Department of Labor’s New Standards for Overtime Eligibility Will Challenge the Construction Industry

A Laurie & Brennan article featured in the Construction Law Corner, Summer, 2016, eNewsletter.

by Daniel Brennan

On May 18, 2016, the Department of Labor’s Wage and Hour Division (the Department) published a Final Rule (Rule) updating overtime regulations.   The new Rule doubles the salary threshold over which an employee is exempt from overtime protection under the Fair Labor Standards Act (FLSA).   The Rule goes into effect on December 1, 2016, and the Department expects that the Rule will extend overtime benefits to over four-million previously-exempt workers within the first year of implementation.[1]

In adopting this Rule, the Department aims to correct the unintended consequences of its most recent 2004 regulations by targeting the standard salary level for Executive, Administrative, and Professional (EAP) employees and the annual compensation requirement for Highly Compensated Employees (HCE). Under the new Rule, the EAP exemption covers employees earning more than the 40th percentile of earnings of full-time salaried workers in the lowest-wage Census Region, currently the South.   EAP employees making up to $913 per week–or $47,476 annually–are non-exempt and will be granted overtime pay and minimum wage protections.   Similarly, the annual compensation requirement for HCE employees–a category introduced in 2004–will be tied to the 90th percentile of full-time salaried workers nationally, or $134,004 annually.   Together, the new thresholds for EAP and HCE exemption will add 4.2 million workers to the overtime pool.   Finally, the Rule introduces a mechanism for automatically updating the standard salary level and annual compensation requirement by tying them to one of two set indices.

The salary level test has been an essential component of FLSA regulations since their inception in 1938, and many consider it “the single best test” of exempt status for its purported ability to assess the “bona fide character” of the employment for which exemption is claimed.[2]   However, the salary level test is not independently dispositive of an employee’s exempt status.   The FLSA also incorporates a job-duties test to screen out employees for exemption based on their degree of managerial authority on the job.

Historically, the Department paired two distinct salary level tests with corresponding job duties tests   – the so-called long test and short test.   The long-test functioned to identify employees that were exempt based on job duties, despite a lower salary, while the short-test identified exempt employees based predominantly on a high salary. Essentially, employers would have to meet more rigorous job-duty requirements in order to exempt lower-paid employees, while the job-duty requirements were less demanding for higher-paid employees.

Unfortunately, though perhaps predictably, the use of these two tests produced incredible confusion as employers became increasingly uncertain as to which employees were exempt.   Seeking clarity, the Department collapsed these historically distinct tests and adopted a single standard test when it issued its most recent regulations in 2004.   However, the 2004 regulations created a mismatch in DOL’s view, exempting many lower-salaried employees who performed minimal EAP work.   The Rule aims to correct this misalignment, but also drastically raises the salary level by an unprecedented degree.

The Department’s announcement comes on the heels of an extensive public comment process, and is in line with President Obama’s 2014 Presidential Memorandum imploring the Department to update the EAP regulations.   Following Obama’s directive, the Department seeks to recover from its 2004 misstep by raising the standard salary levels across the board, with the new rate representing a 200 percent increase from 2004.   The Department similarly raised the HCE annual salary requirement, which will continue to escalate on an annual basis to match the annualized weekly earnings of 90th percentile of full time salaried workers nationally. While the new rates may serve as reliable indicators of an employee’s stature in some settings, its uniform application ignores salary discrepancies across regions and industries, potentially causing the inappropriate classification of millions of employees.   The abrupt 200 percent increase may leave employers scrambling to catch up and employees seeing their wages, hours, and duties cut drastically.

The construction industry’s response to the new Rule has been almost universally critical.   According to Ed Brady, chairman of the National Association of Homebuilders (NAHB), the “sheer arrogance” of the Department in refusing to listen to the voices of small business owners will result in employers scaling back employees’ hours, benefits, and salaries in order to finesse pay-structures to fit under the new Rule while remaining profitable.[3]   Employers will not pay out of pocket for the newly minted non-exempt overtime workers. Instead, they will, in some combination, lower baseline compensation packages in order to offset expected overtime expenditures and strictly monitor and restrict employee hours to limit overtime exposure.   It is true that employers may raise salaries for some employees–those near enough to the new threshold–in order to maintain their exempt status.   However, when taken together, employers’ maneuvering in response to the new Rule will “eviscerate”[4] the EAP exemption and completely undermine the stated goals of FLSA’s overtime requirements.

The industry’s reaction should come as no surprise, as many industry leaders were intimately involved in the public comment process.   A comment submitted back in September, 2015 by Associated Builders and Contractors, Inc. (ABC), a national trade association representing nearly 21,000 members, warned that the unprecedented increase in the salary threshold would be “extremely disruptive and harmful to both employers and many of their currently exempt employees,” and would be a “destabilizing” force to the industry at large.[5]   ABC and other industry groups such as the Associated General Contractors of America (AGC) condemned the Department’s failure to differentiate geographic regions and industry in the creation of the Rule, instead lumping all businesses together with a one-size-fits-all application.[6]   While the Department has superficially responded to this concern by tying the new threshold to the 40th percentile of the lowest-wage Census Region, rather than the national rate, the difference in prevailing wages across different industries is so vast that the new Rule may force construction employers to overcompensate employees relative to their economic value.

Critics also claim that there is a secondary, indirect, harm to workers posed by the new Rule.   Employers may be forced to impose a reduction in hours and responsibilities–together with more rigid scheduling and hours-caps–that will undermine employees’ opportunity to prove themselves and earn advancement in the workplace. Unencumbered by overtime restrictions, exempt employees are free to fully engage in the workplace, putting in the time to get noticed and targeted for promotion.   The flexibility in scheduling also allows these employees to work more efficiently and the freedom in flexibility is greatly appreciated and sought after.   By adopting the new Rule, the Department forces the hand of employers who cannot absorb the cost of overtime payments to strictly monitor and restrict the working hours of newly non-exempt employees.   These employees have worked to gain their exempt status, and may see a change to hourly and a reduction in hours as a demotion, spoiling morale throughout the industry.

The construction industry operates on extremely tight margins, and employers are in no position to absorb the costs associated with the new Rule.   Brian Turmail, spokesman for AGC, stressed the fact that public and private owners are demanding that contractors “deliver projects on tighter margins than ever before” in admonishing those who would “labor under the assumption” that the Rule would result in higher compensation for construction employees.[7]   Instead, employers will face pressure to expend great resources in monitoring employees’ hours throughout the week to ensure they do not pass the 40-hour mark, resulting in even lower take-home pay for employees across the board and higher prices for consumers.   In a survey of human resource professionals of construction employers, the AGC reports that 74% of those surveyed would likely reclassify some or all of the impact exempt workers to non-exempt hourly status at current salaries, 60% expect the institution of policies to ensure that affected employees do not work over 40 hours a week, and 80% expect employee morale to be damaged due to the reclassification.   Some employers have already adopted advanced time tracking technologies that alert them when an employee is approaching 40 hours worked and allows them to reschedule shifts so that they do not pass the threshold.   Together, these costs are expected to force the reduction in employee benefits in 40% of surveyed workplaces, while 33% will eliminate some positions altogether and an additional 23% will change full-time positions to part-time.

Moreover, those bemoaning stagnating unemployment figures may be disappointed by the effects of the Rule, as businesses may impose a moratorium on new hires in conjunction with the restrictions on current employees.   Ron Peppe, a vice president overseeing legal and human-resource functions at Canam Steel Corp., made the issue abundantly clear: “the money has got to come from somewhere.”[8]   And that somewhere will not be employers’ pockets.

According to the Department’s logic, FLSA’s overtime requirements serve the twin purposes of employment-spreading and minimizing excessive working hours.   The industry strongly rejects the Department’s prediction that the new Rule will further these goals.   Instead, the reaction from the construction industry suggests that employees will lose out on wages, benefits, flexibility, and advancement opportunities, while consumers will see prices rise due to these and associated monitoring costs.   However, the industry is not ready to raise the white flag.   Both NAHB and the ABC, as well as countless others, are urging Congress to step in by supporting the Protecting Workplace Advancement and Opportunity Act (H.R. 4773/S. 2707), which would prevent the Department from implementing the new Rule.   The proposed legislation would require the Department to conduct a more thorough and exhaustive analysis of the Rule’s effects across regions and industries, and would bar the Department from implementing the new Rule until it has done so.