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Employers Beware: The Sixth Circuit Clarifies How Sales Commission Plans Can Violate Wage and Hour Laws – Even When the Employer Does Not Enforce the Plan

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The Sixth Circuit’s recent decision in Stein v. hhgregg, Inc. should be required reading for any employer with a commission workforce.

The opinion contains two critical conclusions:

  1. Employers cannot necessarily recover draws against commissions after an employee is discharged or resigns; and
  2. A handbook or other policy might give rise to a wage claim even if the policy was not enforced.  

Employers routinely use commission plans with repayment or “clawback” terms, where the employer pays the employee advances or draws against future commissions, which must be accounted for once the employee actually earns commissions in excess of the draw amounts. To provide themselves flexibility in how such adjustments will work, some employers implement policies that explain the employee’s possible repayment obligations upon discharge or resignation. In the wake of the hhgregg decision, such policies likely require a second look.

The key issue in hhgregg concerned prohibited “kickbacks” under the Fair Labor Standards Act (FLSA). The Department of Labor has issued regulations under the FLSA that require eligible employees to receive a minimum wage “free and clear” of any obligation to return the money to the employer. Thus, one prohibited practice would be requiring an employee to “kickback” part of his or her wages after they have been paid. While outside sales employees can be exempt from both minimum wage and overtime requirements under the FLSA, retail sales employees paid on commission are not exempt from the minimum wage rules–including the kickback prohibition.

In hhgregg, two retail sales employees filed a nationwide collective action against their employer, an electronics and home furnishings retailer. The company paid its retail sales employees on a pure commission basis. The plaintiff employees claimed that their company’s commission plan created an illegal kickback system in two ways: First, they argued that crediting a minimum wage payment against future commissions was a form of kickback. For example, an employee who earned no commissions in one week would be paid $290 (the federal minimum wage for a 40 hour workweek) as a draw against future commissions. If the employee then earned $600 in commissions in the next week, their pay would be reduced by $290 to make up for the preceding period’s draw. The employees claimed this amounted to a kickback scheme because they were inevitably required to pay back the minimum wage payment through reduced commissions.

Second, the company’s handbook provided that if an employee left the company with a negative draw balance (they had been paid draws at minimum wage, and had never earned the commissions to repay it), then the deficit had to be repaid upon the employee’s discharge. The plaintiffs claimed this was also a form of an illegal kickback.    

The company filed a motion to dismiss the lawsuit. The district court concluded that neither theory described an unlawful kickback system and dismissed the case. However, the Sixth Circuit reversed the district court, in part. The appellate court concluded that the commission plan was not a kickback scheme generally, but that it became one if the company tried to recover commission draws when an employee left the company.  

According to the Sixth Circuit, so long as wages are never returned, the FLSA’s “free and clear” rule is not violated. Therefore, looking at the company’s practices, the court reasoned that if the employee had been paid the draw to satisfy minimum wage requirements and was still employed, crediting the draw against a future commission earned was not an unlawful “kickback,” because the employer never required the employee to pay back any money actually received.

However, when the employee receives a draw and then resigns, the situation changes. The employer cannot recover the money from a future commission, so the only way to recover the draw is to demand the employee return the money already paid–an unlawful “kickback.” Based on that principle, the panel held that the repayment-upon-termination policy was unlawful. Note, however, that this conclusion should only apply to commission-eligible sales employees who are not covered by the outside sales exemption (since at least the minimum wage rules must apply to the affected employee, and outside sales employees can be exempt from those rules).

Yet, that conclusion alone would not necessarily have revived the employees’ case. The employees did not allege that they were forced to return any funds after their employment had ended, and the company demonstrated that it did not enforce the post-termination “clawback” rule. Nonetheless, the majority held that the policy alone established a violation of the FLSA.

The Sixth Circuit opinion makes the contents of an employee handbook or commission policy even more significant. Employers that use draws against commissions, particularly for retail sales employees, should pay close attention to the outcome of hhgregg. Policies that provide for the repayment of commission draws should be carefully reviewed–and revised where necessary–to ensure they do not potentially violate the FLSA. Also, following the court’s reasoning in hhgregg, employers may want to review other employee policies, especially those related to pay practices and company reimbursements, to ensure that employees cannot bring claims based solely on the language of the policy–even if the policy is not enforced in practice.

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