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Sixth Circuit Addresses Salary Basis Test under FLSA

Wage and hour claims remain a hot topic in employment litigation. The Sixth U.S. Circuit Court of Appeals recently addressed a case involving pay deductions. While the court rejected some of the employees’ arguments, it ultimately agreed with the district court that the employer violated the Fair Labor Standards Act (FLSA) by making certain deductions from exempt employees’ pay.

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Background
Life Time Fitness, Inc., owns and operates health and fitness centers throughout the country. The individuals who filed this case were current and former employees classified as exempt from overtime. They were subject to a compensation plan that was the basis of the lawsuit. While there were several versions of the plan from 2004 to 2006, two provisions remained constant: (1) Employees who were subject to the plan were paid a guaranteed base salary in addition to bonuses, and (2) if an employee’s performance dropped below a certain level, the company could make deductions from his guaranteed salary to recoup previously paid bonuses.

Life Time made deductions from eight employees’ salaries under the plan in 2005. The employees filed a lawsuit, alleging that the company’s written compensation plan and practice of making salary deductions violated the FLSA’s salary basis test. They argued that they were non-exempt employees entitled to overtime pay, liquidated damages, and attorneys’ fees. In 2006, after the lawsuit was filed, the company changed the plan to state that no deductions would be made to the guaranteed base salary. Instead, they would be made from a “hold-back bank.”

The district court divided the time period applicable to the plans. Before August 23, 2004, when the current U.S. Department of Labor (DOL) regulations went into effect, the employees’ claims were controlled by the U.S. Supreme Court’s decision in Auer v. Robbins. After August 23, the new regulations controlled. Applying those tests, the district court held that the employees were entitled to overtime only for the pay periods when deductions were actually taken from their paychecks. Both sides appealed the decision.

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Sixth Circuit’s decision
In a decision authored by Judge R. Guy Cole, Jr., the Sixth Circuit affirmed the district court’s decision to divide the time period applicable to the claims and agreed that violations of the FLSA occurred in 2005. However, it reversed the trial court’s decision that the pre-August 2004 compensation plan did not violate the law.

To be exempt from overtime, an employee’s position must satisfy a duties test, a salary level test, and a salary basis test. The issue before the court was whether the salary basis test was met. To establish that it was, the employer had to show that the employees were paid (1) a predetermined amount (2) that wasn’t subject to reduction and (3) that was based on the quality or quantity of work performed.

In explaining the need to divide the time period at issue, the Sixth Circuit stated that “for our purposes, the salary-basis test has two interpretations of the phrase ‘subject to,’ both of which are relevant here. In 1997, in Auer, the Supreme Court adopted the interpretation offered by the Secretary of Labor that the salary-basis test denies exempt status ‘if there is either an actual practice of making . . . deductions [based on variations in quality or quantity of work performed] or an employment policy that creates a significant likelihood of such deductions.'”

Following the Auer decision on August 23, 2004, the DOL enacted new regulations. 29 C.F.R. § 541.603 states that “an employee will be considered to be paid on a ‘salary basis’ within the meaning of these regulations if [he] regularly receives each pay period on a weekly, or less frequent basis, a predetermined amount constituting all or part of [his] compensation, which amount is not subject to reduction because of variations in the quality or quantity of the work performed.”

The regulations also state that “an actual practice of making improper deductions demonstrates that the employer did not intend to pay employees on a salary basis.” Referring to this “reinterpretation” of the salary basis test under the current regulations, the Sixth Circuit held that there is a violation of the salary basis test only when actual deductions are made.

Analyzing the period controlled by the Auer decision, the court held that while there were no actual deductions made during that time, “the district court erred in concluding that there was not enough evidence to suggest Life Time Fitness intended to enforce its permissive policy. The Auer subject-to-reduction test requires only a clear and particularized policy — one which ‘effectively communicates’ that deductions will be made in specified circumstances.”

The court went on to explain that “the compensation plan at issue does more than create a theoretical possibility of deduction; instead it plainly lays out a policy under which Life Time Fitness would make future deductions.” Thus, the written policy created a substantial likelihood that impermissible deductions would be made and that the plan violated the FLSA before August 23, 2004. In short, the employees were not exempt during that period and were entitled to overtime.

The court then turned to the time period controlled by the current regulations when Life Time made actual deductions from the employees’ pay. It rejected the company’s argument that the FLSA allows employers to “recoup” overpaid bonuses from an exempt employee’s salary, stating “there is no support for the contention that the FLSA allows for the reduction of guaranteed pay under a purposeful, incentive-driven bonus compensation plan.” Thus, the appellate court affirmed the lower court’s decision that the deductions violated the salary basis test.

The Sixth Circuit clarified, however, that regarding the period covered under current DOL regs, when actual deductions were made, “§ 541.603(b) and its implementing regulations explain that ‘the exemption is lost during the time period in which the improper deductions were made for employees in the same job classification working for the same managers responsible for the actual improper deductions.'”

Thus, the court rejected the employees’ argument that they should have been granted overtime beginning August 23, 2006, finding that the district court properly determined that only employees who worked in the appropriate job classification during the relevant deduction period were entitled to overtime compensation. Baden-Winterwood v. Life Time Fitness, Inc., Nos. 07-4437 & 07-4438 (6th Cir., May 19, 2009).

Learn more about wage laws and correctly classifying workers in the Wage and Hour Compliance Manual

Conclusion
While this decision involved a technical analysis of wage and hour law, the takeaway is very simple: Be cognizant of wage and hour laws when drafting compensation plans or even considering making deductions from exempt employees’ pay. It is an employer’s actual practices, not its intentions, that will determine whether employees are paid on a salary basis.