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This post was authored by David Urban and Christina Rentz

On August 23, 2016, the U.S. Court of Appeals for the Ninth Circuit issued an order declining to reconsider en banc its decision in Flores v. City of San Gabriel. That case, decided in June of 2016, has had far-ranging and significant impacts on the way public agencies compensate employees and provide benefits.  The opinion in Flores was issued by a three-judge panel of the Ninth Circuit.  If the judges of the Court had voted for what is known as en banc review, then an eleven-judge panel would have reconsidered all or part of the decision, and could very well have reached a different result.

As described below, the Flores decision breaks significant new ground under the Fair Labor Standards Act (“FLSA”) for employers who use health plans that can pay employees cash in lieu of benefits.

The primary issue in Flores is whether the FLSA required the City of San Gabriel to include cash payments made in lieu of health benefits into its regular rate calculations for overtime pay purposes under the FLSA.  Four years after the lawsuit was filed, the Ninth Circuit held that such payments had to be included in the regular rate.

The following is a condensed discussion of the Flores decision that appeared in our firm’s special bulletin when the case was first decided in June 2016.

Legal Background

Under the FLSA, overtime hours must be compensated at a rate that is at least one-and-a-half times the employee’s hourly “regular rate.”  (29 U.S.C. sec. 207(a)(1).)  The FLSA “regular rate” is the hourly rate equivalent to what the employee was actually paid per hour for the normal, non-overtime workweek for which he or she is employed.  (29 C.F.R. sec. 778.108, citing Walling v. Youngerman-Reynolds Hardwood (1945) 325 U.S. 419.)  Generally speaking, all forms of remuneration or compensation for employment paid to an employee are included in the regular rate except for certain specifically excluded payments.  (29  U.S.C. sec. 207(e).)

The Flores Facts

The City of San Gabriel provided a “Flexible Benefits Plan” to employees under which a designated monetary amount was furnished to each employee for the purchase of medical, vision, and dental benefits.  Although employees were required to use the Plan’s funds to purchase vision and dental benefits, they could decline the purchase of medical benefits upon proof of alternate medical coverage.  An employee who elected to forgo medical benefits received the unused portion of the designated monetary amount as a cash payment added as a separate line item in the employee’s regular paycheck.  This cash payment is called “cash in lieu.”  Of the total amount the City paid on behalf of its employees pursuant to its Flexible Benefits Plan, between 42% and 47% of that amount was paid directly to employees as cash in lieu benefits each year.  Between 2009 and 2012, the monthly payment paid to employees who declined medical coverage was between approximately $1,000 and $1,300 per month.

The Ninth Circuit’s Holding On Inclusion of Cash In Lieu Benefits in the Regular Rate

The primary issue on appeal was whether the City’s cash in lieu payments were properly excluded from the City employees’ regular rate.

In its June 2, 2016 opinion, the Ninth Circuit rendered two far-reaching holdings.

First, the Court held that cash payments made to employees in lieu of health benefits must be included in the hourly “regular rate” used to compensate employees for overtime hours worked.  The City argued that the cash in lieu payments were not payments made as compensation for hours of employment and were not tied to the amount of work performed for the employer, and therefore were excludable from the regular rate of pay as are payments for leave used and expenses.  The Ninth Circuit disagreed, finding the payments were “compensation for work” even if the payments were not specifically tied to time worked for the employer.  The Ninth Circuit also determined that the cash in lieu payments could not be excluded from the regular rate as payments made irrevocably to a third party pursuant to a bona fide benefit plan for health insurance, retirement, or similar benefits pursuant to section 207(e)(4) of the FLSA since those payments were paid out directly to employees.  Thus, those payments must be added into the employee’s regular rate of pay for the time period that they cover for purposes of determining the employee’s FLSA overtime rate.

Second, the Court held that even payments on behalf of employees pursuant to the plan that were not paid out as cash had to be included in the regular rate.  The federal Department of Labor (“DOL”) interpretations state that a benefits plan can only pay out an “incidental” part of its benefits as cash to be considered a bona fide benefits plan.  (29 C.F.R. sec. 778.215.)  In 2003, the DOL issued an opinion letter that defined cash in lieu benefits as “incidental” if they amount to no more than 20% of the employer’s total contribution to the benefit plan.  The Ninth Circuit rejected the DOL’s 20% rule as unpersuasive, but nevertheless held that the City’s cash in lieu payments to employees were not incidental as they amounted to too great of a percentage of the City’s total benefits contribution (42-47%).  Since the cash in lieu payments were not “incidental,” the plan does not qualify as a bona fide plan under section 778.215.  Thus, the City must also include all amounts that it paid into the flexible benefits plan for employees in their regular rate of pay, not just the cash in lieu payments.  The Ninth Circuit acknowledged that this decision could force employers to discontinue cash in lieu plans, but stated that that is a policy decision for Congress or the DOL – not the courts – to address.

Other Holdings of the Decision

  • The Ninth Circuit affirmed that a City may establish a 207(k) work period for its public safety employees without specifically referencing the term “207(k),” as long as the work period is otherwise established and regularly recurs.
  • The fact that the City’s payroll department consulted the human resources department to categorize the cash in lieu payments as a “benefit” instead of compensation was insufficient to establish the City’s good faith defense to liquidated damages.
  • The officers proved the City’s exclusion of the cash in lieu payments was “willful” under the FLSA, entitling the officers to three years of back overtime pay (rather than the standard two-year period) because the City supposedly did not take affirmative steps to determine whether the payments should be included in the regular rate of pay.  In an unusual concurring opinion, a majority of the panel noted that the willfulness standard adopted by the Ninth Circuit in  Alvarez v. IBP, Inc. in 2003 is “off track” with the standard for willfulness previously established by the U.S. Supreme Court.  The majority explained that it felt compelled to find willfulness based solely on the precedent set by the Alvarez decision.

Review in the U.S. Supreme Court

The next part of the appellate process is for the City to file a petition for a writ of certiorari in the U.S. Supreme Court, asking the Court to take up the Flores decision and reach a different result, in particular one that allows employers to have benefits plans that pay some amounts as cash-in-lieu of benefits but that does not present employers with a considerable threat of liability.  U.S. Supreme Court review could resolve the issues raised by Flores in a way that allows cash-in-lieu plans to exist and confer their desired benefits without doubt as to their FLSA consequences.

The U.S. Supreme Court decides to hear very few cases.  Flores is currently the law for employers in California (and other states like Arizona, Oregon, Washington, and Nevada that are in the Ninth Circuit).  It is important to know whether and how it applies to your agency.

Next Steps

If your agency provides cash payments to employees who opt-out of a health insurance plan, your agency should carefully evaluate the impact of Flores on payroll practices and FLSA liability.  The Flores decision could require either the cash in lieu amount or all plan benefits to be included in employees’ regular rate of pay for FLSA overtime purposes.  Many agencies provide contractual overtime in excess of FLSA minimum overtime requirements, such as overtime for working beyond scheduled hours in a workday (as opposed to overtime for working more than 40 hours in a week).  It is important to remember that the requirement to include cash in lieu or benefit plan amounts in the regular rate of pay only applies to FLSA overtime hours, not contractual overtime hours.  Finally, the Flores holdings on good faith and willfulness reiterate the importance of conducting and documenting regular reviews of all aspects of FLSA compliance for your agency.

Employers who offer cash-in-lieu may also face potential penalties under the Patient Protection and Affordable Care Act.  For more information on this topic, see our article here.

Employers should consult with wage and hour legal counsel before undertaking any remedial efforts based on the Flores ruling.