In a Ruling with Important Implications for Courts’ Deference to Agencies, U.S. Supreme Court Rejects Department of Labor Position on Overtime for “Outside Sales” Employees

June 19, 2012

The United States Supreme Court ruled yesterday that pharmaceutical sales representatives are "outside sales" employees who are exempt from the overtime requirements of the Fair Labor Standards Act ("FLSA").  Christopher v. SmithKline Beecham Corp., No. 11-204, 567 U.S. ____ (2012).  In rejecting an interpretation of the relevant regulations that the Department of Labor had recently put forward in amicus briefs, the Court articulated principles about the government giving "fair warning" to regulated parties that could prove important to litigation under a broad range of other federal statutes. 

Legal and Factual Background

The FLSA exempts certain employees from its overtime requirements, including "any employee employed . . . in the capacity of outside salesman[.]"  29 U.S.C. § 213(a)(1).  The Act defines "sale" or "sell" to include "any sale, exchange, contract to sell, consignment for sale, shipment for sale, or other disposition."  29 U.S.C. § 203(k).  In regulations promulgated through notice and comment, the Department of Labor ("DOL" or the "Department") has defined an outside salesman as an employee "whose primary duty is . . . making sales within the meaning of section 3(k) of the Act," and "who is customarily and regularly engaged away from the employer’s place or places of business in performing such primary duty."  29 C.F.R. § 541.500(a).  The regulations define "sales" to include "the transfer of title to tangible property, and in certain cases, of tangible and valuable evidences of intangible property."  29 C.F.R. § 541.501.

Pharmaceutical companies are prohibited by drug control laws from selling prescription drugs directly to the public.  Accordingly, the companies employ sales representatives to market their drugs to physicians.  The end goal of a physician visit is to obtain a "commitment from [the] physician to prescribe" certain drugs to patients "if the physician believes that the medication is appropriate."  Christopher v. SmithKline Beecham Corp., 635 F.3d 383, 386 (9th Cir. 2011). 

Pharmaceutical companies have long treated sales representatives as outside salespeople exempt from the FLSA’s overtime requirements.  As the Court observed in its decision, this practice had continued for decades without the DOL initiating an enforcement action or having "otherwise suggested that it thought the industry was acting unlawfully."  Slip op. at 12.  That began to change in 2009, however, when the Department filed amicus briefs in the Second and Ninth Circuits in private litigation by sales representatives who claimed they were due overtime.  The Department argued in those briefs that pharmaceutical representatives do not "make sales" within the meaning of the Act because they do not transfer title or physically sell pharmaceutical products to the ultimate end users–i.e., because there is no "consummated transaction directly involving the employee for whom the exemption is sought."  Id. at 9.  And when the issue reached the Supreme Court, the government filed an amicus brief stating an even narrower view:  That an "employee does not make a sale . . . unless he actually transfers title to the property at issue."  Id 

Minimal Deference to the Labor Department’s Recently Announced Interpretation

The Justices agreed that the case’s outcome depended on the proper interpretation of the DOL regulations.  Plaintiffs and the Department claimed that in construing those regulations, the Court should give substantial deference to the interpretation articulated by the Department in its amicus brief.  The Justices unanimously rejected that contention.  Writing for the five-Justice majority, Justice Alito found "strong reasons" to withhold deference to the agency’s shifting interpretations.  Deferring to the recently announced interpretation "would seriously undermine the principle that agencies should provide regulated parties fair warning of the conduct [a regulation] prohibits or requires," the Court stated, producing "precisely the kind of unfair surprise against which th[e] [Court] had long warned."  Id. at 10-11 (internal quotation marks omitted).  "[I]t is one thing to expect regulated parties to conform their conduct to an agency’s interpretations once the agency announces them; it is quite another to require regulated parties to divine the agency’s interpretations in advance or else be held liable when the agency announces its interpretations for the first time in an enforcement proceeding and demands deference."  Id. at 14. 

"Even more important," the Court stated, was that "despite the industry’s decades-long practice of classifying pharmaceutical detailers as exempt employees," the DOL had never initiated an enforcement action or otherwise suggested that the practice was unlawful.  Id. at 12.  "We acknowledge that an agency’s enforcement decisions are informed by a host of factors," the Court stated, citing Heckler v. Chaney, 470 U.S. 821, 831 (1985), "[b]ut where, as here, an agency’s announcement of its interpretation is preceded by a very lengthy period of conspicuous inaction, the potential for unfair surprise is acute."  Slip op. at 12-13.  And on the facts of this case, where the practice in issue was well-known and long-standing, "[o]ther than acquiescence, no explanation for the DOL’s inaction is plausible."  Id. at 13.

Generally, the Court observed, "[o]ur practice of deferring to an agency’s interpretation of its own ambiguous regulations undoubtedly has important advantages, but this practice also creates a risk that agencies will promulgate vague and open-ended regulations that they can later interpret as they see fit, thereby frustrat[ing] the notice and predictability purposes of rulemaking."  Id. (internal quotation marks omitted). 

For these reasons, the Court concluded that the DOL’s interpretation warranted only the low level of deference that is sometimes given agency interpretations under Skidmore v. Swift & Co., 323 U.S. 134 (1944).   The four dissenting Justices disagreed with the majority’s interpretation of the DOL regulations, but agreed that the view expressed in the amicus brief did not warrant "any especially favorable weight."  Slip op. at 2 (Breyer, J., dissenting). 

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Christopher‘s discussion of the "fair warning" that must be given to regulated parties has potentially far-reaching implications for litigation under a broad range of federal regulatory programs.  Going forward, government amicus briefs are likely to prove less important in private litigation than they have in the past.  And, when the government brings its own enforcement actions–or adjudicates in administrative proceedings–it may face a heightened burden to show that the legal rule being applied is one that the defendant had notice of in advance.  Litigants can also be expected to rely on the Court’s suggestion that non-enforcement over an extended period of time may constitute acquiescence to a widespread industry practice.

The Scope of the Outside Sales Exemption:  A "Functional" Approach

On the question of the proper interpretation of the outside sales exemption, the Court first considered the express language of the statute, and concluded that the interpretation advanced in the DOL amicus brief was "flatly inconsistent with the FLSA."  Id. at 15.  On its face, the exemption does not require a "consummated transaction," or that the employee "actually transfer[] title to the property at issue."  Id. at 14-15.  Rather, Congress took a more expansive approach:  "[It] defined ‘sale’ to include . . . transactions that might not be considered sales in a technical sense, including exchanges and consignments for sale."  Id. at 18.  This interpretation is consistent with the Labor Department’s own reports, dating back to 1940, in which the agency "stressed" that the sales exemption applies to any employee who "in some sense, make[s] sales."  Id. at 4.

For this reason, the Court rejected a "formalistic" and "technical" approach to the statute, which would be at odds with "the realistic approach that the outside salesman exemption is meant to reflect."  Id. at 23.  "Exempt status should not depend on technicalities," the Court stated.  Id. at 4.  Rather, given the "broad language of the regulations" and statute itself, Congress intended to accommodate "industry-by-industry variations in methods of selling commodities," by broadly defining the outside sales exemption to include both traditional sales transactions and "arrangements that are tantamount, in a particular industry, to a paradigmatic sale of a commodity."  Id. at 19.  Applying this "functional" inquiry requires that a Court look at "the employee’s responsibilities in the context of the particular industry in which the employee works."   Id. at 17.

This approach, the Court explained, should focus on whether employees bear "all of the external indicia of salesmen" in their industry–i.e., whether they were hired specifically for their sales experience; worked under minimal supervision and at locations outside the office; were trained to obtain the maximum number of nonbinding commitments; and received incentive compensation in addition to their base salary.  Id. at 21.  In Christopher, all of these indicia were met:  The employees "function[ed] in all relevant respects as [] outside salesm[e]n."  Id. at 21, n.3.  The employees’ primary duty was to "provide information to physicians . . . in hopes of persuading them to write prescriptions for the products[.]"  Id. at 5.  "[P]etitioners’ end goal was not merely to make physicians aware of the medically appropriate uses of a particular drug.  Rather it was to convince physicians actually to prescribe the drug in appropriate cases."  Id. at 24.  Any non-exempt "promotion" work was merely incidental to this primary purpose.

Finally, the Court emphasized the general "purpose" of the enumerated FLSA exemptions, which is to exclude employees who typically earn salaries "well above the minimum wage" and perform work that is "difficult to standardize to any time frame."  Id at 21-22.  In doing so, it observed that Petitioners "earned an average of more than $70,000 per year [and] are hardly the kind of employees that the FLSA was intended to protect."  Id. at 22. 

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The Court’s reference to "industry-by-industry" flexibility–coupled with its multi-factored approach to determining whether individuals exhibit "external indicia" of engaging in sales–provides lower courts with a framework for applying the outside sales exemption in other industries.  Of course, how courts apply this framework remains to be seen, particularly outside the "unique regulatory environment" of the prescription drug industry, and in future cases where–like Christopher–the employees do not actually "transfer title" or "consummate the transaction."  Christopher makes clear, however, that the framework should not rest on "formal distinctions"; it should apply a "functional" approach that takes into account both the "the context of the particular industry in which the employee works," id. at 17, and whether the interpretation is consistent with the general "purpose" of the FLSA.  It must also take into account the "primary objective" of employees as reflected by their training, industry norms, incentive compensation, level of supervision, and other realistic and practical considerations which reflect the true character of the job.  Finally, the Court’s skepticism about highly compensated employees using "technicalities" to seek overtime pay is certain to receive attention in other, on-going lawsuits by well-paid employees.     

Gibson, Dunn & Crutcher LLP    

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