The California Supreme Court issued a long-awaited decision on July 15, 2021, in Ferra v. Loews Hollywood Hotel, LLC, regarding the rate of pay employers must use when paying employees premium pay pursuant to Labor Code section 226.7. Specifically, the Court unanimously held that premium payments paid to employees for non-compliant meal, rest and recovery periods must use the employee’s “regular rate” of pay rather than the employee’s base hourly rate of pay. In other words, employers must use the same rate of pay they use for paying overtime when paying premium payments for missed meal, rest and recovery periods, which encompasses “not only hourly wages but also nondiscretionary payments for work performed by the employee.” In addition, the Court held that its decision applies retroactively.

Decision: In Ferra, a nonexempt bartender filed a class action lawsuit against Loews Hollywood Hotel, alleging that it failed to pay its hourly employees the correct rate of compensation for premium pay on occasions when employees were not provided with compliant meal or rest periods. In particular, the plaintiff alleged that her employer did not factor in the nondiscretionary quarterly incentive payments that she had earned into the rate of pay when calculating her premium payments.

Central to the Ferra case was how to properly interpret the term “regular rate of compensation” in Labor Code section 226.7(c). California Labor Code Section 226.7(c) provides that “[i]f an employer fails to provide an employee a meal or rest or recovery period in accordance with state law . . . the employer shall pay the employee one additional hour of pay at the employee’s regular rate of compensation for each work day that the meal or rest or recovery period is not provided.” The term “regular rate of compensation” is not defined in the California Labor Code or in the Industrial Welfare Commission’s Wage Orders.

However, California Labor Code section 510(a), California’s overtime statute, uses the term “regular rate of pay” when describing the employer’s obligation to pay overtime. Consistent with the Fair Labor Standards Act, under section 510(a), an employer’s obligation to use the “regular rate of pay” when calculating overtime requires the employer to account for nondiscretionary payments received by the employee. Relying on the fact that the legislature used the term “regular rate of compensation” rather than “regular rate of pay” in section 226.7(c), many employers, as well as a number of courts (including the court of appeal in Ferra), concluded that calculating premium pay using the employee’s base hourly rate is proper under section 226.7(c)—such that employers need not factor additional compensation into the premium pay calculation.

The question before the Supreme Court was “whether the Legislature intended ‘regular rate of compensation’ under section 226.7(c) to have the same meaning as ‘regular rate of pay’ under section 510(a), such that the calculation of premium pay for a noncompliant meal, rest, or recovery period, like the calculation of overtime pay, must account for not only hourly wages but also other nondiscretionary payments for work performed by the employee.”

The Court unanimously held that the terms “regular rate of pay” and “regular rate of compensation” are “synonymous” and that compensation under section 226.7(c) must “encompass[] all nondiscretionary payments, not just hourly wages.” The Court explained that “the term ‘regular rate’ is a term of art encompassing not only hourly wages but also nondiscretionary payments” and that “the words ‘compensation’ and ‘pay’ appear interchangeably in legislative and judicial usage.” Accordingly, “regular rate” is the “operative term” in interpreting the meaning of section 226.7(c), and consistent with the Fair Labor Standards Act and section 510(a), “courts have consistently understood this language [‘regular rate’] to encompass all nondiscretionary payments, not just base hourly rates.”

Critically, the Court held that its decision applies retroactively, rejecting Loews’ argument that the ruling essentially created new law. In so ruling, the Court opined that “because [the Court’s] reading of ‘regular rate of compensation’ in section 226.7(c) is ‘[o]ne very reasonable way to construe’ the phrase, Loews ‘is simply wrong when it argues that ordinary people could not have predicted plaintiff’s interpretation, and that it would violate defendant’s due process rights to adopt that interpretation.’” The Court also explained that “it is not clear why [it] should favor the interest of employers in avoiding ‘millions’ in liability over the interest of employees in obtaining ‘millions’ owed to them under the law.”

Impact: In light of the Court’s decision, employers should update their policies and payroll systems to ensure that they use the employee’s “regular rate of pay” when paying meal and rest break premiums rather than the base hourly rate of pay. In addition, because the “regular rate” often includes incentive compensation that is paid quarterly, annually or on a different schedule rather than every pay period, employers should consider implementing a true-up process for premium pay during the pay period in which such incentive compensation is paid to pay any additional amounts owed once such incentive compensation is factored into the regular rate—much like the process that many employers implement when truing up overtime payments.

Importantly, and as noted by the Court in its decision, Ferra does not eliminate any defenses available to employers in defending claims alleging a failure to provide compliant meal and rest periods. In order for employees to establish that they are entitled to premium pay, they must first establish that they were not provided with compliant meal and rest periods.