Scheib Wage/Hour Ruling Shields Directors, Executives

Staff Reporter

Corporate officers and directors, increasingly subject to claims from employees alleging breaches of fiduciary duty, were handed a victory when a three-judge panel in Los Angeles extended them further protections in wage/hour litigation.

The decision in a case brought against Sherman Oaks-based Earl Scheib Inc. and eight of its executives, published in early April, held that employees suing for unpaid overtime compensation under California law couldn't look to officers and directors for compensation.

The panel, in the 2nd Appellate District in L.A., ruled directors and officers are not "employers" under state law.

Until the ruling, there had been widespread disagreement over whether California labor codes define an "employer" as only the corporate entity or whether it extended to officers and directors. Trial judges have interpreted the codes both ways.

The ruling is a setback for employees who have been successful in obtaining significant settlements in wage and hour claims against large companies, including Starbucks Corp. and Coca-Cola Co. Two years ago, Farmer's Insurance Exchange paid $90 million in a judgment for 2,400 claims adjusters.

Usually brought as class actions, wage and hour claims are filed by employees with management responsibilities who are classified under state law as exempt from overtime but who believe they should be entitled to it because most of their work is not managerial in nature.

Unlike previous cases, the Earl Scheib case involves a company that may be unable to pay if found liable for the unpaid overtime.

Robert Boulter, a partner at The Legal Solutions Group LLP representing plaintiffs, said he had to target the directors and officers to obtain financial relief for a former Earl Scheib shop manager.

"The company is not going to be able to afford to pay the amount of overtime owing, should we prevail," Boulter said. "Their attorneys have been saying they probably won't be able to afford it. They've been having financial problems, their shareholder equity has been declining, and they've closed a number of shops on the East Coast."

Boulter said Steven Reynolds, the former shop manager, is suing on behalf of 400 other shop managers and assistant shop managers in California who worked at Earl Scheib in the four years prior to the suit's filing in 2000. The case is not yet certified as a class, but Boulter estimated unpaid overtime to be as much as $8 million.

Reynolds originally sued in L.A. Superior Court on 14 claims, including seven labor code violations. The appellate court threw out all the claims.

'Corporate veil'

Plaintiffs' attorneys in the Earl Scheib case, along with a group of 20 associations, unions and other labor groups, pointed to a federal law that allows employees to bring wage/hour claims against directors and officers if they pass a four-point test that determines their role in the violations.

With the ruling, however, the only way California employees can sue directors and officers for wage violations is by applying a doctrine called "piercing the corporate veil."

The doctrine requires proof of widespread mismanagement and tight connections between officers and the corporation, said Matthew Righetti, a partner at Righetti & Wynne PC in San Francisco. Righetti is representing a former Sav-On Drugs employee in a wage and hour claim now on appeal.

Kathleen McDowell, a partner at Munger Tolles & Olson LLP representing the Scheib directors and officers, said most courts have excused directors and officers from wage and hour claims and that the recent challenge is a misinterpretation of California's labor codes.

"This is the first time I've seen someone try to impose personal liability against agents of a corporation," she said. "It's just lawyers who came up with this novel and untested theory."

Steven Katz, a partner at Seyfarth Shaw representing Earl Scheib, said adding officers and directors to wage and hour cases has become increasingly common.

Katz, who is handling dozens of other wage and hour cases, said even if officers and directors are not found liable, adding their names to such cases pressures companies to settle more quickly.

McDowell said there are alternatives to suing directors and officers if a company is unable to pay. They may bring their case before bankruptcy courts, if appropriate, or file a claim with the Department of Industrial Relations.

If they fear a company will dissolve or shift resources to a shell corporation to avoid paying a wage and hour claim, they could have good cause to sue under the "piercing the corporate veil" doctrine, she said.

Holding directors and officers liable in wage/hour claims would "would leave virtually any management employee open to civil liability for violation of wage and hour laws," Judge Michael Nott wrote in the appellate opinion.

Since February 2001, Earl Scheib has been restructuring its retail paint and body business, according to its most recent quarterly report. The company lost $1.6 million in the third quarter ended Jan. 31, compared with a loss of $778,000 for the like period a year earlier. David Sunkin, vice president and general counsel of Earl Scheib, declined to comment on the company's ability to pay any judgment.

Extended Coverage

Key points in the published ruling in a wage/hour case filed against Earl Scheib Inc.

- The section of the Labor Code that allows employees to bring civil actions for overtime wages, does not mention "persons, agents, managers, superintendents, or officers" as parties who may be liable in a private action.

- Rather than alleging specific acts, meetings, conversations or directives, none of the officers or directors was identified as engaging in any prohibited acts.

- The plaintiff did not convince the panel that the officers and directors can be held liable as employers or that they participated in conduct that would make them liable.

- The panel said the plaintiff's arguments would have created new rights under the Labor Code that were not intended in the legislation.

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