©2024 Seyfarth Shaw LLP www.seyfarth.com 2024 Cal-Peculiarities | 245 calculation of a profit-based bonus plan.409 This ruling, had it remained in effect, would have invalidated countless traditional profit-based bonus plans, including those for CEOs. But then, in 2007, the California Supreme Court overruled Ralphs I in a decision (Ralphs II) involving the same employer and the same bonus plan.410 Ralphs II holds that traditional bonus systems based on net profits are lawful, even if net profits necessarily reflect workers’ compensation costs together with other business losses. Ralphs II distinguished (a) a profit-based bonus plan from (b) a bonus or commission plan that first promises a payment and then reduces the promised payment to adjust for business losses. The latter plan, Ralphs II explained, would unlawfully charge employees for the company’s cost of doing business.411 A profit-based plan, by contrast, does “not create an expectation or entitlement in a specified wage, then take deductions or contributions from that wage to reimburse [the employer] for its business costs.” Rather, each employee receives, in addition to a guaranteed wage paid regardless of profit, a promised supplemental incentive compensation based on a profit to be calculated for a relevant period of operation. The bonus plan thus does not recapture or deduct from what the employer had originally promised,412 but rather rewards employees’ “cooperative and collective contributions” by giving them a portion of profits that the employer “would otherwise be entitled to retain itself.”413 Notwithstanding the “reason and common sense” Ralphs II thus invoked, the decision drew the support of just four of the seven justices. The three dissenters protested that the Labor Code must be read liberally in the employee’s favor: “Section 3751 prohibits the pass-through of workers’ compensation costs in the broadest possible terms.”414 The dissenters insisted: “What [the employer] cannot do in constructing its formula is include factors the Legislature has decided should play no role in the calculation of employment compensation. Workers’ compensation is such a factor.”415 Profit-based bonuses in California thus squeaked by the Supreme Court with a vote of 4-3. 7.16.2 Bonuses affected by cash and merchandise shortages Where bonuses depend on net profits, which depend in turn on such items as theft and cash shortages, plaintiffs have claimed that the bonus calculation amounts to a deduction in violation of section 8 of the Wage Orders. Ralphs I distinguished between nonexempt employees (covered by section 8) and exempt employees (not covered by section 8).416 As to exempt employees, Ralphs I held that California employers lawfully may calculate bonuses using a formula that includes deductions for cash and merchandise shortages, because that calculation appropriately encourages exempt employees to manage the business to increase revenue while minimizing expenses. With regard to nonexempt employees, however, Ralphs I held that the employer’s profit-based bonus calculation would unlawfully require them to bear the costs of management. The California Supreme Court’s Ralphs II decision, which overruled Ralphs I with respect to its interpretation of Labor Code section 3751, also overruled Ralphs I with respect to its view that employers must not deduct cash and merchandise shortages in calculating profits for purposes of a profits-based bonus for nonexempt employees.417 But Ralphs II was a hotly contested, 4-3 decision, and the three dissenting justices, while arguing that the employer unlawfully considered workers’ compensation costs in its profits-based bonus plan, suggested that they would also find unlawful the “deduction of cash and merchandise shortages.”418 7.16.3 Longevity bonuses involving restricted company stock The California Supreme Court, in Schachter v. Citigroup, upheld a voluntary employee incentive compensation plan that permitted employees to take shares of restricted company stock at a reduced price in lieu of receiving a portion of annual cash compensation.419 The plan provided that the stock did not vest unless the employee was still employed on a specified date, and that the employee would forfeit the stock—and the portion of cash
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