Carefully Plan Your Wage and Hour Audits

It is often recommended that employers periodically conduct wage and hour compliance audits to ensure that pay practices accord with the strict requirements of the law. The benefits of conducting such audits are that employers can eliminate liability moving forward for any errors they identify and correct, and such audits tend to show good faith to comply with the law, which can limit damages in the event of litigation.

Of course, using an audit to establish good faith has always carried an element of risk. The Fair Labor Standards Act (FLSA) allows an employer to avoid liquidated damages “if the employer shows to the satisfaction of the court that the act or omission giving rise to such action was in good faith and that he had reasonable grounds for believing that his act or omission was not a violation of the [FLSA].” 29 U.S.C. § 260. This serves as an affirmative defense, and the employer has the burden of establishing the defense. The risk comes from a line of cases holding that employers asserting the good faith defense must produce all audit materials.  Some courts have further held that asserting a good faith defense means that even legally privileged communications must be produced.  As such, employers likely cannot cherry pick only the helpful aspects of an audit to reveal in litigation, because all audit materials may be subject to discovery.

A recent Fifth Circuit decision magnifies this concern. In Novick v. Shipcom Wireless, Inc., the employer rapidly expanded its operations after it was awarded a governmental contract.  2020 WL 62876, at *1 (5th Cir. Jan. 7, 2020). It initially classified its trainers as exempt, but later conducted an internal FLSA compliance audit. Id. As a result, it determined that its trainers had been misclassified, converted them to nonexempt hourly positions, and paid the current trainers backpay with a 5% increase. Id. Nevertheless, some trainers sued, alleging the original classification was not made in good faith, and were awarded actual and liquidated damages after a jury trial. Id. at *2.

At trial, the employer believed that the audit results did not help its defenses and sought to keep the audit out of the jury’s hands.  It argued (apparently separate and apart from any attorney-client privilege issues) that as a general matter, evidence of its internal audit was inadmissible under Federal Rule of Evidence (“FRE”) 407 as a subsequent remedial measure and inadmissible under FRE 401-403 as irrelevant to the proper classification of its trainers. Id. at *3. The Fifth Circuit panel concluded that the trial court did not abuse its discretion in admitting the audit evidence because: 1) the audit did not make the earlier misclassification less likely to occur, and was therefore not a subsequent remedial measure under FRE 407; and 2) the audit was relevant to whether the administrative exemption applied under FRE 401-403 because it “actually discussed and analyzed the job duties of Plaintiffs or provided information that would be useful to the jury in classifying them.” Id. at *5. The appellate court further held that even if it had been an abuse of discretion to admit such evidence, it had not affected the employer’s substantial rights in part because the trial court had instructed the jury that the audit was not “de facto evidence of a misclassification.” Id.  The upshot was that the employer failed to keep what it regarded as unhelpful audit documents out of the trial.

The Bottom Line: The Novick decision emphasizes that while wage and hour audits are useful and sometimes necessary to identify practices that need correction, they can also be used against an employer to the extent they reveal misclassification or a lack of good faith by the employer. Employers should carefully consider this issue long before any potential litigation occurs.  With careful planning, and the advice of competent employment counsel, employers can structure an audit process that maximizes value for defense purposes should litigation arise—mindful that much if not all documentation created during the process is probably discoverable if the good faith defense is invoked.