Unlawful to Deduct an Outstanding Loan from Employee’s Final Pay

What can an employer do when an employee leaves a company but has an outstanding loan owed to the company? Can the amount of the outstanding loan be taken out of the employee’s final pay?

The short answer is no. An employer cannot deduct from an employee’s final paycheck any amount representing the unpaid balance of a debt owed by the employee.

In California, wage deductions from final pay are highly regulated. An employer can lawfully make certain deductions from wages, including health insurance premiums and garnishments, but there are strict limitations on other deductions.

Labor Code

California Labor Code Section 221 states it is “unlawful for any employer to collect or receive from an employee any part of wage theretofore paid by said employer to said employee.” This means an employer cannot take back wages already paid to an employee.

In addition, California Labor Code Section 300 states that no assignment of future wages can be made, unless they are assigned for necessities of life and then only to the person furnishing the necessities.

The courts also have held that employers are prohibited from making deductions from wages that are a “self-help” remedy for the employer (Sniadach v. Family Finance, 395 US 337 (1969)).

The California Division of Labor Standards Enforcement (DLSE) wrote in an opinion letter that “case law makes clear that deductions from an employee’s final paycheck for debts owed to the employer are prohibited, even with prior written authorization.”

The bottom line is that an employer is prohibited from deducting an outstanding loan from an employee’s final paycheck.

If an employer makes an unlawful deduction from an employee’s final pay to recover an outstanding loan or any other debt, an employee can file a wage claim with the DLSE or in court, and the employer may face stiff penalties and potential attorney fees.

Written Agreement

Is there anything an employer can do to recover an outstanding loan from an employee upon termination?

Although an employer cannot deduct the amount of an outstanding loan from an employee’s final paycheck, an employer can enter into a written agreement or promissory note with an employee specifying that the employee will be required to repay the loan.

The agreement should include the amount of the loan and clearly state the terms of the loan repayment.

Repayment of a loan by an employee must be made by check or other means to the company, not by a payroll deduction.

If the employee refuses to pay back the loan, the employer can choose to go to small claims or superior court (depending on the amount of the loan) to enforce the written agreement.

Employers should review their handbooks and other written policies on employee loans to ensure compliance with the law. Employers also should consider having written agreements with employees outlining the employee’s obligation to pay back a loan.

As stated above, if an employee has an outstanding loan at time of termination, an employer is prohibited from deducting that outstanding loan amount from the employee’s final paycheck.

Lisa Guzman, HR Adviser, CalChamber

The CalChamber California Employee Handbook Creator Online Tool offers sample policies for subscribers. Each sample policy allows the user to choose from options to create the subscriber’s custom employee handbook.

CalChamber members can read more about Final Pay Explained in the HR Library. Not a member? See what CalChamber can do for you.

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