On August 23, 2007, in the case of Prachasaisoradej v. Ralphs Grocery Company, Inc., the California Supreme Court reversed earlier appellate decisions by holding that a company may lawfully offer its employees bonus compensation (over and above their regular wages) based on a profit calculation that takes into account ordinary operating losses, workers’ compensation costs, tort claims by non-employees, and other business expenses beyond the employees’ control.

In this case, the employer (Ralph’s) had an incentive program (the Plan) that looked at each individual store and determined whether its total earnings (less expenses including workers’ compensation claims, cash shortages, merchandise shortages or shrinkage, and the costs of certain non-employee tort claims) exceeded the net earnings that Ralphs expected from the store. Eligible employees then received bonuses depending on the results of that comparison. Ralphs paid Plan bonuses in addition to employees’ regular wages, which were never reduced as a result of a store’s profitability or non-profitability.

The plaintiff here claimed that the Plan unlawfully deducted the costs of workers’ compensation and other losses from employees’ wages, and sued on a class-action basis for those lost wages, penalties, and other remedies. An appellate court in 2003 had already decided some of these legal issues against Ralphs in a case involving a different plaintiff, and Ralphs lost again at the appellate level with this lawsuit. But the California Supreme Court disagreed, finding that nothing about Ralphs’ Plan (as described) unlawfully deducted anything from eligible employees’ wages or earnings.

The Court first noted that an employee’s wages or earnings 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 occurs only where an employer retains or recaptures a portion of the wages promised or paid, "so that the employee, having performed the labor, actually receives or retains less than the paid, offered, or promised compensation."

The Court then distinguished Ralphs’ Plan from unlawful profit-based compensation calculations, where an employee is offered or promised a specified bonus or commission that is based upon, and immediately measurable by, his/her individual efforts, which is then subject to deductions to cover employer costs. Under those unlawful plans, employees are promised compensation in a measurable amount, but the employer paid a reduced amount to retain or recapture some of the operating expenses.

Under Ralphs’ Plan, by contrast, the basic measure of compensation is the overall profitability of the enterprise, not an employee’s personal efforts. "All eligible employees’ supplementary incentive compensation was equally and collectively premised, at the outset, on store profits, a factor that necessarily considers the employer’s expenses as well as its income." Accordingly, Ralphs did not retain or recapture anything that was promised to employees, because eligible employees were never promised anything under the Plan other than their share of their store’s profit, which by its nature takes into account the listed expenses. Put another way, Ralphs never deducted anything from compensation promised under the Plan, because the only compensation promised under the Plan was the employee’s share of the store’s net profit.

Because compensation under the Plan was paid in addition to employees’ regular wages, which were certain and not subject to unlawful deductions, the Court concluded that the Plan appeared to be a lawful incentive program, rather than a plan designed to unlawfully pass along the costs of Ralphs’ business to its employees.

The Ralphs decision is a victory for employers seeking to motivate their employees with profit-based bonus plans. Bonus and profit-sharing plans remain technically and legally complicated, however, so it is important to review them carefully and regularly, preferably with employment counsel.