Court Rejects Disciplinary Deductions from Exempt Employee Pay |     Free Exempt Employee Policies?

The Sixth Circuit Court of Appeals recently upheld that the docking of an exempt employee’s pay for disciplinary infractions can jeopardize the employee’s exempt status.  The court also limited the circumstances under which employers may correct their mistakes retroactively to avoid losing the exemptions. Get your FREE access to this and 100's of FREE HR resources today.

Does your organization have a policy that docks employees for disciplinary reasons?  Have you applied that policy to your salaried exempt employees?  If you answered “yes,” you may have violated the Fair Labor Standards Act (FLSA), jeopardizing the exempt status of that employee as well as all other salaried exempt employees subject to the policy.  And, according to a recent court ruling, even if you catch the error and correct it, you still may be liable for back overtime pay and penalties.  In Kenneth A. Takacs, et al. v. Hahn Automotive Corporation, No. 99-4431 (6th Cir. 4/13/01), the Sixth Circuit Court of Appeals determined that maintaining a policy that allows the pay of exempt employees to be docked for disciplinary infractions is evidence that an employer did not intend to pay exempt employees on a salary basis.  It also ruled that the “window of corrections” defense is available only to employers who can demonstrate that they intended to pay employees on a salary basis.

Company Docked Managers for Rules Violations                                     [Download Free Policies]

In this case, the employer acquired another company in 1993 that had a policy subjecting managerial employees to suspensions without pay for misconduct on the job.  The employer did not issue new policies after the purchase.  In the following 18-month period, seven managers at the purchased company were suspended without pay for disciplinary reasons and, on another 12 occasions, managers received letters threatening them with suspension without pay because of rules violations.  As a result of an unrelated lawsuit, the employer discovered the problems with the suspension policy, rescinded it, and reimbursed the managers who had been suspended without pay.

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In spite of this action, 27 managers at the purchased company subsequently filed a lawsuit seeking overtime compensation, claiming that they were not bona fide exempt employees.  The employer asked the lower court to award it summary judgment, arguing that because it had identified and corrected the pay-docking errors, it was entitled to the window of corrections defense under the FLSA.  The lower court rejected these arguments and ordered the employer to pay the managers’ damages and attorneys’ fees.  The employer appealed the decision to the Sixth Circuit.

Policy Makes Company Ineligible for Window of Corrections Defense

The Sixth Circuit upheld the district court’s ruling.  The court began its analysis by addressing whether the managers met the definition of exempt employees, and in particular, whether they were paid on a salary basis.  (In addition to meeting certain job- duty criteria, exempt employees must be paid on a salary basis.)  Salary basis is defined as the payment on a weekly or less frequent basis of a predetermined amount that constitutes all or part of compensation, without reductions for variations in the quality or quantity of the work performed.  Only certain limited salary deductions are permitted for time missed without jeopardizing employees’ exempt status.  (Allowed deductions are discussed in greater detail on page 6.)  In particular, employers may make deductions for disciplinary unpaid suspensions for “infractions of safety rules of major significance,” such as rules “relating to the prevention of serious danger.”  Deductions for violations of work rules are not included in this exception.

To determine whether the managers in this case were paid on a salary basis, the court applied the test adopted by the Supreme Court in Auer v. Robbins, 519 U.S. 452 (1997).  In Auer, the Supreme Court ruled that if an employer has a policy that creates a “significant likelihood” of disciplinary pay deductions, or has an “actual practice” of making those deductions from employees categorized as exempt, the employer has not “demonstrated an objective intent” to treat those employees as exempt and has not satisfied the salary basis test.  Applying that test to the case at hand, the Sixth Circuit determined that the managers suing for overtime compensation were not exempt.  In making its decision, it noted that the employer’s disciplinary policy created a significant likelihood that the managers’ pay would be docked and that the managers’ pay had actually been docked for disciplinary infractions.

The court then addressed the issue of whether the employer could use the window of corrections defense.  When an employer inadvertently makes salary deductions not permitted by the FLSA, and for other reasons not related to lack of work, it can still maintain the exempt status if it reimburses the exempt employees for the deductions and promises to comply with the FLSA in the future.  Since the FLSA regulations establishing this special legal defense do not specify exactly when it may be applied, the court relied on interpretations issued by the Department of Labor (DOL) in its amicus brief filed in the Auer case.  In that brief, the DOL stated that the employer’s objective intention to pay an employee on a salary basis should determine whether it could use the window of corrections defense.  According to the DOL, if an employer makes impermissible pay deductions or tells employees that such deductions will be made, it has no intention of paying employees on a salary basis and has no right to invoke the window of corrections defense.  Applying this criteria, the court determined that the employer in this case could not argue it intended to pay its exempt employees on a salary basis since it had, in fact, invoked its disciplinary provisions numerous times and had docked salaried employees’ pay.

Three Lessons on Deductions

This decision underscores three important points.  First, employers should be extremely cautious about docking salaried employee pay.  There are only a few circumstances in which docking can be done without risking the exempt status:

•  For a full day for personal reasons.  Thus, if you do not offer paid vacation or personal days, you may deduct the day off from the employee’s salary.  Similarly, if the employee has used all paid time provided, you may deduct any additional time off.

•  For a full day’s absence due to illness or injury.  You may make this deduction if you have a bona fide plan, policy, or practice that provides compensation for loss of salary due to sickness or disability, such as a policy that allows employees to accrue paid sick leave. This deduction is permissible even if the exempt employee has not yet qualified for the plan or has exhausted the plan’s sick leave allowance.  But, if you do not have a paid sick leave plan, you may not deduct the day if the employee has worked any day that week.

•  For infractions of major safety rules such as smoking in explosive plants, oil refineries, or coal mines. This is the only disciplinary reason acceptable under the FLSA for docking salaried employee pay.

•  For any workweek in which the exempt employee does not perform any work.

The FLSA regulations do not specify any other times when an employer may dock exempt employee pay.  Therefore, if you are docking the pay of salaried exempt employees for any other reason, you should reconsider your policy.

A second point this case underscores is that FLSA violations can be expensive.  Employers that misclassify employees as exempt can be liable for back overtime pay of up to two years for each employee improperly classified.  This liability extends to three years if the FLSA was intentionally violated.  And, if you choose to fight the claim, you may face several years in court (this case was initially filed in 1995) and thousands of dollars in litigation expenses.

A final important point is that a single misclassification can trigger a loss of exemption for all exempt employees if they are treated similarly under the organization’s policies and procedures.

Therefore, to avoid the loss of employee exempt status and the very real expenses of overtime liability and litigation, make sure that your policies on discipline do not dock exempt worker pay for rule infractions.  If you have a policy dealing with any disciplinary pay docking, you need to be very clear that it does not apply to exempt employees.  

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Question: If an employee is currently a salaried/exempt employee, can her status be changed to hourly/non-exempt? Similarly, if an employee is currently categorized as hourly/nonexempt, can her status be changed to salaried/exempt?

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This article is not intended as legal advice. Readers are encouraged to seek appropriate legal or other professional advice.