Calif. OKs retailers’ use of incentive compensation

SAN FRANCISCO Prachasaisoradej v. Ralphs Grocery Company, Inc. reverses a lower court ruling that incentive compensation plans based upon store profits violated California’s prohibition against deducting routine business expenses from employees’ wages. The Supreme Court confirmed that profit sharing plans do not violate the law, even if costs are deducted from revenue to determine the amount of profits on which the incentive compensation is based. —A sharply-divided California Supreme Court handed down on August 23 a major win for retailers in the state. The decision in

Store employee Eddie Prachasaisoradej claimed that Ralphs’ profit-sharing plan violated California laws, prohibiting deductions from wages for expenses such as workers’ compensation costs, cash shortages, breakages and loss of equipment. Under the plan, employees were entitled to incentive compensation based upon the net profits of the stores in which they worked. Using accepted accounting procedures, Ralphs calculated store profits by subtracting store expenses from revenue, including those expenses which employers are generally barred from deducting directly from employees’ wages. The California Court of Appeals held the plan illegal.

California’s highest court disagreed, finding that applying statutes prohibiting direct deductions of costs from employees’ wages to a plan whose purpose is to give employees an incentive to improve profits “would defy reason and commons sense.” The Supreme Court held, “The plan was not illegal…simply because, pursuant to normal concepts of profitability, ordinary business expenses, such as storewide workers’ compensation costs and storewide cash and merchandise losses, were figured in, along with such other store expenses as the electric bill and the cost of goods sold, to determine the store’s profit, upon which the supplementary incentive compensation payments were calculated. After fully absorbing the expenses at issue, Ralphs simply determined what remained as profits to share with its eligible employees in addition to their normal wages.”

The dissent, however, strongly objected to this logic and urged that Ralphs’ plan created a “perverse incentive” for employees not to report workers’ compensation claims, so as to boost the profit figure upon which the plan’s compensation would be based. The majority, by contrast, suggested that the plan would inspire employees to maintain a safer workplace and limit abusive claims.

So what is the bottom line?

The decision removes a vast cloud of uncertainty hanging over standard profit sharing plans widely used by retailers in California. If the California Supreme Court had gone the other way, it may well have been the death knell for retailers’ ability to share profits with their employees in exchange for the employees’ collective efforts to improve profitability. Now, retailers can adopt (or maintain) such plans without fear of liability.

But be careful. While the Ralphs decision is a common sense victory for retail and other employers, the decision does not give retailers carte blanche to deduct workers’ compensation costs or routine business losses directly from salaries, commissions or bonuses of employees under the guise of “profit sharing.” Retailers must still craft incentive compensation plans carefully, lest they become the next target for claims of unfairly burdening employees with expenses the law requires them to bear themselves.

Afew tips for retailers:

Do not deduct expenses from fixed amounts of money promised to employees. For example, dollar for dollar deductions from promised commissions for inventory shortages remain illegal.

Promise employees only a share of whatever profits are left after expenses are subtracted from revenues.

Try to base the plan on store, district or regional profits calculated using generally accepted accounting principles.

Consult with counsel and financial advisors before adopting any plan.