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Overtime Lawsuits Are You at Risk

September 30, 2001
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There's a very clear message echoing through the American workplace: categorizingemployees as exempt or non-exempt is no longer just a prickly payroll decision.Misclassifying employees as exempt from overtime pay when they are entitledto it is to risk being slapped with a huge lawsuit. In the past year, a numberof class-action complaints have been filed by employees accusing companies ofcheating them out of overtime pay.

    In recent well-publicized cases, Rite Aid, U-Haul,and Taco Bell have been charged with overtime violations, settling for $25 million,$7.5 million, and $13 million, respectively. In July, a jury ruled that FarmersInsurance Exchange owed $90 million for not correctly paying its 2,400 claimsadjusters and examiners. The presiding judge in the Alameda County, California,case reasoned that the insurance adjusters were the equivalent of productionworkers.

    That same month, Starbucks Coffee Co. was accused ofovertime violations. As in many similar lawsuits, the firm's managers are challengingtheir exempt status, arguing that they work very long hours at tasks such asmaking coffee and cleaning out cappuccino machines, work that can hardly bedefined as managerial. The company, which prides itself on its corporate citizenry,denies wrongdoing.

    And the rash kept spreading. In August, a federal judgeawarded nearly $2.9 million in overtime pay, plus interest, to Waffle Houserestaurant managers. The theme of the class-action lawsuit was no different.Many of the company's "managers" regularly worked as cooks and servers,and put in nearly twice as many hours as they were told to expect. The lawsuit,filed by 125 current and former managers against Treetop Enterprises Inc., ownersof about 100 Waffle House franchises predominantly in the South, claimed thatthey were initially told they could expect to work 53 hours a week. Instead,they regularly worked far longer hours as cooks, and also filled in for servers.

    The startling rise in the number of overtime lawsuitsin recent years -- especially in the retail-chain industry -- shouldn't be allthat surprising, says Dennis Moss, a Santa Monica, California, lawyer who isrepresenting two managers in a suit against Starbucks filed in July in Los AngelesCounty Superior Court. "Retail chains are especially well-suited for class-actionsuits because of their cookie-cutter nature. They have the same procedures,such as formulas for allocating work time. The standardization makes it appropriatefor class-action lawsuits.

    "Most employees are dependent on their employers.They don't sue, because they are afraid to bite the hand that feeds them. Andespecially in California, where most employees work 'at will,' it's easy toterminate them." With a class-action suit, only one or two employees filea complaint on behalf of a large group of people, Moss says. "Employeescan remain relatively anonymous."

    Overtime lawsuits, however, aren't limited to majorcorporations and chains. Even small companies are facing big settlements. Arecent study by the Department of Labor estimates that almost half of all U.S.companies have misclassification errors. "There is a huge problem in thiscountry with workers being classified as exempt when they're not," saysJim Finberg, an attorney with Lieff Cabraser Heimann and Bernstein in San Francisco,a firm that specializes in this kind of employee class-action case. "We'llkeep seeing a rise in suits."

Why these cases are exploding now
    The roots of the overtime issue go back to the FairLabor Standards Act of 1938. The law originally established minimum-wage andovertime laws in order to protect employees from exploitation. Over the years,a variety of other items have been added to the legislation, such as instructionon how to deal with employees who receive tips. In the following decades, individualstate laws regulating wages and overtime -- some more stringent than the federallaws -- also have been enacted.

    In order to qualify for overtime exemption under theFLSA, an employee must be paid a salary and must fall into one of four mainjob categories: executive, professional, administrative, or outside sales.

    Misclassification can occur for several reasons. Someemployees prefer an exempt position because it gives them white-collar status,and the financial security of receiving the same amount of pay each week. Employersare generally more than happy to accommodate. The exempt status saves them timekeepinghassles and eliminates the major expense of overtime. As long as the employeeprofits, the arrangement appears trouble-free.

     Given the downturn in the economy, however, some expertstheorize that employees are being pushed to work longer hours, and are beginningto realize that earning overtime pay could be much more lucrative. "Workersare like everyone else: they want the best deal," says Neil Martin, a partnerin the Houston office of Gardere Wynne Sewell. "Times are leaner, so peoplewho were previously content about their financial arrangements are less so.Employees are looking at whether they're better off being paid hourly or onsalary. It's a self-interest-driven issue."

    Others say it is quite the opposite. Before the economicslump, the labor market was very tight. Employees' hours began creeping up becausein many industries, there weren't enough people to hire. Instead of hiring moreemployees at, say, $7 an hour, many companies just didn't -- or couldn't --fill the positions. Salaried managers were expected to take on the work. "Thebig chains run on balance-sheet mentalities," Moss says. "They don'tlook at the human element. They view the balance sheet as a math project ratherthan seeing the pressure on managers."

    Martin says recent headlines about big law settlementsmake these cases all the more enticing to attorneys. "Plaintiffs' lawyersare always searching for new fields to harvest," he says. "Once abig verdict hits the radar, they begin to go fishing. They (advertise) in newspapers,trade publications. They alert unions. They offer free calls and free consultations."

    Adds Moss, "It was the success of the suits thatspread the rash."

    The recent boom in "knowledge workers" isalso bringing a whole new set of job classifications that have yet to be defined.These include retail managers, pharmacists, sales reps, engineers, and claimsadjusters. Companies often glibly miscategorize employees simply because theydon't want to change old habits, or because they don't understand the rulesand regulations. Sometimes they grasp the intricacies of the FLSA but ignoretheir own state laws. This can be a serious mistake. "That's how a lotof employers get stuck," says Debra S. Friedman, a partner in the Philadelphiaoffice of Cozen and O'Connor. "They're complying with federal wage andhour laws, but not state laws. State laws aren't checked as often. It's tricky."

How to avoid the trouble spots
    The first step in protecting a company is to make surethat exempt employees fall correctly into one of the four FLSA categories. Then,of course, ascertain if the exemptions hold under state law. Many state lawsare more generous to employees than federal laws. Under California state law,employers must pay overtime unless an employee qualifies for an exemption, which,among other things, requires that he spend more than half his time on managementduties.

    If the state law is more beneficial to employees, thelegislation takes precedence over the FLSA. New York, Florida, and Michigantend to favor employees on wage and hour issues. California, however, is themost worker-friendly. Since January 2000, more than 175 class-action suits havebeen filed in that state by employees claiming they were misclassified and areowed overtime pay.

    As employers review their workforces, they are advisedto make sure they aren't placing employees in exempt categories that don't fitthe reality of the job. Simply giving someone a managerial title doesn't qualifythat person as a manager. Such employees may meet some of the qualificationsfor an exemption. Perhaps they occasionally supervise shifts or make businessdecisions. The legal question is whether the person meets what's called theprimary duty test. Is managing this person's primary duty?

    It's the middle-range employees, those who dabble inexempt duties, that can be the most difficult to classify. Examples includeaccount executives, data processors, legal assistants, and various knowledgeworkers.

    "A company should look at people who are in thelowest-paid salary categories," Martin says. "That's the categorythat will be questioned. Not the hourly folks, not the senior executives, butthe people in the middle."

    "Look closely at these tests," adds AdairBuckner, an employment attorney at Brown and Fortunato in Amarillo, Texas. "Ifyou're talking about a lot of employees, it's real risky business to err onthe side of going exempt if there's any question about it."

    There is, of course, a flip side to the issue. HR mayhave categorized exempt employees faultlessly, but the company can still getinto trouble. In order to be considered exempt, an employee must have a highdegree of job independence. That means, in part, that these employees are incharge of how they use their own time. If they decide to take part of the dayoff, HR may not dock their pay. "You're paying them a certain amount eachweek regardless of the quality or quantity of work," says Rob Cottington,a partner with Reed Smith LLP in Pittsburgh. "If you dock for a Fridayafternoon, the DOL says that person isn't really salaried, because the companywas focusing on the hours worked."

    It's serious business. The Supreme Court has ruledthat if an employer has a policy that permits or requires pay deductions forpartial-day absences for exempt employees, they lose their status. If, for example,your company has a policy that allows deductions for tardiness of more than15 minutes, and that policy "creates a significant likelihood" thatan exempt employee will have wages deducted, you lose the exemption for allthose employees -- whether they're actually subject to the policy in practiceor not.

How to conduct a self-audit, and what happens if a case comes courting
    Before you begin hunting for potential problems, HRmight consider having the company's lawyer conduct an audit, setting it up asan attorney-client privileged investigation. "Then when we start turningover every rock, that's not something that necessarily gets into the hands ofinvestigators," says John Zaimes of Weston Benshoof Rochefort Rubalcavaand MacCuish in Los Angeles.

    What happens if you discover that the company has indeedmisclassified employees? The statute of limitations on back pay under the FLSAis three years for a willful violation, two years for non-willful (most courtshave been ruling three years). Many experts advise working with employees toestimate the overtime they're owed for that two- or three-year period, thenpaying the money. "At a certain level, you just have to make assumptionsabout what's owed," Friedman says. "It's not a situation where youoffer to pay 10 cents on the dollar. You can't deny someone wages they earned."

    Zaimes agrees that earned wages must be paid. "Youdo the investigation with the knowledge that you may have to pay something tofix whatever was done wrong," he says. "By fixing it ahead of time,you avoid penalty situations and an adversarial context."

    Such situations can crop up from several places. Anemployee might complain to the wage-and-hour division of the DOL, which willcontact the employer to review payroll records. A complaint might come througha labor union, or a person might directly contact an attorney.

    If the DOL wants to conduct an audit, it's wise tocooperate, Buckner says. "If they discover an error, you're better offtrying to work with the DOL than getting into the (potential) damages and attorneys'fees you could get if you push the thing to court."

    Many problems can occur if such a case goes to court.It is sure to be disruptive to a company's day-to-day operations. Plaintiffs'lawyers often have employees "shadowed." This means that an auditorindependent of both parties follows employees through their workday, notingtheir tasks. In theory, this will prove that these "exempt" employeesspend the majority of their time doing non-exempt duties, and are thereforemisclassified.

    Taking a case to court is, of course, a gamble. Ifthe plaintiff wins, there's two to three years' worth of back pay to reimburse.Where time records are kept, the amount owed an employee can be readily ascertained.But if the employer has failed to keep time records for its non-exempt employees-- as mandated by state and federal law -- disputes about the number of hoursworked will arise. An employee might say he or she worked an average of 70 hoursa week, whereas HR thinks the figure is closer to 45. The burden is on the employerto prove the hours, because it was obligated to keep accurate records. Often,a judge or jury decides how many hours were worked. "The employer is goingto have a very short stick in that fight," Martin says.

    The FLSA also allows for "liquidated damages."These are similar to punitive damages, except that the amount is predetermined,rather than decided by the judge or jury. The fee is equal to the amount ofthe back pay owed. If it is ruled that a company owes an employee $5,000 inback pay, for example, a court may award that same amount, $5,000.

    "It's like the concept of punitive damages,"Friedman says. "You did bad." Other costs include interest on theback pay, attorneys' fees, and court costs. In addition, the DOL allows fora fine of up to $10,000. Once interest and attorneys' fees are added to the$90 million that Farmers Insurance Exchange has to pay its 2,400 misclassifiedadjusters, the final cost to the company could be more than $130 million. (Thecompany plans to appeal.)

    Reflecting on how HR can best approach the overtimeissue, Martin says that you have to do it "very carefully. It's like kissinga porcupine."

    The U.S. Congress appreciates the complexity of thelaw. New legislation is regularly introduced in an effort to simplify exemptionissues for employers. One recent bill before the House, for example, would clarifythe exemption requirements for computer professionals. "Congress understandsthat the FLSA needs some explanation," Martin says. "It's being continuallyamended."

    Because of the momentum that has been building behindwage-and-hour class-action litigation in the past several years, employers arecautioned to review applicable state and federal rules carefully to ensure compliancewith classification and overtime obligations. Although California has been thesite of the most highly publicized suits, employers in other states are equallyat risk.

    Attorneys urge employers not to sit idly by and hopethat this employment-law rash will simply clear up on its own. "This canbe the hardest thing to convince employers of: that it is cost-effective tobe proactive," Zaimes says. "Even if you're going to have to pay something,it's better than waiting to get hooked."

Workforce, October 2001, pp. 36-42, Subscribe Now!

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