On September 20, 2016, business groups and states filed two lawsuits in the U.S. District Court for the Eastern District of Texas challenging President Obama’s new overtime rule that is set to take effect December 1, 2016 . Twenty-one states banded together to challenge the U.S. Department of Labor’s (“DOL”) new overtime exemption rule in States of Nevada et al. v. United States Department of Labor et al, Case No. 1:16-cv-004070., and the U.S. Chamber of Commerce, leading a coalition of 50 national and Texas business groups, filed a similar lawsuit in Plano Chamber of Commerce et al. v. Thomas Perez et al. Case No. 4:16-cv-00732. The two lawsuits argue that DOL unconstitutionally overstepped its authority to establish a federal minimum salary level to qualify for the Fair Labor Standards Act’s (“FLSA”) white collar exemption and violated the Administrative Procedure Act (“APA”).
The New Rule & its Impact on Employers
The long awaited controversial rule was released in May 2016 to the disdain of employers, as we’ve explained in prior blog posts. The most significant change in the final rule is the new $47,476.00 minimum threshold salary required to qualify as an exempt employee, representing more than a 100% increase from the present level and a huge financial undertaking for employers. All employers throughout the country must meet this same mandatory salary level to classify an employee as exempt, despite the substantial differences in cost of living from state to state and region to region.
Furthermore, the new rule implements an automatic increase in the threshold salary level every three years based on the 40th percentile for salaried workers in the lowest-wage region. The first automatic increase would take place January 1, 2020. This portion of the new rule differs greatly from DOL’s previous views on triennial or annual increases. In the 2004 Final Rule regarding the Exemptions for Executive, Administrative, Professional, Outside Sales and Computer Employees, the DOL specifically stated:
[t]he Department has repeatedly rejected requests to mechanically rely on inflationary measures when setting the salary levels in the past because of concerns regarding the impact on lower-wage geographic regions and industries. This reasoning applies equally when considering automatic increases to the salary levels. The Department believes that adopting such approaches in this rulemaking is both contrary to congressional intent and inappropriate.
69 Fed. Reg. 22122, 22171-72 (Apr. 23, 2004).
This triennial increase will certainly have a significant impact on employers. First, it makes it harder for employers to determine whether to raise the salaries of their exempt employees or reclassify them because it is difficult to predict exactly what the salary level will be in three years. Such a raise may become more burdensome to employers as the average salary level gets higher from year to year, particularly if employers are unable to continuously raise salary levels prior to the automatic increase. This will ultimately force employers to reevaluate their exempt employee classifications every three years to determine whether it is financially feasible to take on that additional salary increase to maintain exempt status. Second, a mandatory increase guarantees a raise in the minimum salary threshold even during difficult economic times when employers may be less likely to afford such a pay increase.
Challenge to the New Rule Filed by 21 States and Chamber of Commerce
The lawsuits filed by the group of 21 states and the coalition of businesses led by the U.S. Chamber of Commerce seek to enjoin the DOL from implementing and enforcing the new rule and a declaratory judgment that the rule is unlawful. The plaintiffs rely mainly on the FLSA and the APA to support their argument that DOL overstepped its authority in increasing the salary level and implementing an automatic triennial increase.
Both lawsuits argue that the DOL’s actions are in excess of Congressional authorization although on slightly different grounds. The states contend that the applicability of the white collar exemption must be determined based upon the duties and activities actually performed by the employees, not merely with respect to their salaries. While the plaintiffs admit that salary may be one factor to consider, it cannot be a litmus test or a proxy for distinguishing between overtime-eligible employees and overtime exempt white collar workers. Essentially, the states are complaining that DOL did not update the duties test which should be the ultimate guide in determining whether an employee qualifies for overtime. In contrast, the U.S. Chamber of Commerce claims that the salary threshold is indefensibly high and defies the mandate of Congress to exempt executive, administrative, professional, and computer employees from the overtime requirements of the FLSA.
The lawsuits similarly claim that the DOL violated the APA in implementing automatic updates of the salary basis test and compensation level every three years because it violates the FLSA’s statutory command to define and delimit the meaning of an employee employed in a bona fide executive capacity. 29 U.S.C. § 213(a)(1). Furthermore, the plaintiffs allege that the automatic triennial increase in the salary basis test and compensation level violates APA’s notice and comment rulemaking procedures. In effect, the automatic increase permits the DOL to avoid its responsibility to assess the financial impact of such an increase prior to its implementation. Finally, the plaintiffs claim that DOL acted arbitrarily, capriciously, and otherwise not in accordance with the law by departing from decades of precedent and Congressional intent without any reasoned explanation.
Unique to the Complaint filed by the 21 States, they argue that the rule is unlawful as applied to the States because it violates the 10th Amendment. The plaintiffs claim that enforcing the FLSA and the new rule against the States infringes upon state sovereignty and federalism by dictating the wages that States must pay to “whom they employ in order to carry out their governmental functions, what hours those persons will work, and what compensation will be provided where these employees may be called upon to work overtime.” These are matters that the States believe to be indisputable attributes of State sovereignty – i.e. employment relationships, services, functions, and budgets.
Whether any of these claims will succeed remains to be seen. In addition to declaratory relief, both lawsuits seek a temporary and permanent injunction preventing the DOL from implementing and enforcing the new overtime rules and regulations. However, in the event the Texas federal court does not rule on the injunction before the December 1, 2016 roll-out deadline, employers should be prepared to comply with the new rule.
Next Step for Employers
Despite this challenge to the new rule, employers still need to reevaluate how to effectively handle the exempt employee classification of all those currently exempt employees below the new threshold salary level. For those assistant managers and supervisors earning pay near the new threshold salary level, especially those who generally work more than 40 hours per week, it may be a more financially feasible decision to raise their salary rather than try to address the issue of potential overtime pay. Alternatively, for those employees currently earning a wage closer to the prior threshold level of $23,660.00, reclassifying them as non-exempt and closely monitoring hours worked to keep them at or below 40 hours per week would likely be the more feasible option. However, it would be wise for employers to evaluate and handle these decisions on a case-by-case basis.
Many employers will also have to provide new training on time recording policies. Exempt employees do not have to track the time they work because they are paid on a salary basis. When exempt employees are reclassified as non-exempt, accurate tracking will become essential, requiring training for these employees, as well as their managers. Furthermore, time tracking systems should be evaluated and potentially upgraded to ensure they have the capacity to track the influx of newly non-exempt employees. Employers must also update pay systems and ensure pay calculations have been properly restructured to reflect the proper hourly pay and overtime rates.
Finally, employers should review their related policies and procedures to determine which need to be updated to reflect the requirements of this new rule. Given the nuances of these regulations and the current duties test, guidance from legal counsel will be useful for any employee classification and policy review.