California Supreme Court: Paying Meal and Rest Period Penalty Based on Employee’s Base Hourly Rate Is Not Enough

On July 15, 2021, the California Supreme Court ruled that an employee’s “regular rate of compensation” for the purposes of meal and rest break penalties includes all nondiscretionary payments, not just hourly wages. This decision will have significant impact on all employers in California because (1) going forward, employers cannot simply pay the employee’s base hourly rate for meal and rest break violations, and (2) this decision is retroactive.

Facts and Procedural History

This case arose from Loews Hollywood Hotel, LLC’s (“Loews”) payment of meal and rest break penalties to plaintiff Jessica Ferra (“Plaintiff”). When hourly employees, including Plaintiff, did not receive a compliant meal or rest break, Loews paid them a premium as required by Labor Code section 226.7(c), which provides that employers must pay employees who are not provided with a compliant meal or rest break “one additional hour of pay at the employee’s regular rate of compensation.” When calculating meal and rest break premiums, Loews interpreted “regular rate of compensation” to mean the employee’s base hourly pay, exclusive of nondiscretionary payments, such as Plaintiff’s quarterly incentive payments.

The trial court agreed with Loews’ interpretation of the term “regular rate of compensation” and granted summary adjudication for it on Plaintiff’s meal and rest break claims. The Court of Appeal affirmed the ruling, holding that the term “regular rate of compensation” as used in section 226.7(c) was not synonymous with the term “regular rate of pay” as used in Labor Code section 501(a), the latter of which governs the calculation of overtime pay and requires that nondiscretionary payments be included in this calculation. In so holding, the Court of Appeal adopted the approach endorsed by several federal courts that “regular rate of compensation” means an employee’s base hourly rate only.

Supreme Court’s Ruling

The California Supreme Court reversed the Court of Appeal’s decision and unanimously held that, under Labor Code section 226.7, an employee’s “regular rate of compensation” for the purposes of meal and rest break penalties includes all nondiscretionary payments, not just hourly wages.

The supreme court explained that, under California law, employers must provide employees with overtime pay when employees work more than a certain amount of time as provided for in Labor Code section 510(a), and to calculate the overtime amount, an employer must compensate an employee by a multiple of the employee’s “regular rate of pay.” The court also explained that if an employer does not provide an employee with a compliant meal, rest or recovery period, the employer must “pay the employee one additional hour of pay at the employee’s regular rate of compensation” per Labor Code section 226.7(c).

In analyzing the legislative history and intent behind Labor Code sections 226.7(c) and 510(a), the supreme court emphasized the importance of the phrase “regular rate” and concluded that it is a term of art that was intended to include both hourly wages and nondiscretionary payments. The court further reasoned that because the words “compensation” and “pay” were used interchangeably within the pertinent Labor Code sections, there is no evidence indicating that the California State Legislature intended different meanings between the phrases “regular rate of compensation” and “regular rate of pay.”

As such, the supreme court held that meal and rest break premiums must be calculated in the same manner as overtime pay, using “not only hourly wages but all nondiscretionary payments for work performed by the employee.” The court further held that this interpretation was proper, based on the principle that California’s labor laws should be liberally construed in favor of employees.

Retroactivity

The supreme court held that its holding applies retroactively for three reasons:

1. First, there was no “settled law” on which Loews and other employers could have reasonably relied.
2. Second, the court rejected Loews’ argument that its holding should not be applied retroactively because retroactive application would have the substantive effect of exposing employers to “millions” in liability. Even if there were any evidence that retroactivity would have such an effect, there is no reason why the interest of employers in avoiding “millions” in liability should be favored over the interest of employees in obtaining the “millions” owed to them, the court explained. Further, the court went on, retroactivity is not disfavored simply when a judicial decision may have the substantive effect of imposing liability.
3. The court reasoned that restricting its holding to prospective application would negate the full extent of the remedy that the legislature had determined to be appropriate in this context, causing the court to exceed its appropriate judicial role.

Takeaways

As a result of the California Supreme Court’s decision in Ferra v. Loews, employers should reevaluate how they calculate meal and rest period penalties, to ensure that the value of any nondiscretionary earnings during the relevant pay period is factored into the hourly rate of pay used to calculate the penalty. Employers should also update payroll policies and procedures in order to accurately reflect revised meal and rest period penalty calculations.

Finally, employers should consult with their legal counsel to determine whether their wage-and-hour practices are compliant and if they need to conduct an audit on previously paid meal and rest period penalties, in light of the retroactive application of the supreme court’s decision.