We all make mistakes, and when we do, we just hope we have a chance to fix them and learn from them. But when somebody gives you a second chance to fix a mistake, you'd better actually fix it because third chances are harder to come by.

When the U.S. Department of Labor (DOL) passed regulations governing the overtime exemptions under the Fair Labor Standards Act (FLSA), it recognized that employers sometimes make mistakes and that second chances are necessary.

The 10th Circuit recently applied the FLSA's "window-of-correction" regulation to an employer that made a one-time mistake by deducting wages from an exempt employee who worked less than a full workweek. The employer promptly fixed its mistake and won a lawsuit as a result.

The law

Under the FLSA, employees are designated as exempt or nonexempt. Nonexempt employees have a right to overtime pay at time and a half for all hours worked over 40 during a single workweek. Exempt employees, of course, are exempt from the overtime pay requirement.

The FLSA contains several categories of exempt employees, and an employee must fall within the definition of one of the exemptions for the employer to avoid paying overtime. A key component of many of the exempt categories is whether an employee is paid "on a salary basis" rather than an hourly basis.

Once an employee is categorized as exempt, the employer must continue to pay the employee on a salary basis to retain the exempt status. That means employers typically cannot dock an exempt employee's pay for working less than a full workday.

Indeed, employers can lose the right to treat employees as exempt if they make improper deductions from an exempt employee's pay because the deductions can demonstrate their intent to pay the employee on an hourly, rather than a salary, basis.

Making improper deductions can yield terrible results for employers. If the DOL or a court concludes that frequent improper deductions demonstrate an employer's practice and intent not to pay exempt employees on a salary basis, the employer can lose the exemption for a whole category of employees. Also, the employer can be required to pay years of retroactive overtime payments to employees.

Fortunately, the DOL recognizes that everyone can mess things up now and then. Among the FLSA regulations, the DOL included a "window-of-correction" defense. The defense allows an employer to maintain the exempt status of an employee if the employer made an isolated or inadvertent deduction and promptly fixed the mistake by reimbursing the employee.

Facts

Sandra Ellis was a store manager for J.R. Country Stores, Inc., a chain of convenience stores located throughout Colorado. The company had a written salary plan that stipulated that store managers were considered exempt "salaried" employees and were expected to work a minimum of 50 hours each week or "whatever number of hours per week is necessary to effectively run [the] store."

For years, Ellis worked the requisite 50-plus hours each week, earning a set weekly salary plus monthly bonuses based on her store's performance. Then, in April 2012, her paycheck was short one week. That week, she worked only 40.91 hours, and she received $593.80 instead of her usual weekly salary of $625. That paycheck was the only one that was ever less than her set weekly salary in her more than 4 years with the company.

Ellis resigned after receiving the short paycheck and sent a letter to the company demanding more than $42,000 in unpaid overtime. She claimed that the one-time deduction from her pay for not working the requisite 50-hour week resulted in a loss of her exempt status, thus entitling her to more than 3 years of retroactive overtime pay. She alleged that the one-time deduction constituted a "willful" practice of making improper deductions.

In response, the company denied that it had a practice of making improper deductions. It went ahead and paid Ellis $332.88 to make up for the one-time deduction, using a calculation that was advantageous to her and arguably resulted in a windfall for her given the fact that her paycheck was only about $31 short. Still, the $332 payment was much smaller than the $42,000-plus she wanted, so she sued. The district court ruled in favor of the employer, and Ellis appealed.

Court's ruling

The 10th Circuit upheld the district court's ruling. The court's decision had two key components.

First, the court held that the employer's one-time deduction from Ellis' pay did not demonstrate an intent not to pay her on a salary basis. Rather, the undisputed facts demonstrated that the employer always intended to pay her as an exempt employee.

The most persuasive evidence bolstering that conclusion was, of course, the fact that she received a set weekly salary every week for more than 4 years until the one-time slipup. Indeed, in the past, she had always received her set weekly salary, including when she worked less than 50 hours during a week on 13 occasions.

Moreover, the court cited the employer's handbook as further evidence of the company's intent to follow the requirements outlined in the FLSA. The handbook stated, "The Company prohibits deductions from an exempt, salaried employee's pay except under the circumstances set forth in the [FLSA] and state law. If you believe that improper [deductions have occurred], it will promptly reimburse the employee and ensure the mistake will be corrected in the future." Contrary to Ellis' argument that the employer had a policy mandating improper deductions, the court found that the language in the handbook proved just the opposite.

The court also held that the employer's policy requiring managers to work a hard floor of 50 hours per week and mandating that managers record their hours did not violate the FLSA. Indeed, in 2004, the DOL amended the FLSA regulations to state that "employers, without affecting their employees' exempt status, . . . may require exempt employees to record and track hours; [and] may require exempt employees to work a specified schedule."

The second part of the court's opinion addressed the fact that the employer promptly paid Ellis after she complained about the one-time deduction. The court held that even if the one-time deduction constituted evidence of the employer's intent to pay her on an hourly basis, it could avoid liability because of the FLSA's "window-of-correction" defense.

The "window-of-correction" defense states that "improper deductions that are either isolated or inadvertent will not result in loss of the exemption . . . if the employer reimburses the employee for such improper deductions." The court noted that Ellis identified only a single improper deduction in all her years of employment, the company promptly reimbursed her, and she did not dispute that the deduction was isolated or that she was fully reimbursed in a timely manner.

After considering all the evidence, the court found in favor of the employer and against Ellis on every count. Ellis v. J.R.'s Country Stores, Inc., 2015 U.S. App. LEXIS 3667 (10th Cir., Mar. 9, 2015).

Lessons learned

The employer in this case did everything right. When it received a letter from a former employee for more than $40,000 in retroactive overtime, it paused and took the high road. The employer recognized that it had made a mistake—once—and it paid for that mistake.

Its handbook policies made clear that it had every intent to comply with the FLSA and encouraged employees to bring improper deductions to the company's attention so that it could promptly correct any mistakes. The company learned that promptly fixing a mistake can pay off in the long run.

This article was edited by the attorneys of Holland & Hart LLP for the Colorado Employment Law Letter.