By Kate McGovern Tornone

The 9th U.S. Circuit Court of Appeals—which covers Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington—has given employers another thing to worry about in light of the new overtime regulations. In a case of first impression, the court ruled that when an employer pays an employee cash for opting out of its health insurance, that payment must be considered part of the employee’s “regular rate of pay” under the Fair Labor Standards Act. This means it must be used in calculating compensation for overtime hours.

In Flores v. City of San Gabriel, Nos. 14-56421, 14-56514 (9th Cir. June 2, 2016), the court said the city of San Gabriel owed back overtime pay to its police officers; the employer’s liability was limited, however, by a partial overtime exemption for police and fire departments.

Background

The city of San Gabriel provided a cash payment to employees who declined to participate in its health insurance. The “cash-in-lieu of benefits” payment was provided through workers’ regular paychecks and, as of 2012, amounted to about $1,305 per employee per month. This payment appeared as a designated line item on an employee’s paycheck and was subject to withholdings.

The city, however, did not consider the payment part of employees’ regular rate of pay and therefore did not include it when calculating their overtime rates. San Gabriel paid its police officers overtime when they worked more than 80 hours in a 14-day period. (Employers generally must pay overtime for hours worked beyond 40 in a single workweek but public police departments may use FLSA §207(k)’s partial overtime exemption; it only requires overtime when workers engaged in law enforcement activities work more than 171 hours in a 28-day work period.)

A group of officers sued, alleging that the city violated the FLSA by failing to include the benefits payment in their “regular rate of pay.” The U.S. District Court for the Central District of California agreed but found that because the violation was not willful, the officers only were entitled to recovery for the FLSA’s 2-year statute of limitations period. It also determined that the city qualified for the FLSA’s “partial overtime exemption.”

Appeals court weighs in

The city appealed, arguing that the cash-in-lieu of benefits payment should not be included in the regular rate of pay. The plaintiffs cross appealed the court’s other rulings.

Regular rate. On appeal, the 9th Circuit explained that the FLSA defines “regular rate” as “all remuneration for employment paid to, or on behalf of, the employee,” except for a few exclusions:

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 the 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.

The city argued that the final phrase — “other similar payments to an employee which are not made as compensation for his hours of employment”— allowed it to exclude payments that do not depend on when or how much work the employee performs.

The court, however, found that the U.S. Department of Labor’s (DOL's) regulation on the topic disagrees. In 29 C.F.R. §778.224(a), DOL says it is “clear that the clause was not intended to permit the exclusion from the regular rate of payments such as bonuses or the furnishing of facilities like board and lodging which, though not directly attributable to any particular hours of work are, nevertheless, clearly understood to be compensation for services.”

The regulation provides examples, including amounts paid to an employee for the rental of her vehicle; loans or advances made to the employee; and the cost to the employer of conveniences furnished to the employee such as parking space, restrooms, lockers, on-the-job medical care and recreational facilities.

Additionally, the FLSA’s inclusion of a separate exemption specifically addressing benefits — §207(e)(4) — suggests that payments related to benefits should be considered compensation, the court said.

Therefore, the cash-in-lieu of benefits payments must be included in employees’ regular rates of pay, the 9th Circuit ruled.

Partial overtime exemption. The appeals court also agreed with the lower court that the city was eligible for the FLSA’s partial overtime exemption. Specifically, the city had met its requirement of establishing a regularly recurring §207(k) work period, having maintained an 80-hour, 14-day overtime period since 1994.

The plaintiffs argued that the city did not qualify because it did not reference §207(k) in any documents, unlike documents for the city’s fire department. The court however, said that no such requirement exists. “An employer need not expressly identify §207(k) when establishing a §207(k) work period in order to qualify for the exemption,” the 9th Circuit said. “[A]ll we require … is that the employer show that it established a § 207(k) work period and that the § 207(k) work period was regularly recurring.”

Damages permitted. The appeals court, however, reversed the lower court’s ruling on liquidated damages, finding that the city did not act in good faith when it classified the payment as a “benefit” in its payroll system.

The city attempted to show good faith by explaining that the payroll department had consulted with the human resources department in classifying the payment. But the appeals court said that such “paltry evidence” was not sufficient.

“The City has presented no evidence of what steps the human resources department took to determine that the cash-in-lieu of benefits payments were appropriately classified as a ‘benefit’ under the FLSA and excluded from the calculation of the regular rate of pay,” the court said.

The city then argued that it had demonstrated good faith because it had established a more generous overtime policy than the partial overtime exception required. The court, however, said the city was “grasping at straws.”

“Evidence that the City complied with its other obligations under the Act or that it agreed to pay overtime more generously than required by law do not demonstrate what the City has done to ascertain whether its classification of the payments at issue here complied with the FLSA,” it said.

Statute of limitations. The appeals court also disagreed with the lower court’s ruling on the statute of limitations.

The employer’s testimony that it carefully considered whether the payment should be a “premium” or a “benefit” shows that it was aware of its obligations under the FLSA, the 9th Circuit said. Despite notice of the FLSA’s requirements, the city failed to show that it took affirmative actions to ensure that its classification of the payment complied with the law, it continued.

Therefore, back pay and liquidated damages are available for 3 years, the court concluded.

Employer takeaway

The 9th Circuit noted that its ruling may cause employers to discontinue cash-in-lieu of benefits payment programs.

But “such arguments are ‘more appropriately ... made to Congress or to the Department of Labor, rather than to the courts,’” it said. “The potential effect of our ruling on municipal decision-making does not give us license to alter the terms of the FLSA.”