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Sixth Circuit Provides Clarification On Legality Of Draw-On-Commission Policy

Last month, the Sixth Circuit revived a lawsuit brought under the Fair Labor Standards Act (“FLSA”) alleging that a retailer’s commission policy was unlawful in Stein v. hhgregg, Inc., 2017 U.S. App. LEXIS 19908 (6th Cir. Ohio Oct. 12, 2017). The decision provides support for the legality of taking a draw on an employee’s future commissions, and highlights the problem with having a policy that requires repayment of draws upon termination.

Background

Plaintiffs worked for Defendants hhgregg, Inc. and Gregg Appliances, Inc. as retail sales employees and were subject to Defendants’ draw-on-commission policy. Under this policy, all retail sales employees are paid solely on the basis of commissions. However, in pay periods when an employee’s commissions fall below the minimum wage, he or she is paid a “draw” to meet minimum wage requirements. If an employee reports working forty hours or less in a week, the draw equals the difference between the minimum wage for each hour worked and the amount of commissions actually earned. If an employee works more than forty hours in one week, the draw equals the difference between an amount at least one and one-half times the applicable minimum wage for each hour worked and the amount of commissions actually earned. Draw payments are calculated on a weekly basis. An employee receives a draw only if the commissions earned that week fall below the minimum wage (in a non-overtime week) or one and one-half times the minimum wage (in an overtime week).

According to Plaintiffs, employees who receive a draw are required to repay it by deducting the amount of the draw from commissions earned during the next week. As an example, “if the weekly minimum wage were assumed to be $290, and an employee earned only $100 in commissions in one week, he would receive a draw of $190 to meet the minimum wage of $290. However, if the following week he earned $600 in commissions, he would receive only $410, and the remaining $190 would be credited back to the company to repay the $190 draw from the previous week.” Plaintiffs claimed that if the subsequent week’s commissions were insufficient to repay the draw, Defendants would deduct the amount of the outstanding draw from the next paycheck the employee received for a week in which the employee’s commissions exceeded the applicable minimum wage. Further, Defendants’ policy stated that “[u]pon termination of employment, the [employee] will immediately pay the Company any unpaid Deficit amounts.”

In addition to alleging that Defendants’ commission plan was improper, Plaintiffs’ alleged that employees worked off-the-clock with management approval. Plaintiffs’ brought the lawsuit, seeking to represent current and former retail sales employees, alleging various violations of the FLSA and state law.

Defendants filed a motion to dismiss pursuant to F.R.C.P. 12(b)(6).

District Court

The District Court dismissed all of Plaintiffs’ federal claims, relying on several DOL opinion letters to find that Defendants’ policy was lawful. While the District Court noted the questionable legality of the provision requiring repayment of unpaid deficit amounts upon termination, it also noted that there had been no facts demonstrating that the policy was enforced when an employee was terminated.

Court of Appeal

The Court of Appeal held that Plaintiffs failed to allege sufficient facts demonstrating that Defendants’ practice of deducting the amounts of the draw from future earnings violates the FLSA. However, the Court also concluded that Plaintiffs did allege sufficient facts to demonstrate a violation where Defendants’ policy holds employees liable for any unearned draw payments upon termination.

The DOL regulations state that when an employee earns less in commissions than he was advanced through a draw, “a deduction of the excess amount from commission earnings for a subsequent period, if otherwise lawful, may or may not be customary under the employment arrangement.” 29 C.F.R. § 779.416. Plaintiffs claimed that Defendants’ deductions were not “otherwise lawful,” because Defendants failed under this policy to deliver the minimum wages “free and clear” as required by 29 C.F.R. § 531.35. The Court disagreed, noting that the deductions only made from future commissions do not constitute an unlawful kick back because the deductions are only made from wages not delivered. The Court noted that this interpretation is consistent with the DOL Field Operations Handbook and several DOL opinion letters which make clear that crediting draws against future earnings are permissible under the FLSA, so long as the employer does not deduct from wages already paid.

However, the Court found that Defendants’ policy that an employee must “immediately pay [defendants] any unpaid Deficit amounts” upon termination to be in violation of the “free and clear” regulation, because it requires a repayment of wages already delivered. While the District Court looked at the practice of Defendants’ not collecting the deficit amounts, the Court of Appeal found that it was “more practical and realistic” to focus on the actual written policy in this case, noting: “Even if defendants never demanded repayment in practice, an employee may believe he owes a debt to the company for which he could be made responsible at a later date. Incurring a debt, or even believing that one has incurred a debt, has far-reaching practical implications for individuals. It could affect the way an individual saves money or applies for loans. An individual might feel obligated to report that debt when filling out job applications, credit applications, court documents, or other financial records that require self-reporting of existing liabilities.” Therefore, the Court found that Plaintiffs alleged sufficient facts to support a claim that Defendants’ policy, as written, violates the FLSA by continuing to hold employees liable for draw payments even after termination.

The Court of Appeal also found that Plaintiffs alleged sufficient facts to support a claim that Defendants’ policies and practices encouraged employees to work off-the-clock without compensation. Defendants argued that even if Plaintiffs’ allegations were true it would not violate the FLSA because if the employees under-reported their working time in draw weeks they increased the amount of commission pay they subsequently received by the same amount. Therefore, Defendants argued, the alleged off-the-clock work did not deprive employees of pay; it simply shifted it to a different week. The Court disagreed with Defendants, noting that employers must actually pay the minimum wage for all hours worked in each pay period. Further, the Court walked through a hypothetical where off-the-clock work would short the employee for hours worked under Defendants’ commission policy. As such, the Court found that Plaintiffs alleged sufficient facts to support a claim that the practice violates the minimum wage and overtime requirements of the FLSA. The District Court also revived derivative claims brought by Plaintiffs.

Takeaways

This decision provides support for the legality of draw-on-commission policies that deduct draws from future earnings for commissioned employees. However, it should also be a warning for employers to review their written policies to ensure that they do not require employees to pay back draws or deficit amounts upon termination. Even if such a policy is not enforced, Stein suggests that this could still be a violation of the FLSA. It is also important to remember that this decision assesses the legality of such policies under federal law. Employers should be mindful that the outcome may be different under applicable state law.

Copyright © 2017, Sheppard Mullin Richter & Hampton LLP.

TRENDING LEGAL ANALYSIS


About this Author

Associate

Ryan Krueger is an associate in the Labor and Employment Practice Group in the firm's Los Angeles office

Education

    J.D., University of California, Los Angeles, 2013

    B.A., University of Wisconsin, 2008, with distinction

Clerkships

    Extern to the Honorable Morton Denlow, U.S. District Court for the Northern District of Illinois.

213.617.5594
Matthew A. Tobias, Sheppard Mullin, Los Angeles Labor Lawyer, Employment
Associate

Mr. Tobias is an associate in the Labor and Employment Practice Group in the firm's Los Angeles office.

Mr. Tobias specializes in labor and employment matters on behalf of employers, including wage and hour violations, employment discrimination, wrongful termination in violation of public policy and sexual harassment.

Prior to joining Sheppard Mullin, Mr. Tobias worked for the City of Los Angeles in the Personnel Department.  During this time, Mr. Tobias represented the City in Unfair Employee Relations Practice hearings pursuant to claims filed under the City's Employee Relations Ordinance.  Mr. Tobias also represented the City in grievances, arbitrations and mediations involving union-represented employees and was involved in risk management and policy analysis in the Personnel Department.

One of Mr. Tobias's primary functions for the City of Los Angeles was as a neutral fact-finding investigator in response to claims of unlawful discrimination, harassment, and retaliation.  Mr. Tobias investigated numerous complaints and defended his findings before the City's Civil Service Commission.  He also conducted lectures to City employees on compliance with the Americans with Disabilities Act and the Fair Employment and Housing Act. 

213.617.5421