California Supreme Court Overturns Court of Appeal Ruling That Had Jeopardized the Legality of Profit-Based Bonus Plans

On August 23, 2007, the California Supreme Court reversed a decision by the California Court of Appeal that had called into question the legality of profit-based bonus plans.  The plaintiff in Prachasaisoradej v. Ralphs Grocery Co., Inc. was an employee who received incentive compensation from the Ralphs store for which he worked.  Ralphs calculated the payout under its supplementary incentive compensation plan based on the amount each store’s profits exceeded preset profitability targets.  The problem, plaintiff alleged, was that in calculating these store profits, Ralphs improperly deducted certain expenses, i.e., workers’ compensation insurance premiums, cash shortages and other losses, and costs of claims not caused by dishonest acts or gross negligence of employees.  California law generally prohibits making deductions from employee “wages” for such business expenses.  The California Court of Appeal agreed with the plaintiff’s argument, holding that the profit-based incentive plan unlawfully included such costs in its calculation of profits.  Because profit calculations typically take into account all types of costs, including the foregoing ones, this ruling called into question the legality of essentially all California profit-based bonus plans. 

Reversing the Court of Appeal, the California Supreme Court held that it was lawful for Ralphs to include such business expenses when calculating profits to share with eligible employees.  The Court found that this was not a deduction from “wages” because the amount of this bonus-based “wage” was not determined until after profits were calculated. The Court distinguished the Ralphs plan from unlawful plans in which companies deduct from or recapture expected wages for the purpose of saddling employees with prohibited employer costs.  For example, the Court found that employers could not deduct such costs from an employee’s “regular” wages (e.g., salary or hourly wage).  The Court also stated that such costs could not be used in the calculation of an employee’s commission, or in a bonus plan that operates like a commission plan (e.g., bonuses based upon a percentage of sales that the employee was responsible for generating).