On May 6, 2024, the California Supreme Court, in Naranjo v. Spectrum Security Services Inc., clarified that an employer is not liable for statutory penalties for inaccurate wage statements when it had a good faith and reasonable belief that the issued statements were accurate. The court's holding offers employers a mechanism to avoid penalties reserved for a “knowing and intentional” failure to report accurate wage statements in California wage and hour class actions.

What Are Employers’ Duties? Cal. Labor Code Section 226 requires employers to issue earnings statements to employees that include, among other items, the legal name of the employer, the pay period, gross and net wages earned, all applicable hourly rates, and the corresponding number of hours (full list here). Employees (most often on a class basis) can seek hefty statutory penalties if an employer “knowingly and intentionally” failed to issue accurately recorded pay statements.

When Does This Issue Commonly Arise? Often, employers face claims of Cal. Labor Code Section 226 wage statement reporting violations when a putative class of employees aver that the company has failed to pay wages or missed break premiums. Consequently, the earning statements may be inaccurate because they reflect the employees’ actual compensation, and not the amounts employees aver or a court concludes the employees should have been paid. In other words, pay statement violation claims are often derivative of the underlying wage and hour claims and do not arise from the employer’s failure to accurately reflect the amounts paid to employees at the time. Nonetheless, in the past decade, these derivative claims arising under Section 226 have cost employers millions of dollars in class action lawsuits, in addition to the underlying wage claims.

In Naranjo, a security guard brought a putative class action for employer Spectrum’s failure to pay and report premiums for missed meal and rest breaks. Due to the job nature, security guards were required to take “on-duty” meal and rest breaks to escort incarcerated individuals to appointments outside custodial facilities. In prior proceedings, the court found that Spectrum owed wages for unpaid premiums for missed meal and rest breaks. As a result, Spectrum faced potential penalties under Section 226 because its earnings statements did not record the unpaid premiums. The California Supreme Court answered the Section 226 penalties question by first analyzing what qualifies as a “knowing and intentional” failure to accurately record earnings. (Spoiler alert, the Court concluded Spectrum did not intentionally fail to accurately record earnings).

What Is a “Knowing and Intentional” Failure? First, the California Supreme Court has made clear that isolated and unintentional payroll errors are not “knowing and intentional” errors. But, in most instances where the inaccurate wage statements are due to underlying wage and hour violations, the Court will review whether the employer “reasonably and in good faith, albeit mistakenly,” believed it complied with the law. This inquiry is fact-specific.

How Can Employers Best Avoid Claims? To avoid Section 226 penalties, an employer will have to show that it made a good faith effort to comply with contemporaneous wage and hour laws. For example, in Naranjo, the Court agreed with employer Spectrum that it failed to record meal premiums as “wages” at a time when the law was unresolved as to whether break premiums classified as “wages.” As such, a court may find an employer’s inaccurate pay statements were not knowing and intentional when the law governing the underlying wage claim or recording requirements is unsettled, even if the employer’s practice is ultimately found to be unlawful.

Ways Employers Can Ensure Compliance

Regularly review legal publications and the California Labor Commissioner’s Office website for wage and hour law updates. A good place to start is the New Labor Laws in California page.

Audit earning statements practices to ensure compliance. Consult with your third-party vendor if you contract out your payroll services.

Audit company employment policies and practices, particularly for “hotbed” wage and hour issues that will ultimately impact what information must be recorded on wage statements. Examples include:

• Timekeeping practices – ensure timekeeping procedures are as precise as possible and do not involve rounding.
  • As technology continues to allow for more precise timekeeping procedures (e.g., time stamps that include fractions of a second), employers should use caution in applying outdated “neutral” rounding policies. Even though the California Supreme Court has held that employer time rounding policies may be lawful in California, employers are increasingly facing potential liability when using time keep practices that do not accurately and precisely reflect the hours the employees worked. See e.g., Camp v. Home Depot U.S.A., Inc., 84 Cal. App. 5th 638 (2022) (reversing summary judgment where employer had a neutral timekeeping policy that involved rounding to the quarter-hour).
• Meal and rest break compliance – set policies and practices in place to ensure strict compliance.
  • Accurately record meal and rest break premiums when any are missed by a non-exempt employee.
  • Review meal break waivers for legal compliance.
  • The California Supreme Court opined in Donohue v. AMN Services, LLC, 11 Cal. 5th 58 (2021) that time rounding cannot be used for meal breaks. Employers using time rounding practices for meal breaks expose themselves to both unpaid meal premiums and wage claims.
• Regularly audit any roles classified as exempt to reduce risk of misclassification.
  • A good place to start is to review the exemption classification requirements on the California Labor Commissioner’s website.
  • Multistate employers should be wary of the difference between overtime exemption analysis under the Federal Labor Standards Act and the California Labor Code. Notably, the California Labor Code prescribes higher minimum salary requirements and a qualitative job duties analysis (versus a qualitative analysis). Generally, an employee must be performing over 50% exempt job duties to qualify as exempt. If a close call, it is generally safer to classify an employee as non-exempt.

Reprinted with permission from the June 7, 2024 issue of The Recorder © 2024 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.