On September 7, 2010, a divided U.S. Court of Appeals for the Third Circuit affirmed a grant of summary judgment to NutriSystem, Inc. (“NutriSystem”) in a lawsuit challenging the concept of “commissions” under the retail commission exemption of Section 7(i) of the Fair Labor Standards Act (“FLSA”).1 In Parker v. NutriSystem, Inc.,2 the Third Circuit held, in a 2-1 decision, that NutriSystem’s call center sales associates were not entitled to overtime pay under the FLSA because, in relevant part, they received “commissions”3 that qualified them for the Section 7(i) exemption. In finding for NutriSystem, the Third Circuit refused to defer to the U.S. Department of Labor’s interpretation of the term “commission.”
The FLSA’s Section 7(i) exemption applies to employees in retail or service establishments if, among other things, more than 50% of their compensation is derived from commissions on the sale of goods or services. The term “commissions,” however, is undefined by the FLSA or its interpretive regulations.
NutriSystem had created a compensation plan to pay its call center sales associates flat-rate payments based on the direct sales of pre-packaged meal programs to consumers. These flat-rate payments were not based on the consumer’s price paid, but rather on when a sale was consummated and from what type of sales call it resulted. NutriSystem’s flat-rate fees were paid to its sales associates at varying rates of $18.00, $25.00, and $40.00 per sale. These payments were not linked to the costs of any particular meal program sold. Rather, the higher rates were paid on sales made on outgoing sales calls and for sales on calls made during less desirable work shifts (such as the overnight shift).
The employees claimed that such payments were not “commissions” because they were not based on the final cost to the consumer. NutriSystem, on the other hand, argued that its payments were commissions in that the sales associates’ pay varied across pay periods, their compensation was not linked to the number of hours worked, and the payments were proportionate to the cost to the consumer. The DOL filed an amicus brief in support of the sales associates, arguing that “to qualify as a commission, an increase in the costs to the consumer must result in a corresponding increase to the amount of payment made to the employee.”
In affirming the summary judgment for NutriSystem, the Third Circuit made two critical decisions: (1) it declined to grant deference to the DOL’s interpretation and arguments; and (2) it rejected the premise that, to be a commission, payments must be based on a percentage of the price paid by the consumer.
The significance of the Third Circuit’s refusal to defer to the DOL should not be underestimated. The Third Circuit did not simply bow in deference to the DOL’s interpretations. Rather, it appeared to hold the DOL to a higher standard, intently analyzing the rationale behind the DOL’s arguments before rejecting them. The decision clarifies for retail sales employers in the Third Circuit (Delaware, New Jersey, Pennsylvania and the U.S. Virgin Islands) that their compensation plans do not have to be strictly based on a percentage of sale prices to qualify as a “commission” under Section 7(i). However, employers should be aware that the Third Circuit’s decision in this case likely will not be embraced by the DOL. Accordingly, for example, if the DOL conducts an audit, it may adhere to its own interpretation of the term “commission,” leaving the employer to battle to reach a potentially more favorable venue in the courts of the Third Circuit.
The Third Circuit held that “when the flat-rate payments made to an employee based on that employee’s sales are proportionally related to the charges passed on to the consumer, the payments can be considered a bona fide commission rate for the purposes of [Section] 7(i).” In reaching that decision, the Third Circuit was persuaded by four primary factors. First, although NutriSystem’s flat-rate payments ranged from 5% to 14% of the price of the meals charged to the consumer, the variance was nominal, and, therefore, the flat-rate payments were proportionate to the costs. Second, the flat-rate fees were based on sales made by the associates and not on the number of calls made or on time worked. Third, from a policy standpoint, the flat-rate fees created incentives for sales associates to be actively making outgoing calls and to work less desirable shifts, thereby allowing NutriSystem to operate at peak efficiency around the clock. Finally, NutriSystem’s compensation system did not offend the history or intent of the FLSA and its overtime provisions, which were enacted to protect lower income employees, to spread available work among the larger pool of employees, and to compensate workers for the increased risk of workplace accidents that they might face from exhaustion in having worked overtime hours.
The Third Circuit’s decision has provided retail employers within the Third Circuit with greater latitude in developing commission plans for employees under the Section 7(i) exemption. Of course, any retail employer must remain mindful of the potential for the DOL to take a conflicting position as it did in this case, and also of how future courts within the Third Circuit interpret this opinion. However, a retail employer may now embark on a path to develop a commission plan similar to the NutriSystem plan that better fits its business model, knowing that the Third Circuit has supported such an effort.
1 29 U.S.C. §207(i).
2 Parker v. NutriSystem, Inc., 2010U.S. App. LEXIS 18691 (3d Cir. Sept. 7, 2010).
3 The element of Section 7(i) of the FLSA at issue in this case was the meaning of the term “commission.”