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In U.S. Department of Labor v. Fire & Safety Investigation Consulting Services LLC, 2019 U.S. App. LEXIS 3971 (6th Cir. 2019), the Court of Appeals for the Fourth Circuit recently held that a company violated the Fair Labor Standards Act (FLSA) by paying employees pursuant to a blended hourly rate that attempted to replicate a regular rate for certain hours and an overtime rate for other hours. The court ruled that the blended rate became the employees’ regular rate and, as a result, the employer owed the employees an additional $1.6 million in overtime pay.

The company employed consultants to provide safety and environmental services to oil and gas clients in West Virginia and Pennsylvania. The consultants worked 12-hour workdays for 14 consecutive days – known in industry parlance as a “hitch” – followed by 14 days off. Consultants working a full hitch worked a total of 168 hours over two weeks. Sometimes, however, they worked fewer hours.

The company paid the consultants based on a hitch rate. If a consultant worked a full hitch, the company paid them a fixed sum that was allegedly calculated by using one rate for the first 40 hours each week and a rate of 1.5 times the first rate for the remaining 44 hours each week. But if a consultant worked fewer than 168 hours during any hitch, the company adjusted the consultant’s pay using a blended rate, which it calculated by dividing the amount due for the full hitch by 168 to determine a blended rate and then multiplying that blended rate by the number of hours actually worked.

The court offered the following example to show how the system worked. Suppose that a consultant’s purported regular rate was $10. Under the company’s payment system, the fixed rate for a full hitch would be based on 80 hours of non-overtime at $10/hour ($800) and 88 hours of overtime at $15/hour ($1,320) for a total of $2,120. However, if the consultant worked less, he was paid using a blended rate of $12.62 (or $2,120 divided by $168).

While the Company’s approach may seem fair and appeared to pay the consultants who worked less than a full hitch more than they would have earned had the Company simply applied the $10 rate for the non-overtime hours and $15 for overtime hours actually worked, the court held that by using the blended rate approach, the employer actually made the blended rate the consultants’ regular rate.

The court explained that “[t]he FLSA shields employees from precisely the type of payment scheme” the company used – “one that appears to compensate employees for both non-overtime and overtime but in reality, uses a single rate for all hours worked, regardless of whether they are non-overtime or overtime hours.” The court added that “[o]ur holding guards against creative payment schemes in which employers retroactively divide a fixed payment into non-overtime and overtime components to demonstrate supposed compliance with the FLSA … To rule otherwise would permit employers to invent payment schemes that fail to pay proper overtime and then post-hoc attempt to reverse-engineer compliance with the FLSA.

In reaching its conclusion, the court rejected the company’s contention that its blended-rate system actually “overcompensated” the consultants since they received more under a blended rate if they worked less than a full hitch than they would have received if the company calculated their pay at their purported regular. In the court’s view, however, the alleged overcompensation was “illusory” because the blended rate actually functioned as the regular rate. Therefore, it should have been the baseline in calculating the consultants’ overtime rate, which would have led to the employees being paid more than they actually were.

The court also rejected the company’s argument that only those employees who worked less than a full hitch were harmed by the blended rate. Instead, having determined that the blended rate was the consultants’ regular rate, the court held that the company owed all of the consultants additional overtime pay for each overtime hour they worked, whether during a full or a partial hitch, and that the company violated its recordkeeping obligations by not tracking all of the consultants’ hours on a daily basis.

The court’s decision reaffirms that employers generally cannot design “creative payment schemes” to simplify pay practices, even if they appear to pay the employees more than they would receive if the employer strictly adhered the required calculations. Indeed, as in this case, such practices can actually create a new, higher regular rate, with the effect being that the employer will owe much more in overtime pay.