California, standing alone, has the eighth largest economy in the world, with a gross state product of nearly $2 trillion in 2010. It is no surprise that the state is an irresistible market for many leading (and emerging) companies with significant workforce populations. But California is also one of the most perilous jurisdictions for employers, featuring a harsh, unforgiving and sometimes unexpectedly quirky regulatory environment, all enforced by a large population of zealous plaintiffs’ lawyers. Doing business in California can be perilous indeed. Here's our top 10 list of California employment "potholes" to avoid.

  1. Improper Payment of Wages to California Employees. The federal minimum wage is $7.25 per hour. California and its local governments have higher minimum wage requirements. California’s minimum wage is $8 per hour, and the city of San Francisco’s is $9.92. Ignoring these minimum wage rates can be costly, even if your employees "agree" or your executives want to be paid in stock or stock options rather than cash. Either approach violates minimum-wage requirements and can expose employers to costly wage-hour litigation.

    The failure to provide proper wage statements is a related problem. California has very specific requirements for wage statements. For example, the statement or “pay stub” must show net wages paid to the employee. Often payroll companies show net wages of zero for employees who receive their paycheck via direct deposit. This violates California law and your company should insist on correct, compliant wage statements. 

    Another common mistake is not paying an employee’s final wages on time. Upon involuntary termination, an employee must be paid all compensation due and owing on the last date of employment. If employees quit, and provide less than 72 hours notice, you must pay them their final wages within 72 hours.

    Along the same lines, companies may not have “use it or lose it” vacation policies. Under this type of policy, an individual who does not use all accrued vacation time by a particular date, forfeits the right to be paid for those days at a later date. Such a policy is unlawful under California law. Rather, vacation that is not used must continue to accrue. Companies may place a cap on accrual (usually one-and-one-half to two times annual vacation amount). This is important because all unused and accrued vacation time must be paid at the time of termination. Frequently, this includes accrued sick time where a company's policy permits employees to use sick time for reasons other than when the employee or his or her family member is sick. Doing so converts “sick time” into vacation time, requiring that it be paid at the time of termination.

  2. Failing to Monitor the Exempt Status of Employees. Another common mistake is misclassifying employees. California law separates employees into “exempt” and “nonexempt” categories. The most common exempt categories are executive, administrative, professional, outside sales, commissioned employee and computer professional. While the categories appear similar to federal law, their minimum salary requirements and exempt duties are distinct. 

    If you think this is an obscure and relatively unimportant administrative detail, think again. This single largest source of class action liability has plagued California employers during the past decade, and the exposure can be breathtaking. Worse, a job description doesn't provide an adequate defense if the actual job responsibilities have evolved over time, so "fixing" the problem once won't guarantee that it won't happen again.

    Vigilance is the only sure defense. Companies should regularly monitor the exempt status of their employees. When undertaking an audit of exempt status, payroll practices or pay differentials, companies should use counsel to establish and maintain the privileged nature of the audit and its results. Failing to do so could make the audit discoverable should litigation ensue and the results could be potentially disastrous.

  3. Improperly Calculating a Salaried Employee’s Regular Rate. All nonexempt employees are entitled to one-and-one-half times their hourly rate for time worked in excess of (a) 40 hours in a week or (b) eight hours in a day. Under California law, an employee’s regular rate is determined by dividing the employee’s total compensation for the workweek by 40 hours, regardless of how many hours the employee worked. Calculating the regular rate is essential to appropriately calculating a nonexempt employee’s overtime compensation rate. These rules are different than those required by federal law so paying close attention here is crucial to avoiding costly wage-hour litigation. 

  4. Failing to Pay Employees for Reporting to Work. If you require an employee to report to work and he or she does but is then not put to work or is given less than half of his or her usual schedule, the company must pay the employee for half of the usual or scheduled day’s work. This amount should be no less than two hours or more than four hours at the employee’s regular rate. This extra payment is not due where interruptions are caused by things not within the company’s control (e.g., acts of God, threats to employee or property, etc.). Companies can steer clear of this pothole by working with legal and human resources professionals to establish timekeeping and payroll procedures that are compliant with applicable law.

    The consequences of violating California’s payroll and wage and hour laws are stiff – at a minimum, the company will be required to pay unpaid wages and payroll taxes with interest and penalties. In certain cases, the company and its executive officers can face criminal penalties (fines and imprisonment). These are relatively easy problems to avoid, so companies should be aware of the laws and work closely with human resources professionals and legal counsel to establish proper timekeeping procedures.

  5. Mischaracterizing Employees as Independent Contractors. If there is a ground zero of potential liability this year, this is it. Cash-strapped federal regulators and states are focusing on misclassification cases with renewed zeal and enthusiasm. And companies, even with the best of intentions, often mischaracterize employees as independent contractors (consultants or advisers). Independent contractors are not subject to wage and hour laws, meaning they don’t need to be paid minimum wage or overtime, are not subject to payroll taxes, and are not entitled to meal and rest periods. Some companies use the “try and buy” approach of hiring a “contractor” for a few months before “converting” him or her to a full-time employee. But companies and contractors are not free to decide what type of relationship they are creating. Federal and state laws alone dictate what constitutes an employee versus an independent contractor relationship.

    California has a multi-factor test to distinguish independent contractors from employees, including whether the worker provides his or her own supplies and instruments, whether the worker renders services on the company’s premises, what type of services are being rendered, the permanence of the working relationship, whether the parties believe that they were entering into an employer-employee relationship, and many other factors. Note that having a written contract or consulting agreement is not dispositive. 

    The mischaracterization of independent contractors who are actually employees usually results in the nonpayment of wages to which the individual would otherwise have been entitled, unpaid payroll taxes with interest and multiple penalties for nonpayment of wages. Companies should ensure that their workers are in fact properly classified as independent contractors and seek guidance from legal counsel when uncertain.

  6. Not Providing Suitable Seating for Employees. California generally requires employers to provide employees with suitable seating when the “nature of the work reasonably permits the use of seats.” In the past year, a number of retailers have been sued under the Private Attorneys General Act ("PAGA") for failure to provide suitable seating, including Home Depot, 99 Cents Only Stores, Whole Foods, Costco, Abercrombie & Fitch Co. and Nordstrom, just to name a handful of examples. Two recent appellate decisions have allowed employees to use PAGA to pursue such claims, leaving employers facing millions of dollars in potential monetary damages. Employers should take steps to ensure that they comply with this provision by either providing seats to employees, when practicable, or posting notices informing employees that suitable seats can and will be provided should an employee need or want one. 

  7. Inconsistently Applying Leave of Absence Policies. While this appears obvious, employers often fall into the trap of treating employees differently because they feel bad for employees who are in difficult situations. Unfortunately, this can result in the classic “no good deed goes unpunished litigation.” When employers inconsistently apply leave policies, they expose themselves to potential discrimination claims. By way of example, an employee can allege discrimination because others were granted extra personal leave and he or she was not. While the decision to uniformly apply policies may force employers to make decisions that are potentially uncomfortable, it reduces the risk of exposure to claims that allege differential treatment based on some protected category such as race, national origin, gender, disability, etc. 

  8. Using Unenforceable Noncompetition Agreements or Provisions. Many employers use some form of noncompetition provision to prohibit an employee from working for a competitor for a certain period of time or within a large geographic area after employment ends. But in California, broad “noncompetes” are prohibited and unenforceable following termination except (1) to protect the company’s trade secrets and/or confidential and proprietary information, (2) where the employee enters into a noncompetition agreement in connection with the sale of his or her business and (3) where entered into by a departing partner from a partnership or a member from a limited liability company. But, even then, the post-employment noncompetition agreement must be reasonable with regard to duration, scope and geography. 

    Similarly, many employers use nonsolicitation provisions to prohibit a former employee from “directly or indirectly hiring” his or her former colleagues. Although a former employee can agree not to target his or her former colleagues, that former employee can still hire such persons who approach him or her on their own initiative or in response to a general solicitation (e.g., a job listing). Companies should work closely with legal advisers to ensure that agreements are tailored to comply with California law. Failure to do so may result in claims for, among other things, violation of the Unfair Practices Act (Cal. Bus. Prof. Code § 17200), tortious interference with contract and tortious discharge for refusing to sign an unenforceable covenant. 

  9. Not Insisting (and Confirming) That Employees Leave Confidential Information Behind. New employees may not bring with them or use materials or confidential information that belongs to former employers or other parties, such as proprietary computer codes, confidential pricing information or confidential customer lists. But they often do and it's always a huge mistake for employers not to have policies forbidding such conduct and requiring new employees (and especially new technical employees) to affirm in writing compliance with that policy. A new employer’s use of such materials may subject the company to costly litigation and liability. Companies should prohibit new hires and independent contractors from bringing onto the company’s premises materials that are owned by others or subject to confidentiality or from otherwise using such materials when rendering services to the company. Such prohibitions should be included in a properly worded policy that requires each new employee's express acknowledgment. 

  10. Not Complying With Armendariz in Drafting Employment Arbitration Agreements. In general, based on California Supreme Court precedent from Armendariz v. Foundation Health Psychcare Services, Inc., California requires that all arbitration agreements governing employment disputes comply with the elements of “essential fairness” including (1) neutral arbitrator; (2) adequate discovery; (3) all types of relief otherwise available in court (monetary damages, injunction, reinstatement, etc.); (4) a written arbitration award that permits limited judicial review; and (5) that the employer pays the arbitrator’s fees and all costs unique to arbitration. While the U.S. Supreme Court’s decision in Concepcion v. AT&T Mobility created debate over whether the Armendariz requirements remain viable, unless and until either the California Supreme Court or U.S. Supreme Court overrule Armendariz, employers should continue to comply with it.


This is, of course, only a partial list of threats posed by doing business in California. Terminations, layoffs, disciplinary actions, background checks and harassment claims all present challenging and unique issues under state law. Careful attention and good counsel are critical to avoiding these common errors.

© 2011 Perkins Coie LLP