Over the summer, the U.S. Supreme Court punted on the question of whether “Service Advisers” or “Service Writers” at auto dealerships fall within the Fair Labor Standards Act’s exemption for “any salesman, partsman, or mechanic primarily engaged in selling or servicing automobiles.” For those outside of the auto industry, these are the people who greet you when you pull into the service department and communicate with you about what work your car might need. Since the question of whether service advisers count as “salesmen” may not be definitively resolved for some time yet, many auto dealers find themselves looking for other overtime exemptions that may apply to these positions.
The Section 7(i) Exemption
The “white collar” exemptions for executive, administrative, and professional employees don’t fit because service advisers don’t perform the sorts of job duties that fall under those exemptions, and many of them are paid mostly on commission rather than on a salary basis. There is, however, another exemption that may apply to at least some service advisers. Section 7(i) of the FLSA creates an exemption that applies when all three of the following conditions are met:
- The employee must be employed by a retail or service establishment.
- The employee’s regular rate of pay must exceed one and one half times the minimum wage for every hour worked in a workweek in which any overtime hours are worked.
- More than half of the employee’s total earnings in a “representative period” must consist of “commissions.”
“Retail or Service Establishment”
A “retail or service establishment” is one where 75% of the annual sales are of goods or services not for resale, and that is recognized as a retail sales or service establishment in the particular industry. Automobile dealerships typically meet this test, but not all individuals who work within a dealership necessarily qualify. For example, financial services such as insurance agencies are generally not regarded as “retail” services, even if they operate out of what one would ordinarily think of as a storefront. If an auto dealership maintains a captive insurance agency, for example, that agency may be regarded as a separate “establishment,” and its agents may not be “employed by a retail or service establishment” even if their desks are located in the dealer’s showroom. Likewise, the central office of a dealership group may be regarded as a separate “establishment” for purposes of this rule even if the individual retail showrooms and service departments qualify as retail or service establishments. As a result, employees working in the central office may not qualify for the Section 7(i) exemption even if their compensation is heavily incentive-based. However, as service advisers are usually employed directly by a dealership as part of its retail service operation, they will typically meet the first prong of the Section 7(i) exemption.
Minimum Rate of Pay
The second requirement for the 7(i) exemption is that the employee’s “regular rate” must be at least one and a half times the minimum wage for every hour worked in a workweek in which any overtime hours are worked. An employee’s “regular rate” means their total (non-overtime) compensation (including but not limited to any salary, hourly wages, commissions, bonuses and incentive pay) divided by the employee’s total work hours for the workweek. The “minimum wage” for this purpose is the federal minimum wage (currently $7.25 per hour), but in states (like Illinois) or municipalities that have a higher minimum, the state or local labor department may take the position that the 7(i) exemption only applies if an employee receives at least 1.5 times the minimum wage for that jurisdiction. This requirement applies only in weeks where the employee works overtime. In non-overtime weeks, the employee need only be paid the applicable minimum wage.
The astute observer will note that in order to determine whether this requirement is being met, an employer must keep accurate time records for their employees. This means that even if service advisers are treated as exempt from overtime under the Section 7(i) exemption, they should be required to “clock in” and “clock out,” or use some other reliable method to make an accurate record of their daily work hours.
The last requirement to qualify for the Section 7(i) exemption is that more than 50% of an employee’s compensation over a “representative period” must be paid as commissions. The employer can decide what “representative period” used to measure this requirement, so long as the period used is at least 1 month and no longer than 1 year, and is genuinely “representative” of the employee’s earning patterns with respect to any fluctuation of the proportion of the employee’s commission earnings to total compensation. Employers using the Section 7(i) exemption should designate the selected “representative period” in their records and be prepared to substantiate the basis for their selection.
While the term “commissions” is not precisely defined, at least one court construing the regulation has held that the “essence of a commission is that it bases compensation on sales, for example, a percentage of the sales price….” Yi v. Sterling Collision Centers, Inc., 480 F. 3d 505 (7th Cir. 2007). Consequently, even compensation that is not referred to as a “commission” may count toward the “more than 50%” requirement provided that it is incentive compensation tied in some way to sales performance, either of an individual employee or of the department or enterprise. However, incentives that are not tied in some clear way to customer sales – for example, attendance bonuses – would not qualify as commissions.
Because an hourly wage or salary does not vary based on sales performance, those payments necessarily fall on the opposite side of the scale when evaluating whether an employee meets the commission requirement for the 7(i) exemption. However, a minimum commission “guarantee” or draw may count toward the requirement provided that it is a component of an otherwise bona fide commission pay plan. Thus, for example, an employee whose pay for a given period consists of a $400 draw, an additional $200 in commissions over the draw, and $400 in salary will meet the “more than 50%” requirement for that period. However, if a compensation plan is structured so that the employee effectively receives the same fixed compensation in all or nearly all pay periods, it the commission requirement may not be met because. For example, if an employee’s weekly draw is set at $500 and the employee rarely if ever earns commissions sufficient to receive any amount over and above the draw, they will not qualify for the Section 7(i) exemption. Likewise, if a compensation plan is structured so that the employee receives a fixed percentage of sales up to an amount that the employee will almost always meet, but a drastically reduced percentage for additional sales that offers little or no opportunity to earn any extra compensation, the commission plan may not be regarded as bona fide, and the employee may not qualify for the exemption.
Put simply, for compensation to qualify as commissions, it has to vary in some meaningful way based upon sales performance. Usually, the point of paying employees on a commission basis is to provide a performance incentive, so most commission plans meet this requirement. However, employers that seek to disguise what is in essence a flat-rate compensation structure as a commission-based plan simply to avoid paying overtime should think twice, and perhaps call their lawyer.
Insights for Employers
Auto dealers seeking to take advantage of the Section 7(i) exemption should do so mindfully, understanding that all three elements of the test must be met for the exemption to apply to a given employee. They also need to keep in mind that the burden of establishing that an exemption exists always falls on the employer claiming the exemption. This means that the employer must maintain solid records needed to establish the exemption, including a clear written pay plan, detailed and accessible payroll records, and accurate and complete records of daily work hours. Employers should also regularly review their compensation structures and pay records to ensure that employees’ compensation continues to meet all of the requirements for the Section 7(i) exemption.