Third Circuit OK's Carrot-Stick PTO Driven Pay System

In today’s evolving labor market, business owners often search for unique ways to motivate employees to perform at high levels through the use of benefit-linked incentive structures. While performance-linked incentives are certainly nothing new, some employers have developed systems where employees who fail to satisfy certain performance standards will experience benefit reductions tied to those failures. One of these demerit systems was recently challenged via allegations that the system violated the Fair Labor Standards Act (FLSA) overtime rules by converting a salary-based employee to an hourly employee. The Third Circuit Court of Appeals has provided guidance on one specific type of arrangement by clarifying that paid time off (PTO) is not part of an employee’s salary for FLSA purposes—but employers should tread cautiously and pay close attention to the details to avoid running afoul of the FLSA rules.

Higgins v. Bayada: The Facts

As a general matter, under the FLSA, employers must pay overtime wages to employees who work more than 40 hours per week if their income does not exceed certain thresholds (which will increase from $684 per week to $844 per week on July 1). Exceptions exist based on job duties and for employees who are paid a set amount regardless of the quantity or quality of the work they perform (i.e., salary-based employees).

The plaintiff in this case claimed that the employer’s benefit structure caused the company to violate the FLSA because the system, in practice, converted her from a salary-based employee to an hourly employee who should have been paid overtime.

The plaintiff was a nurse who worked on a salary basis providing in-home health care services for Bayada Home Health Care. One of the benefits offered by Bayada was a PTO system based on employee performance. All employees were subject to certain productivity minimums. Depending on productivity, which essentially translated into the number of patient visits and hours worked, employees would earn or lose points.

When employees earned points, those points were translated into pay increases. Conversely, when an employee failed to meet those standards, Bayada operated a demerit system where points were deducted to reduce balance in the employee’s PTO account.

Employees could request increases or decreases in their productivity minimums, which would result in increases or decreases in the employee’s actual salary. However, the employer did not deduct from the employee’s salary if the employee failed to satisfy productivity minimums and yet did not have sufficient PTO to cover the deficiency. Employees’ salary could only be reduced if they took a day off from work without sufficient PTO.

Third Circuit: PTO Deductions Do Not Violate FLSA

After the plaintiff ceased employment, she sued her employer based on allegations that the PTO demerit system constituted an unlawful salary reduction based on the amount of work she completed. Basically, she claimed that the points system was essentially a covert way of compensating employees based on the number of hours worked, so that the demerits converted her to an hourly employee who should have been paid overtime.

To begin, the Third Circuit court noted that the FLSA does not actually define the terms salary or fringe benefits. However, based on the regulations, an employee is considered a salary-basis employee if they are paid a predetermined amount which cannot be reduced based on the quality or quantity of the work performed. The employee must receive the full amount of their salary regardless of the number of days or hours worked. Reductions can transform the employee’s pay from salary to hourly.

The court then found that the plaintiff’s base pay was never reduced based on the performance standards. Only the balance of the PTO-benefit account could be reduced when employees failed to satisfy the productivity minimums. Because the plaintiff’s guaranteed base salary always remained constant, the PTO demerit system did not convert her into an hourly employee.

The court further found that even if the system confused employees, the relevant issue is whether the employer actually deducted from the employees’ base pay. The PTO system was a type of fringe benefit, and fringe benefits are not considered to be part of an employee’s salary for FLSA purposes.

Conclusion

The Third Circuit’s ruling is binding for employers in New Jersey, Pennsylvania, Delaware and the Virgin Islands. However, employers in all states should be cautious when implementing systems that deduct from an employee’s fringe benefits because it is always possible that courts could take a more narrow view of how the law should be implemented to protect employees.

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