Wage Forfeiture and Valid Set-Offs in Massachusetts

Generally, any contractual provision that requires an employee to forfeit earned wages is a “special contract” prohibited by the Massachusetts Wage Act, M.G.L. c. 149, § 148. As the Attorney General has put it, “an employer may not enter into an agreement with an employee under which the employee forfeits earned wages.” See An Advisory from the Attorney General’s Fair Labor Division on Vacation Policies, 99/1. The concept of wage forfeiture often, but not always, arises along with the concept of set-off. As the Wage Act allows a “valid set-off” to be deducted from wages, when an employer has a potential wage set-off, it will usually assert it as a defense in a wage case. This usually doesn’t work. As an example, we once had a school system defend the docking of teachers’ pay due to their inability to get students to return all their textbooks. This was not a valid set-off. Notably, the Massachusetts Supreme Judicial Court recently held in Camara v. Attorney General, 458 Mass. 756 (2011) that a set-off for damage caused to the property by garbage collectors was not permissable under the Wage Act. The employer in that case had created a procedure in which it would be the sole judge of the fault and damages caused by a garbage collector in, say, knocking over a customer’s mailbox. As the court put it:

An arrangement whereby [the employer] serves as the sole arbiter, making a unilateral assessment of liability as well as amount of damages with no role for an independent decision maker, much less a court, and, apparently, not even an opportunity for an employee to challenge the result within the company, does not amount to “a clear and established debt owed to the employer by the employee.” The option afforded [the employer]’s employees to choose “voluntarily” to accept either wage deductions or discipline offers them only unpalatable choices. This procedure does not come close to providing an employee the protections granted a defendant in a formal negligence action.

Id. at 763-4.

So, the circumstances in which an employer can involuntarily deduct wages are narrow. In general, it is only permissible when there is “clear and established” debt to the employer; when the matter is subject to potential dispute–as in the garbage case–the debt is not clear and established. However, there is another situation in which compensation can be taken from an employee: when that compensation isn’t really earned in the first place or, put another was, when the vesting in the right to compensation is subject to contingencies that the employee must fulfill in order to earn the wage in the first place. That’s what the SJC held in another case related to restricted stock grants.

In Weems v. Citigroup Inc., 453 Mass. 147 (2009), the basic story was that Citigroup either granted restricted stock as a bonus or employees could buy it via a payroll deduction. Restricted stock is a type of stock that you don’t actually vest to full ownership unless you stay employed. Typically, restricted stock vests at intervals over several years, and the employee forfeits any unvested restricted stock when their employment ends. In Weems the SJC held that this was permissible.

First of all, Weems was, at least in part, a results-driven opinion due to the peculiar nature of restricted stock. Rolling vesting schedules are a common and well-established way of rewarding employees for staying in their jobs. The IRS has special rules that make this type of compensation feasible. No tax is due on grants of restricted stock (unless the employee makes a special election). Tax liability only accrues when the stock vests. However, the IRS requires that there be a “substantial risk of forfeiture” of the stock for this tax treatment to be allowed. (Here’s a PDF discussing the taxation of restricted stock). If the SJC in Weems had held that the restricted stock was already earned for past services when granted instead of when it vested, any forfeiture of it would have violated the Wage Act. However, this would have also removed any substantial risk of forfeiture in all restricted stock in Massachusetts. Besides creating a major change in the long-standing ability of employers to use restricted stock to incentivize employees, it would have rendered all unvested restricted stock in Massachusetts immediately taxable as ordinary income as of the date of the decision. The SJC made several references to the tax issue, and this was a radical consequence they were clearly trying to avoid.

We shall further assume for purposes of answering the certified question that [the plan] is designed to comply with the provisions of Federal tax law that require some element of forfeiture for tax deferred plans.

Id. at 155.

Still, the SJC had to find an intellectually-defensible basis to find that the unvested restricted stock was subject to forfeiture. As I mentioned above, there were two kinds of restricted stock at issue: the kind that was given as a bonus and the kind that was purchased by employees via payroll deductions. In Weems, the parties stipulated to the fact that the bonus stock was given in an entirely discretionary manner.

The operative fact here is that bonus awards under these programs are discretionary, not because they are labeled bonuses, but because the employers are, apparently, under no obligation to award them.

Id. at 153-4.
This meant that the plaintiffs did not have Wage Act rights in the restricted stock before it was granted. However, this wasn’t really the point of the case: No one really contends that a purely discretionary bonus is subject to Wage Act coverage before it is decided upon by the employer.

The real question in the case was whether the bonus stock could be taken back before it vested. As the court put it:

[A]n employee who received such an award would receive the full benefit of the stock (i.e., the restriction would be lifted and the stock would vest fully) only if the employee remained with the company for the defined period after the award. The only thing they “earned” as a result of their bonus was stock that had limited value to them until it vested.

Id. at 154.
So the bottom line is that the court allowed the forfeiture of the restricted stock because it was a special type of compensation earned only by continued employment. This is one interpretation. One might also argue that Weems created a legal fiction to achieve a desired result, i.e. that the bonus restricted stock had only no real value and, therefore, could be forfeited without a violation of the Wage Act?

The bottom line is that employers will try to use Weems to excuse the forfeiture of bonuses and commissions after they are earned when a condition subsequent to their payment exists under employer policies. I don’t think Weems requires this result. The line between a bonus and a commission is also often hazy, and the status of bonuses under the Wage Act isn’t exactly clear-cut. However, it is my opinion that despite Weems, once a commission (or “bonus”) is calculable and due and payable that a condition subsequent to its payment will be held to be a special contract in contravention of the Wage Act.

(The court had an easier time quickly disposing of the second type of stock, that kind that was purchased by employees. The court also held that M.G.L. c. 154, s. 8 specifically removed employee stock purchase plans from the protections of the Wage Act.)

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