A California Court of Appeal sided with an employer in a recent lawsuit over unpaid overtime wages. Clarifying the definition of a commissioned inside salesperson, the court found that the employer properly classified the employees as exempt, and therefore owed the employees no overtime compensation. Muldrew v. Surrex Solutions Corp., 202 Cal.App.4th 1232 (2012)

The court also offered guidance for employers who pay their employees on a commission basis. Rather than requiring employers to strictly limit commission wages to a percentage of products or services sold, the court permits employers, in some circumstances, to base commissions on overall company revenue.

Inside Salesperson Exemption

California Industrial Welfare Commission (IWC) Wage Order 7 states that employees whose “earnings exceed 1 ½ times the minimum wage if more than half of that employee’s compensation represents commissions” are exempt from overtime requirements. In previous decisions, California courts established a two-part test for determining whether a wage constitutes a “commission:”

• The employee must be principally involved in selling a product or service, not in making the product or rendering the service.
• The amount of the commission compensation must be a percentage of the price of the product or service.

Recruiters can be Salespersons

Tyrone Muldrew worked for Surrex Solutions Corporation as a recruiter. Surrex provides employee placement services to business clients. When a client contacts Surrex with a job opening, Muldrew would attempt to find candidates qualified for that position. After scouring internal databases and Internet job boards for appropriate candidates, Muldrew then had to convince both the candidate and the client that the placement would succeed.

Surrex classified Muldrew as a commissioned exempt inside salesperson. Muldrew filed a lawsuit on behalf of himself and his co-workers alleging that they were misclassified and that Surrex owed them unpaid overtime wages. Muldrew argued that in his position as a recruiter he did not “sell” a product or service, and that his compensation structure did not represent a percentage of Surrex’s services.

The court disagreed with Muldrew. First, the court determined that the tasks performed by Muldrew and other recruiters constituted a sales role, because Muldrew “sold” both the candidates and the clients on the job placements. Executives for Surrex testified that Muldrew had to convince a candidate that he or she was the right person for a job, convince the business client that the candidate was qualified, and help both sides agree on an appropriate wage rate.

Additionally, the court noted that the client would only pay Surrex once the placement was successfully finalized. Therefore, Surrex was “offering a candidate’s employment services in exchange for money,” which the court defined as “selling.”

Calculating Commissions

Next, the court evaluated whether Surrex’s compensation system met the second part of the commission-wage test: whether the compensation was a percentage of the price of the product or service. Surrex used two compensation structures. First, when Surrex directly placed a candidate with an employer and received a placement fee from the employer, Muldrew received a percentage of that payment. Muldrew conceded that this type of payment constituted a commission.

In other cases, Surrex billed clients an hourly rate for candidates placed as consultants. In this structure, Muldrew received a percentage of the annual gross profit generated by the placed consultant. Muldrew argued that this compensation structure was not simply a percentage of the payment for the service he provided, because adjusted gross annual profit included factors such as costs, overhead and benefits.

The court found that limiting the definition of “commissions” only to a percentage of sales price – rather than including other factors that affect overall revenue – constituted an “excessively wooden and narrow” application of the law. The court therefore found that Surrex’s payments to Muldrew constituted commissions, and that the employer properly classified him as exempt.

Best Practices

• Ensure that job descriptions are up-to-date, particularly for exempt employees.
• If you employ commissioned employees, draft clear company policies defining the commission structure.
• Employers who pay commissions in whole or in part must comply with 2012 legislation that requires a written commission agreement. The law takes effect on January 1, 2013, and requires that the agreement state the method by which the commissions are computed and paid. The employer must give a copy of the agreement to the employee, and the employer must get a signed receipt from the employee.
• Consult legal counsel if your commission structure is not simply based on a percentage of goods or services sold but, instead, includes an evaluation of overall revenue.