who receive such payments may be entitled to additional overtime pay. Because California law generally follows the FLSA with regard to the forms of pay that may be included in the regular rate,³ and federal law sets the “floor,” this decision may have significant consequences for California employers.

Background: The Regular Rate and 29 U.S.C. Section 207(e)

The FLSA, like California law, requires employers to pay an overtime compensation rate of one and one-half times the “regular rate of pay.”⁴ The regular rate includes “all remuneration for employment paid to, or on behalf of, the employee,”⁵ subject to certain exclusions enumerated by statute, including two relevant here.

Section 207(e)(2) of the FLSA provides that the regular rate shall not include

payments made for occasional periods when no work is performed due to vacation, holiday, illness, failure of the employer to provide sufficient work, or other similar cause; reasonable payments for traveling expenses, or other expenses, incurred by an employee in furtherance of his employer's interests and properly reimbursable by the employer; and other similar payments to an employee which are not made as compensation for his hours of employment.⁶

In addition, Section 207(e)(4) provides that the regular rate shall not include

contributions irrevocably made by an employer to a trustee or third person pursuant to a bona fide plan for providing old-age, retirement, life, accident, or health insurance or similar benefits for employees.⁷

Flores: Cash-in-Lieu of Benefits Payments Increase the Regular Rate

The City of San Gabriel (the City) maintained a flexible benefits plan under which a designated monetary amount was credited to each employee for the purchase of medical, vision, and dental benefits.⁸ All employees were required to use a portion of these funds to purchase vision and dental benefits.9 However, if an employee had alternate medical coverage, he or she could opt out of using the remainder of these funds to purchase medical insurance and, instead, receive the unused portion of their benefits allotment as a cash payment.¹⁰ The City designated such payments as “benefits” and excluded them when calculating employees’ regular rate of pay for purposes of overtime.¹¹

Non-exempt employees who had declined coverage and received cash payments of up to $1,300 each month filed a lawsuit alleging that they were due additional overtime compensation because the City failed to include the benefits payments in their regular rate of pay and, as a result, the benefits were excluded from the City’s calculation of the overtime rate.

FLSA Section 207(e)(2)

The City denied the plaintiffs’ allegations, first arguing that the payments were excludable under Section 207(e)(2) of the FLSA as “other similar payments to an employee which are not made as compensation for his hours of employment.”¹² Drawing on case law from other circuits, the City contended that the “other similar payments” language “permits exclusion of any payments that do not depend on when or how much work the employee performs.”¹³ The Ninth Circuit rejected that assertion, holding that a “payment may not be excluded from the regular rate of pay pursuant to Section 207(e)(2) if it is generally understood as compensation for work, even though the payment is not directly tied to specific hours worked by an employee.”¹⁴

In reaching its decision, the Ninth Circuit rejected the City’s assertion that Reich v. Interstate Brands Corporation supported the assertion that its cash-in-lieu of benefits payments were not dependent upon hours worked and were therefore excludable.¹⁵ In Reich, the Seventh Circuit Court of Appeals determined that the “other similar payments” clause of Section 207(e)(2) “refers to other payments that do not depend at all on when or how much work is performed.”¹⁶ Applying that standard, the court in Reich held that Section 207(e) (2) did not cover “earned work credits” paid, pursuant to a collective bargaining agreement, to bakers who did not receive two consecutive days off in a week.¹⁷ Such payments had to be included in the regular rate, the Seventh Circuit found, because they were akin to premium wages paid “for working weekends, or the night shift, or in noisy plants.”¹⁸ Contrary to the City’s interpretation, the Ninth Circuit concluded that “[a]t bottom, the Seventh Circuit’s reading of the statute is not so different from our own—both look to whether the payment at issue is generally understood as compensation to the employee, not whether the payment is tied to the specific hours worked by the employee.”¹⁹

The Ninth Circuit also rejected the City’s argument that the Third Circuit Court of Appeals’ decision in Minizza v. Stone Container Corporation Corrugated Division East Plant²⁰ compelled a different result. In Minizza, employees who ratified a collective bargaining agreement received lump sum payments “negotiated as a trade-off for wage increases [that] also served as an inducement to the employees to ratify the agreement.”²¹ The Third Circuit held that those payments were properly excluded from the regular rate as “other similar payments” under Section 207(e)(2) because they were “not payments relating to hours of employment or service.”²² The Flores court acknowledged that the standard applied in Minizza “hews more closely” to the City’s interpretation, but “decline[d] to adopt a similar requirement.”²³ The Ninth Circuit also distinguished Minizza on the ground that the purpose of the lump sum payment in Minizza “was to secure the employees’ ratification of a collective bargaining agreement,” not to compensate them for work performed.²⁴

FLSA Section 207(e)(4)

The City next argued that the cash-in-lieu of benefits payments qualified for exclusion under Section 207(e)(4) as “contributions irrevocably made by an employer to a trustee or third person pursuant to a bona fide” employee benefits plan.²⁵ Although the payments were made directly to employees, not to a trustee or third person, the City claimed that they “generally” satisfied the requirements because they funded employee benefits, and the City “should not be penalized for administering its own flexible benefits plan.”²⁶

The Ninth Circuit rejected this argument as well, finding that the plain text of Section 207(e)(4) applies only to payments made to a “trustee or third person,” and that the court was “not at liberty to add exceptions to the clear requirements set forth in the statute.”²⁷

In addition to holding that the City’s cash-in-lieu of benefits payments must be included in the regular rate, the Ninth Circuit reversed the district court’s conclusion that the City had acted in good faith in excluding the payments, and, instead, concluded that the City’s overtime violations were willful. The court based its willfulness finding on the fact that the City had not shown that the human resources personnel who made the determination took any affirmative steps to ensure that the payments qualified for exclusion—despite the fact that there was no binding, on-point case authority at the time.

Impact of the Decision

Cash-in-lieu of benefits payments made directly to employees who have alternate coverage have become an increasingly common benefit. According to the Ninth Circuit’s decision in Flores, making such payments to non-exempt employees will create an added overtime cost, as the payments must be included in the regular rate of pay for calculating overtime compensation. Therefore, employers who have adopted this benefit for non-exempt employees should take steps to evaluate the effects of this decision on their pay practices.

Zach Hutton is a member of the Employment Law Department of Paul Hastings. His practice spans all aspects of employment law, including discrimination and harassment, wrongful termination, family and medical leaves, and wage and hour issues. He has successfully represented employers in numerous class actions, individual plaintiff cases, labor arbitrations, and administrative hearings. Mr. Hutton also provides advice and compliance guidance on complex wage and hour issues to clients in a variety of industries. Justin Scott is a senior associate in the Employment Law practice of Paul Hastings and is based in the firm’s San Francisco office. Mr. Scott litigates employment matters with a specific focus on defending wage-and-hour class and collective actions. He also has a wealth of experience defending individual actions, including numerous discrimination, retaliation, and individual wage-and-hourclaims, as well as advising employers on compliance issues.

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Bender’s Labor & Employment Bulletin, Volume 16 • Issue No. 10. Copyright © 2016. Matthew Bender & Company, Inc., a member of the LexisNexis Group. All rights reserved. Materials reproduced from Bender’s Labor & Employment Bulletin with permission of Matthew Bender & Company, Inc. No part of this document may be copied, photocopied, reproduced, translated or reduced to any electronic medium or machine readable form, in whole or in part, without prior written consent of Matthew Bender & Company, Inc

1. 2016 U.S. App. LEXIS 10018 (9th Cir. June 2, 2016). 2. 29 U.S.C. § 201 et seq. 3. See, e.g., Division of Labor Standards Enforcement (DLSE) Enforcement Policies and Interpretations Manual § 49.1.2 (“In not defining the term ‘regular rate of pay,’ the Industrial Welfare Commission has manifested its intent to adopt the definition of ‘regular rate of pay’ set out in the [FLSA] 29 U.S.C. § 207(e).”). 4. 29 U.S.C. § 207(a). 5. 29 U.S.C. § 207(e). 6. 29 U.S.C. § 207(e)(2). 7. 29 U.S.C. § 207(e)(4). 8. Flores, 2016 U.S. App. LEXIS 10018, at *6. 9. Id. at *6. 10. Id. at *6–7. 11. Id. at *8–9. 12. Id. at *12–13 (quoting 29 U.S.C. § 207(e)(2)). 13. Id. at *12–13. 14. Id. at *17. 15. 57 F.3d 574 (7th Cir. 1995). 16. Id. at 578. 17. Id. at 578–79. 18. Id. at 578. 19. Flores, 2016 U.S. App. LEXIS 10018, at *17. 20. 842 F.2d 1456 (3d Cir. 1988). 21. Id. at 1458. 22. Id. at 1462. 23. Flores, 2016 U.S. App. LEXIS 10018, at *18. 24. Id. at *18. That ground for distinguishing Minizza is questionable, as the opinion made clear that the payments had a dual purpose: to induce employees to ratify the agreement and substitute for future wage increases. See Minizza, 842 F.2d at 1458. 25. 2016 U.S. App. LEXIS 10018, at *21 (quoting 29 U.S.C. § 207(e)(4)). 26. Id. at *21. 27. Id. at *22. The plaintiffs in Flores also contended that payments made to the plan itself, to provide for benefits, did not qualify for exclusion. Although beyond the scope of this article, the Ninth Circuit concluded that those payments were included in the regular rate of pay on the ground that the plan was not “bona fide,” as that term is used in Section 207(e)(4), because far too high a percentage of the payments were made directly to employees. Id. at *9.