Question:

I would like to implement a bonus plan, for my employees, that’s based on my company’s profits. Am I allowed to adjust bonuses based on profitability each year, or do I have to guarantee a certain bonus amount in advance? I want to be able to reward my employees, but I don’t want to commit to bonuses that I might not be able to afford.

Answer:

The recent California Supreme Court decision in Prachasaisoradej v. Ralphs Grocery Company, Inc. addressed this very issue. The employer, Ralphs, had established an incentive program for its employees. The plan looked at each store individually, and determined whether its total actual earnings (less expenses such as workers’ compensation claims or cash shortages) exceeded its projected earnings. Depending on the results of the earnings assessment, eligible employees were then entitled to receive bonuses. These bonuses were paid to employees in addition to their regular wages, which were not affected by a store’s profitability or non-profitability.

The plaintiff in the Ralphs case successfully argued at the trial court level that the company’s incentive plan unlawfully deducted the costs of workers’ compensation and other business expenses from employees’ wages, because these things affected a store’s profit margins. The California Supreme Court disagreed, ruling that Ralphs’ bonus plan did not unlawfully deduct anything from eligible employees’ earnings. The Court found that a company can offer its employees profit-based bonuses (i.e., compensation in excess of their regular wages) that take into account ordinary operating losses, including workers’ compensation costs and other business expenses that are beyond the employees’ control.

In reaching its decision, the Court explained that an employee’s wages are “the amount that the employer has offered or promised to pay, or has paid pursuant to such an offer or promise, as compensation for that employee’s labor.” A deduction in wages therefore occurs only when an employer retains or recaptures a portion of the wages promised or paid, so that the employee actually receives less than he/she was promised for the work that he/she has performed. In this situation, the employee is essentially required to make a “forced contribution” from his/her wages, because their bonus is subjected to deductions in order to cover the employer’s operating expenses.

Under the Ralphs’ Plan, each eligible employee’s bonus was determined by the overall profitability of the store where they worked, not by their personal performance. As such, Ralphs did not retain or recapture anything that had been promised to its employees, because employees were never promised anything other than their share of their store’s net profit. That profit necessarily took into account the types of business expenses discussed above. Additionally, the Court pointed out that each Ralphs employee was paid in full for his/her work at a rate that was unaffected by their store’s “financial fortunes.”

In short, employees were guaranteed their regular wages, and were given a chance to share in the profits that their efforts had produced (which profits Ralphs would otherwise have been entitled to keep for itself). The Court therefore concluded that because compensation under the bonus plan was paid in addition to employees’ regular wages, and because those wages were certain and not subject to unlawful deductions, Ralphs’ plan was a proper incentive program and did not unlawfully pass along Ralphs’ business expenses to its employees.

The Ralphs decision is a positive one for employers such as yourself, who wish to motivate their employees with profit-based bonus plans, but who also need to take into account legitimate business expenses before determining bonus amounts. Employers should keep in mind that bonus plans can be complicated, however, and that care must be taken when establishing a bonus compensation structure. Employers are therefore encouraged to consult with legal counsel prior to implementing a profit-based bonus plan.
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