Alert: California Supreme Court Holds That Bonus Awards May Consider Store Losses

August 28, 2007

On August 23, 2007, the California Supreme Court held that employers may base bonuses upon store net profit, despite California legal limits on business losses affecting employee compensation.  In Prachasaisoradej v. Ralphs Grocery Company, Inc., 07 C.D.O.S. 9940 (Aug. 23, 2007), the court reversed the California Court of Appeals and found that Ralphs' profit sharing bonus did not violate provisions of the California Labor Code which prohibit an employer from shifting certain operational costs to employees by withholding, deducting, or recouping the costs from wages or earnings.  The decision offers unprecedented direction in how employers may structure profit-based compensation consistent with California law.

Ralphs had maintained a written incentive compensation plan ("ICP") providing certain employees of each store with bonus payments if the store reached certain net profit targets.  In calculating store profits, Ralphs subtracted store operating costs, including the number of worker's compensation claims and other losses such as cash shortages, merchandise shortages, and non-employee tort claims. 

A produce manager filed suit alleging that the supplementary incentive program violated various provisions of the California labor code, because each employee's net earning were reduced by including the aforementioned costs in the bonus calculus. California statutes and case law have prohibited employers from deducting business losses from employee wages based upon the principle that employees are not sureties of their employers.  The California Court of Appeals found that the ICP violated this prohibition because the bonus was reduced or eliminated when business losses reduced profit below specified levels.

The California Supreme Court reversed, finding that the bonus did not reduce any previously established wage.  The court explained that "wages" are only amounts that the employer has promised to pay in exchange for labor performed.  Here, Ralphs had paid the amounts promised without any deductions.  Participants in the ICP understood that their entitlement to additional payments, above and beyond their normal wages, was wholly dependent on the store's performance vis-à-vis the preset profitability targets. The ICP payment could only be properly characterized a "wage" after Ralph's determined the amount by which the store's revenue exceeded its operating costs for the relevant time period.  The fact that the calculation would include a component of business losses did not create a deduction from wages because the wage amounts had not been previously established.  The court emphasized that the bonus was not based upon the subject employee's individual profit contribution but, rather, upon the profit of the entire store. 

Thus, this decision appears to have relied upon several premises.  First, the ICP was calculated after labor was performed.  Second, the ICP was paid over and above compensation which had already been guaranteed by the employer.  Third, the ICP was calculated based upon profitability of the entire store rather than based upon costs created by the subject employee. 

Employers should examine their profit sharing bonus plans with counsel to assure that they stand the best chance of being upheld under the Prachasaisoradej decision.