Moving On Up: How an Escalator Clause Affects PAGA Settlements

When dealing with Private Attorneys General Act (PAGA) lawsuits in California, settlement agreements often include an important provision called an escalator clause. The escalator clause plays a critical role in ensuring that the settlement amount remains fair, particularly when there’s uncertainty about the number of pay periods worked by the affected employees during the statutory look-back period.

The Role of Pay Periods in the Negotiation of PAGA Settlements

One of the central variables in a PAGA settlement is the number of pay periods worked by all aggrieved employees during the statutory look-back period. The look-back period typically spans one year before the PAGA notice is filed with the Labor and Workforce Development Agency (LWDA) and continues through a date certain, such as the date of the mediation.

The parties to a mediation should come equipped with the actual number of pay periods worked by all aggrieved employees during the look-back period. Oftentimes, defense counsel will provide the total pay periods to plaintiff's counsel in the weeks leading up to the mediation, either formally (in discovery) or informally (in a pre-mediation exchange of information). Sometimes, in the absence of data provided by the employer regarding the number of workweeks, the parties will estimate the number of pay periods.

Most plaintiffs begin their PAGA penalties calculations by multiplying the total number of pay periods by the corresponding penalty amounts for each type of alleged Labor Code violation. For example, if the plaintiff alleges meal period and expense reimbursement penalties, the corresponding penalty for each pay period could be $150—$50 for the allegedly unlawful meal periods (per Labor Code section 558) and $100 for the alleged non-reimbursement for expenses (section 2699, subdivision (f)(2)(A)). (There could be other potential penalties for these Labor Code violations, but that is a topic for another day.) In this example, if there were 100,000 total pay periods worked by all affected employees during the look-back period, the plaintiff's PAGA penalty calculation would therefore be $1,500,000.

The plaintiff typically uses the total possible PAGA penalties as a starting point in negotiations. The defendant may then counter the plaintiff's demand with an offer that is predicated on a per-pay-period amount, such as $5 per pay period. The parties then go back and forth negotiating until they reach a settlement, with the per-pay-period amount of the settlement increasing throughout the day.

Once the case settles, the attorneys often will express the value of the settlement in terms of how much the defendant will pay for each of the total pay periods worked during the look-back period. For instance, one might say, "The case settled for $80 per pay period."

What Is an Escalator Clause?

In almost every PAGA settlement, the plaintiff's counsel will insist on including an escalator clause. An escalator clause is a provision that adjusts the total settlement amount if it turns out that the actual number of pay periods worked by the aggrieved employees is greater by a designated percentage than what the parties had used as the basis for their negotiations at mediation.

Typically, the parties will discover the deficiency when they prepare for the administration of the settlement payments. The employer will provide its payroll data to a third-party administrator, whose job it is to distribute checks to the aggrieved employees. The administrator must calculate the total number of pay periods in order to know how much each employee will receive as a settlement payment. In order to confirm the amount of the settlement payments, the administrator will contact counsel for the parties in order to show its calculations. It is then that the parties will see the actual number of pay periods worked by the aggrieved employees.

An escalator clause may state that, if the actual number of pay periods worked exceeds the number of workweeks used in settlement negotiations by five (or ten, or some other negotiated number) percent, then the employer will increase the gross settlement amount for every pay period worked in excess of the five percent buffer.

How Does the Escalator Clause Affect Settlement Amounts?

The escalator clause can significantly impact the total settlement amount if the actual number of pay periods exceeds the estimated threshold. Here’s an example:

• Suppose the total settlement is $1,000,000, and the parties used for their settlement negotiations an estimate of 200,000 pay periods worked by all aggrieved employees. This means the per-employee-per-pay-period settlement amount is $5.

• As part of the settlement, the parties agree to an escalator provision whereby the gross settlement amount will increase by $5 for every pay period actually worked in excess of a five-percent buffer.

• If the settlement administrator finds that 250,000 pay periods were actually worked, the escalator clause would be triggered. Five percent of 200,000 is 10,000. Hence, in this example, for every pay period over 210,000, the employer would be required to pay $5 for each of the additional pay period, adding $200,000 to the total settlement.

Conclusion: To Avoid an Escalating Settlement, Come Prepared to the Mediation

As the above example makes clear, an escalator clause could drastically increase the gross settlement amount in a PAGA case. In order to avoid such a result, employers and their counsel should come to the mediation with an accurate number of pay periods worked by all aggrieved employees. (They should also exchange this figure with their opposing counsel well in advance of the mediation.) Merely estimating the number of pay periods is usually not advised, since an estimate can always be too low. If it turns out later that the number of workweeks was underestimated, an escalator clause may end up requiring the employer to pay much more than they expected.