Calif. Ruling Clarifying Paystub Compliance Is Win For Cos., Law360

In a rare win for California employers, the California Supreme Court recently clarified the showing that an employee must make to recover derivative penalties under the state's paystub law.

The statute at issue in the case, Labor Code Section 226, requires establishing that a "knowing and intentional" violation occurred before statutory penalties can be recovered.

In its May 2024 decision in Naranjo v. Spectrum Security Services Inc., the court sided with the employer in holding that an employer's good faith — but erroneous — belief that it had complied with the wage statement law precludes recovery of statutory penalties, because the employer's conduct does not qualify as a knowing and intentional violation of the law itself.

The decision comes as welcome news for employers in the employee-friendly state.

Background

In California, it is common practice for employees to assert multiple liability theories in their wage and hour claims, especially in the class action context. Employees often assert a variety of substantive claims, such as alleged violations of the minimum wage, overtime, and meal and rest break laws.

In addition, the employees often assert derivative claims for penalties. The claims are called "derivative" because the plaintiffs bar has long contended that establishing a substantive violation automatically establishes the derivative claims, too. While employers have rejected that view, the pleading approach allowed the plaintiffs bar to exert settlement pressure on employers by ratcheting up claimed exposure without needing to allege any additional facts that can be disproven.

California's wage statement law, Section 226, has long been a derivative claim favored by the plaintiffs bar. The statute requires employers to provide employees written paystubs called wage statements that notify employees about certain categories of employment-related information. This includes listing gross and net wages earned, hourly pay rates, hours worked and deductions, among other things.

An employee who shows that the employer has failed to comply with the law may obtain an injunction compelling compliance and an award of attorney fees and costs. In addition, where the employer's failure to comply is knowing and intentional, Section 226 provides for statutory penalties of up to $4,000 per employee or actual damages, whichever is greater.

To show the alleged violation was knowing and intentional, the plaintiffs bar had long argued that it was enough to show the employer knew about the underlying facts giving rise to the statutory violation. Under this view, the paystub claim can be derivative because a violation of a substantive law, such as a failure to pay overtime, automatically results in a violation of the paystub law.

In contrast, employers relied on the statutory language to argue that recovering paystub penalties required the employer to establish a knowing and intentional violation of the wage statement law itself. Under this view, an employer's good faith belief that it had complied with the law precluded the imposition of penalties, even if the employer was wrong.

Naranjo Decision

Advocates on both sides advanced these competing views in courtrooms and conference rooms across the state for years, but the California Supreme Court's Naranjo decision resolves the dispute.

In Naranjo, employer Spectrum Security Services believed it did not owe its guards premium pay for missed breaks and therefore was not required to report missed-break premium pay on the guards' paystubs. Under employee Gustavo Naranjo's theory, the employer would be liable under Section 226, given its knowledge of the underlying facts of the missed-break claim, including that it did not provide guards with off-duty meal breaks, it did not pay meal premiums for missed breaks, and it did not report missed breaks or unpaid meal premiums on wage statements.

It was irrelevant, in the employee's view, whether the employer knew — or should have known — what the law requires.

Spectrum countered that the plain meaning of the phrase "knowing and intentional" requires a showing that the employer knew it was required to include certain information on the paystubs — here, unpaid premium pay for missed meal breaks — and nevertheless intentionally omitted that information from the wage statements it provided. The employer further argued that it was not liable for penalties under Section 226 because it had a reasonable, good faith basis for believing that (1) it did not owe its guards premium pay for missed breaks, and (2) it was not, in any event, obligated to report missed-break premium pay on wage statements.

In the trial and intermediate appellate courts, both of those questions were ultimately decided against the employer after years of litigation.

The key debate between the parties was not so much what the terms "knowing" and "intentional" mean, but what the terms modify. That is, what, precisely, must be done knowingly and intentionally: violating the law, or the acts or omissions constituting the violation?

The California Supreme Court decided in favor of the former. The court rejected the employee's harsh interpretation of the phrase "knowing and intentional." Instead, it held: "An employer that believes reasonably and in good faith, albeit mistakenly, that it has complied with wage statement requirements does not fail to comply with those requirements knowingly and intentionally."

In reaching its decision, the California Supreme Court compared Section 226's "knowing and intentional" language to Section 203, which imposes penalties where an employer willfully fails to pay all wages at termination. Courts have uniformly recognized the same good faith defense to Section 203's so-called waiting time penalties. In Naranjo, the California Supreme Court affirmed and extended this principle — that employers that have inadvertently violated the law do not need strict liability penalties to prevent them from repeating their mistake, as long as they proceeded on a reasonable, good faith belief to comply.

Conclusion

Employers defending wage-and-hour cases by asserting derivative claims for penalties, including in the class action context, should evaluate Naranjo, as well as persuasive federal authorities reaching the same conclusion, to determine whether a partial summary judgment or summary adjudication motion makes sense based on the facts and circumstances of their case.

Disposing of these derivative claims has the potential to reduce exposure materially and to fundamentally alter the stakes of the litigation, regardless of whether victory is defined as a satisfactory settlement or as vindication after a trial on the merits.

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