Avoid a Walk in Kenneth Cole's Shoes
Employers That Make Mistakes in Wage and Hour Compliance Create Big Liability
What happens if you misclassify an employee as exempt from wage regulations, fail to provide meal and rest periods, and then decide to take a firm stand when the Labor Commissioner rules in favor of an ex-employee? The high-end shoe store Kenneth Cole found out—the hard way.
In a closely-watched decision issued on April 16, 2007, the California Supreme Court in Murphy v. Kenneth Cole Productions, Inc. reminded employers of the importance of paying attention to wage and hour regulations. Everything that could go wrong (almost), did go wrong for the shoe retailer. The following highlights several key issues in the case.
The Decision
The Supreme Court resolved two important issues. First, the Supreme Court determined the additional pay owed to an employee not provided a required meal period or rest period was a wage, and not a penalty. Second, the Supreme Court held that when an employer appeals a decision by the Labor Commissioner to state court, the court may allow the employee to pursue new wage claims not originally made. Why is this important?
A wage claim is subject to a three-year statute of limitations, while an employee can only recover a penalty for matters occurring within the prior one-year period. Employees can now potentially recover three times as much for missed meal and rest periods than if these payments were considered to be a penalty.
Further, employers may also be liable for waiting-time penalties if these unpaid "wages" are not paid immediately upon the employee's termination (72 hours if they resign). Therefore, classifying the additional pay owed for missed meal and rest periods as a wage can significantly increase an employer's financial exposure.
In addition, if an appeal from a Labor Commissioner's award is filed, the employee may now be allowed to introduce new claims that were not presented to or decided by the State Labor Commissioner. What starts as a small dispute over overtime may mushroom into a much larger dispute for employers, as it did to Kenneth Cole.
Background
What mistakes did Kenneth Cole make? First and foremost, it misclassified its employee, John Murphy. The company assumed that paying Murphy a salary (rather than hourly wages) and calling him a "store manager" would make him exempt from California Industrial Welfare Commission wage orders. Wrong! California's wage orders require overtime pay, meal periods, rest periods, and the like, for most employees, unless they qualify as "exempt" employees. Exempt employees typically are licensed professionals (doctors, lawyers, accountants, etc.) or executive or administrative employees who, generally speaking, regularly exercise independent judgment and are involved in managing the general operations of a business more than 50% of their time.
Murphy, in reality, spent the majority of his day on the sales floor selling shoes. He regularly worked 9 to 10 hour days during which he was only able to take an uninterrupted duty-free meal period approximately once every two weeks. Murphy rarely, if ever, had the opportunity to take a rest period during the workday.
Certainly, Murphy did perform some decision-making responsibilities that might be expected of an "executive" or manager of a store. He occasionally communicated with the district manager and performed some human resource duties, like scheduling and recommending raises for his employees, but he did not have authority to fire employees without the approval of the district manager, decide the price of shoes, or select the type of shoes his store would sell. While designated the store manager and paid a salary that was more than twice the minimum wage (the "salary" test), Murphy did not perform exempt duties for more than 50% of his workweek (the "duties" test) to qualify as being exempt from California wage orders.
Murphy Files Claim
When Murphy resigned, he filed a wage claim with the State Labor Commissioner. Murphy used the "check the box form" to make claims for unpaid overtime and waiting time penalties (for not being paid the claimed overtime wages owed to him within 72 hours of his resignation). Murphy did not know he could also make a claim for missed rest and meal periods. Nor did he know he could make a claim for not receiving itemized pay statements (as is required for all employees who are classified as nonexempt).
The Labor Commissioner conducted a hearing and issued a decision in Murphy's favor, finding that Kenneth Cole failed to establish Murphy was an exempt employee and awarded $26,000 in unpaid overtime, interest and waiting time penalties.
That Could Have Been the End of It
After the adverse decision, Kenneth Cole decided to appeal the Labor Commissioner's award to the San Francisco Superior Court. Before filing its appeal, Kenneth Cole failed to conduct a "duties" test analysis to determine whether it could actually prove Murphy performed exempt, management duties more than half of the time he worked. This thoughtless decision was another mistake.
Murphy then sought legal representation from the Hastings College of the Law Civil Justice Clinic. With the help of lawyers, Murphy added new claims for missed meal and rest periods and itemized pay statement violations. The matter was tried anew in the San Francisco Superior Court, despite Kenneth Cole's objections to the introduction of new claims.
The Superior Court awarded damages for Murphy's original claims and his new wage claims, plus added interest, so that the total award increased to $64,000. But wait, Murphy was now entitled to an award of attorneys' fees, which the court granted in the sum of $62,000. What started as a $26,000 award mushroomed up to more than $120,000. And this did not even include all of the fees Kenneth Cole also paid to its own legal team.
Kenneth Cole Appeals . . . Again!
Not being satisfied with the outcome of the Superior Court decision, Kenneth Cole appealed again, and eventually it reached the California Supreme Court. This is how the Court resolved the key issues and, unfortunately, expanded employer liability for wage claims.
Wage or Penalty?
The Labor Code states that employees are entitled to an "additional hour of pay" for any missed 10 minute paid rest period or 30 minute unpaid meal periods. The two sides argued whether this pay was a lost wage or a penalty. Kenneth Cole argued the additional one hour of pay was an arbitrary amount not based on the actual time worked. It further argued the primary purpose of this payment was to shape employer behavior by acting as an incentive for employers to comply with legal standards and, thereby, acted as a penalty. Even the Labor Commissioner agreed that these payments were penalties and not wages—all to no avail.
The Supreme Court rejected these arguments and concluded they were really "premium pay," which historically has been classified as wages. The Court held that it was similar to overtime pay, when an employee is paid at the rate of 1.5 times his regular wages for each overtime hour worked. Overtime pay has always been considered to be wages, and not a penalty. The same is true, the Supreme Court held, when employees are entitled to one hour of additional pay, whether a 10 minute rest period or 30 minute meal period is missed.
Kenneth Cole tried to argue that if the back payments were classified as wages, thereby allowing claims for the prior three years, employees would be encouraged to bring stale claims, when evidence was no longer fresh and witnesses may no longer be available. Maybe with its collective "tongue in cheek," the Supreme Court rejected this concern, noting that employers are required to keep all time records, "including records of meal periods," for a minimum of three years. The Court, however, overlooked that employees misclassified as exempt from overtime will likely not have timecards or other records that prove whether meal or rest periods were taken.
New Claims Allowed
Equally important is the second question the Supreme Court addressed. Can a trial court, considering an appeal of the State Labor Commissioner's proceedings, consider new wage claims not presented at the original hearing? The Supreme Court answered yes.
Employees with wage claims can either file a civil lawsuit or pursue their claims administratively before the Labor Commissioner. The Supreme Court determined that administrative hearings were designed to provide "a speedy, informal and affordable method of resolving wage claims." In other words, they encouraged parties to pursue wage claims without lawyers, who likely would identify additional legal claims.
Further, when appeals are made to the State Superior Court, the claims are tried anew, a "de novo" hearing is held and the court has "broad discretion" to decide what claims may be pursued. To allow additional claims, the Court held, would encourage employees to use the informal administrative process, without punishing them by limiting their claims if an employer appealed the Labor Commissioner's award.
The Court also warned that it was the Legislature's intent "to discourage frivolous and unmeritorious appeals from the Commissioner's awards." The Court emphasized that "[a] party who appeals a Labor Commissioner award does so at its own peril." If an employer appeals, and the employee obtains legal representation, it should be aware that new claims may be discovered and pursued on appeal.
What Was Kenneth Cole Thinking?
In the end, Kenneth Cole failed to use good business judgment in resolving this wage claim. While it may have been worthwhile to dispute Murphy's claim before the Labor Commissioner in the hope that an award might be denied or minimized, it was a poor decision to appeal. Kenneth Cole failed to first analyze whether its store manager was properly classified as an exempt employee, as discussed above. Presumably, if Kenneth Cole had done so, it would have reasonably concluded that he was not exempt from California wage orders and let the matter rest.
Further, once Kenneth Cole appealed the Labor Commissioner's award, it triggered Murphy to do what many employees do. He sought the assistance of legal counsel and the scope of the inquiry grew exponentially. In the end, Kenneth Cole exposed itself to an award that was more than double the Labor Commissioner's original amount, and became subject to a substantial award of attorneys' fees (that multiplied at each level of appeal), only adding monetary salt to its wounds.
What Should Employers Do?
Employers need to periodically audit their employee classifications. An employee's title and a substantial salary are mere components in determining whether employees are exempt from wage orders; they are not determinative. Employers must be assured that more than 50% of an employee's time is spent performing exempt duties. An analysis must be made of each exempt employee's workweek activities.
Employers are often hard-pressed to explain exactly what management employees do on a day-to-day basis. If an employer cannot do so, it should establish procedures to that end. A variety of things can be done to help employers accomplish this task:
- Job Descriptions: Employers should prepare job descriptions that clearly identify the employee's primary duties and responsibilities, and which presumably demonstrate independent judgment and decision-making of matters of importance. Employers must avoid the temptation to list every little thing that a manager or administrator might do during the day.
- Discretion and Independence: Employers should confirm the primary job duties reflect the exercise of discretion and independent judgment that are truly in the nature of an exempt executive or administrative employee.
- Recordkeeping: Employers may also want to consider having their exempt employees record the time spent on daily tasks and projects to demonstrate performance of exempt duties (without docking them for missed work time of course!). This kind of task accounting can double as a management tool to evaluate a manager's effectiveness and value to the business.
- Policies and Handbooks: Employee handbooks should clearly state that meal periods and rest periods are to be taken by employees to allow them to rest and be energized to return to work.
- Monitoring: Supervisors should be trained to understand nonexempt employees are entitled to take, and should take, meal and rest periods regularly and timely, and breaks and meal periods should be monitored.
- Annual Reviews: During annual employee reviews, ask your employees whether they regularly take their meal and rest periods. Do not be afraid to ask these questions. It is much better to know sooner, so that corrective action can be taken, than later when an employee quits and decides to make a claim for the prior three years of working. Remember, the burden is on employers to prove their nonexempt employees were afforded the opportunity to take rest periods and did, in fact, take their meal periods each day they were entitled to take them.
Be Smart
Individual employee wage claims, as well as class action wage claims, are everyday occurrences. Employers cannot, and should not, wait until they are served with a notice from the Labor Commissioner's office (or a civil summons and complaint) before they take action. By understanding your obligations as an employer and establishing an internal procedure to regularly audit exempt classifications, you can avoid . . . walking in Kenneth Cole's expensive shoes.
