The administrative exemption is perhaps the hardest to understand and apply.
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California Supreme Court Addresses Administrative Exemption Favors Employers, But Leaves Unanswered Questions
By Christopher W. Olmsted
When an employer classifies a group of employees as exempt under state and federal wage and hour law, that decision is subject to challenge by the employees or a government agency. The wrong decision can result in expensive litigation and huge liability to the employer. The administrative exemption is perhaps the hardest to understand and apply. In a recent case titled Harris v. Superior Court, the California Supreme Court made a ruling favorable to employers, but it left a number of unanswered questions regarding the administrative exemption.
Defining the Administrative Exemption
In this case, Liberty Mutual Insurance Company classified a group of its insurance claims adjusters as exempt under the white collar administrative exemption. Certain employees filed a class action lawsuit, alleging that they were improperly classified as exempt, and that they were entitled to overtime pay.
The five criteria for the administrative exemption can be found in title 8 of the California Code of Regulations, section 11040. The employee must meet all of the following:
(1) Perform office or non-manual work directly related to management policies or general business operations of the employer or its customers; and
(2) Customarily and regularly exercise discretion and independent judgment; and
(3) Perform under only general supervision, work along specialized or technical lines requiring special training, or execute under only general supervision special assignments and tasks; and
(4) Be engaged in the activities meeting the test for the exemption at least 50 percent of the time; and
(5) Earn twice the state’s minimum wage.
Administrative vs. Production
The key question in this was related to item (1). Did the adjusters perform work “directly related to management policies or general business operations”?
Before the case went to the California Supreme Court, a California Court of Appeal made a ruling which appeared to very significantly narrow the administrative exemption. The court ruled that the claims adjusters were exempt as a matter of law, essentially handing the employees a victory.
The appellate court ruled that in classifying administrative workers, they were exempt if they worked at a level of making management policy or general operations. Employees were not exempt if they merely carried out the day-to-day operations of the business. Such employees were in “production,” not administration. The court decided that insurance adjusters are in production because they produced insurance claims and did not make policy.
The California Supreme Court analyzed the administrative exemption and determined that the appellate court had erred by narrowly defining the exemption in terms of the “administrative/production dichotomy.” The exemption rules, as amended in 2000 and which incorporated federal regulations, were not as simplistic as the appellate court defined them.
For example, the Supreme Court pointed out that the California exemption incorporates a federal regulation found in former part 541.205(b). That regulation supplies a general description of the types of duties that constitute administrative operations of the business. It includes work performed by white-collar employees engaged in servicing a business as, for example, advising the management, planning, negotiating, and representing the company. The Supreme Court noted that the appellate court did not take that nuance into consideration. As the dissenting judges at the lower appellate court level wrote, arguably claims adjusters could be exempt because they negotiate settlements (and conclude some without seeking approval), advise management, and process claims. The incorporation of former part 541.205(b) shows that whether work is part of the administrative operations of a business depends, in part, on whether it involves advising management, planning, negotiating, and representing the company. “It is not so narrowly limited as the [lower appellate court] majority below declared,” wrote the unanimous Supreme Court.
This decision favors employers but it leaves many questions unanswered. The decision helps employers because it disposes of the overly simplistic “administrative/production dichotomy” and directs courts to look to the regulations. But the Court intentionally avoided giving any specific guidance on applying the administrative exemption. As a practical matter, this leaves employers with ambiguous rules, which in turn leaves them vulnerable to lawsuits.
Practical Tips:
Before classifying employees as exempt under the administrative, executive, professional, or other exemption, carefully review the unique criteria applicable to each exemption.
The administrative exemption requires “non-manual work directly related to management policies or general business operations of the employer or its customers.” Federal regulations provide some insights into the meaning of this phrase. But due to the high cost of mistakes, it is prudent to seek advice from an attorney regarding proper classification.
For an overview of the exemptions, email Chris Olmsted at cwo@barkerolmsted.com and ask for the firm’s California and Federal Exemption Chart.
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