Commission Or Piece-Rate?

The FLSA establishes minimum wage, overtime pay, record keeping, and youth employment standards affecting employees in the private sector and in Federal, State, and local governments. Covered nonexempt workers are entitled to a minimum wage of not less than $7.25 per hour effective July 24, 2009. Overtime pay at a rate not less than one and one-half times the regular rate of pay is required after 40 hours of work in a workweek.

Commission or piece-rate? The Fair Labor Standards Act (FLSA) generally requires employers to pay employees at one-and-a-half times their hourly rate for every hour that they worked per week in excess of 40 hours. There are exceptions, though, and an Illinois federal court recently handed down a decision which illustrates one of them: Employees that are paid commissions on goods or services sold are exempt from overtime pay – if certain criteria are met – whereas employees who are paid piece-rate are not.

At first blush, the distinction is not an easy one to make. In both cases, the employee’s compensation appears to depend on his or her output. The former is not earned, however, until a sale is actually made. That’s the rub, and it was demonstrated in Alvarado v. Corporate Cleaning Services.  There, a group of window washers sued their employer for violating the FLSA. They claimed that they were paid piece-rate for their work – effectively for the number of windows that they washed. But the U.S. District Court for the Northern District of Illinois disagreed. It explained:

Here, the abundance of window-washer work at CCS does tend to obscure that window-washer pay is still dependent on sales.  But the only reason that there is a regular workflow is because CCS is such a big player in the industry and is extremely successful.  Part of this success is based on the company’s compensation system, which incentivizes window washers to work efficiently and, in turn, to increase the number of sales that CCS can make and complete.  Thus window washers’ work is still dependent on sales.

If you’re an employer that pays by commission ask yourself whether your employees earn their “commissions” for each item made or service performed or whether their “commissions” depend upon a sale. The distinction is an important one, and it may allow you to take advantage of the Alvarado exemption.

Affirming Dismissal, Seventh Circuit Holds Window Washing Business Is a “Service” Establishment and Its Employees Are Paid on a “Commission” Basis, Bringing Clarity to Application of 7(i) and Sharply Criticizing DOL Regulations and Its Application of 7(i)

In one of the most comprehensive circuit court opinions to address application of Section 207(i) of the FLSA—the provision of the law that allows employers to comply with the overtime provisions of the FLSA by paying commissioned employees of a retail or service establishment at least 1.5 times the minimum wage, instead of their regular hourly rate—the Seventh Circuit, in an opinion by Judge Posner, has clarified this section which recently been the subject of increasing litigation in the federal courts. Alvarado v. Corporate Cleaning Servs., 2015 U.S. App. LEXIS 5270 (7th Cir. Apr. 1, 2015).

The Court directly addresses two of the core requirements in applying 7(i): (1) what is a “commission” for purposes of 7(i); and, (2) what types of establishments constitute a “retail or service establishment.” In doing so, the Court rejects DOL regulations, noting the DOL (who submitted an amicus brief on behalf of the employees) has, in its interpretation of 7(i), become “obsessed with its incomplete, arbitrary and essentially mindless catalog of sellers lacking a ‘retail concept.’” The Court also criticizes the Plaintiffs’ attorneys for seeking a voluntary dismissal to avoid an adverse ruling on appeal, with the Court refusing to dismiss the case even though the parties filed a joint stipulation of dismissal. For these reasons, the opinion is a “must-read” for anyone considering FLSA compliance through application of 7(i).

Plaintiffs in Alvarado were window washers. They were paid using a point system, where each job was assigned a certain number of points, which were then multiplied by a rate to determine their pay. Points were assigned based on the complexity of the task and the number of hours the job was expected to take. Plaintiffs were not paid overtime wages at 1.5 times their regular rate of pay for the hours they worked in excess of forty hours per week.

Plaintiffs argued Section 7(i) did not apply because they were paid on a piece-rate system, not a commission basis, and that the defendant’s business was not a “retail or service establishment” because it lacked a “retail concept.” The Seventh Circuit disagreed. Addressing first the commission versus piece-rate conundrum, Judge Posner explained that “nomenclature is not determinative” and that word “commission” need not be used for 7(i) to apply. He then rejected the dueling tests urged by the parties (and the DOL)—i.e., whether the compensation bore an “identifiable and consistent correlation” to the price charged to the customer (Plaintiffs’ test) or whether the compensation was “proportional and correlated” to the price (Defendants’ test). Instead, he explained, the distinction between the two compensation schemes is much simpler: in a piece-rate system, “a worker is paid by the item produced” regardless if there has been an actual sale; whereas in a “commission system,” the worker is paid a specified amount only when there has been a “sale.” An employee working in a piece rate system, for example, is paid for producing goods for inventory for potential future sales (which are not guaranteed) but for a commissioned employee, they are only paid if there has been a sale.

The Court also noted that typically commissioned employees work irregular hours—which was consistent with the work performed by the window washers, who worked fewer hours in the winter and during inclement weather. And that is consistent with the purposes of 7(i), which was to level the compensation for those who work irregular hours.

Turning to the second issue—whether the defendant operated a “retail or service establishment”—the Court explained that a “service establishment” is “much broader” than a “retail establishment” and noting that the statute applies to “retail establishment” or a “service establishment,” in the disjunctive, and does not require the “service establishment” to be a “retail service establishment.” The Court concluded the window washing services provided by the defendant was a service. But even if that were not enough (the Court held it was), the defendant was a “retail service establishment” too because it was not a wholesaler and provided a service to the ultimate consumer (again, a simple and straight forward standard readily interpreted and applied). It did not matter that the window-washing service was sold primarily to commercial and governmental buildings or that the building owners passed on the cost to the tenants.

The Court rejected the DOL’s decades-old regulatory list of establishments that “lack a retail concept,” finding the list provides “no explanation for the choice of which firms to describe as lacking a retail concept,” and describing it as a “mindless catalog” that is “arbitrary”. Finally, the Court distinguished cases applying the defunct 13(a)(2) exemption, which contained the term “retail or service establishment” (and a definition of it), finding that it bore no connection to Section 7(i), a provision enacted for a different purpose than the 13(a)(2) exemption (now repealed), which applied to intrastate employers.

This decision brings needed clarity to employers seeking to apply Section 7(i) to their workforce.

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