(September 27, 2007) The California Supreme Court recently ruled that an employee incentive compensation plan based on the employer’s profits, which was calculated by subtracting operating expenses from revenues, is not an unlawful wage deduction.
The long-awaited decision in the Prachasaisoradej v. Ralphs Grocery Company, Inc., case ends years of uncertainty and multitudes of class action lawsuits, reversing two California Court of Appeal decisions that profit-based incentive compensation plans (such as bonus plans) are unlawful under California law.
Read the decision.
In December 2004, the California Chamber of Commerce filed a letter urging the court to review the case, arguing that the court of appeal decision in Prachasaisoradej eliminates the flexibility businesses once had in providing economic incentives to its employees.
The Supreme Court ruled that an employer is not in violation of California wage protection laws if it offers supplementary compensation, in addition to regular wages, designed to reward employees if and when their collective efforts result in higher profits for the company.
Eddy Prachasaisoradej worked as a produce manager for Ralphs Grocery, which implemented an incentive compensation plan (ICP) to provide certain employees additional compensation depending on the profits of each store. The formula used to determine the supplementary monies under the ICP subtracted each store’s operating expenses from store revenues. Prachasaisoradej claimed the formula violated California law because Ralphs was shifting its costs of running its business to the employees by withholding, deducting or recouping from them wages belonging to the employees. California law prohibits wage deductions except in very limited circumstances.
The court of appeal found the ICP invalid because the store considered workers’ compensation costs when calculating the store’s profit and invalid as to non-exempt employees because it factored cash shortages and merchandise damage and loss into the profit calculation. In essence, according to the court of appeal, Ralphs was charging back a portion of its costs to employees through deductions from their wages.
The California Supreme Court disagreed. The ICP did not create an entitlement or expectation for a specific wage and then deduct from it to reimburse Ralphs for its business costs. All employees earned the rate of pay they were promised for the hours they worked regardless of how profitable the store was.
The ICP was in addition to the regular wage and plan participants understood that their entitlement to ICP money and the amount received resulted from a formula that compared the store’s actual ICP-defined profit with the company’s pre-defined target figures. Once the employee’s ICP compensation was calculated using this formula, Ralphs did not reduce it by taking unauthorized deductions from any employee wages. According to the court, “After fully absorbing the expenses at issue, Ralphs simply determined what remained as profits to share with its eligible employees in addition to their normal wages.” As such, no violation of law occurred.
Best Practices
The CalChamber urges employers to follow best practices when implementing an ICP:
- Ensure that any profit-sharing plan is reviewed with legal counsel.
- Never make deductions from employee pay unless legally authorized.
- Clearly define all terms and conditions of any employee profit-sharing or incentive-based plan.
Read the decision.
Staff Contact: Erika Frank