The Ninth Circuit Changes the Rules on Tip Pools

In Oregon Restaurant & Lodging Association v. Perez, No. 13-35765, (9th Cir. Feb. 23, 2016), the Ninth Circuit (which covers Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington) just issued a surprising decision in a case involving tip pools and the tip credit. This is one that the restaurant industry needs to carefully review. To understand what the decision is all about, some background is needed.

The Fair Labor Standards Act’s most basic rule is that employers must pay their employees at least minimum wage. The FLSA has a partial exemption to that rule in 29 U.S.C. 203(m): if an employee earns tips, then the employer can count those tips as part of the employee’s wage. This is commonly known as taking a “tip credit.” The language is below:

(m) “Wage” paid to any employee includes the reasonable cost, as determined by the Administrator, to the employer of furnishing such employee with board, lodging, or other facilities, if such board, lodging or other facilities are customarily furnished by such employer to his employees:

Provided, That the cost of board, lodging, or other facilities shall not be included as a part of the wage paid to any employee to the extent it is excluded therefrom under the terms of a bona fide collective-bargaining agreement applicable to the particular employee:

Provided further, That the Secretary is authorized to determine the fair value of such board, lodging, or other facilities for defined classes of employees and in defined areas, based on average cost to the employer or to groups of employers similarly situated, or average value to groups of employees, or other appropriate measures of fair value. Such evaluations, where applicable and pertinent, shall be used in lieu of actual measure of cost in determining the wage paid to any employee. In determining the wage an employer is required to pay a tipped employee, the amount paid such employee by the employee’s employer shall be an amount equal to—

(1) the cash wage paid such employee which for purposes of such determination shall be not less than the cash wage required to be paid such an employee on August 20, 1996; and

(2) an additional amount on account of the tips received by such employee which amount is equal to the difference between the wage specified in paragraph (1) and the wage in effect under section 206(a)(1) of this title.

The additional amount on account of tips may not exceed the value of the tips actually received by an employee. The preceding 2 sentences shall not apply with respect to any tipped employee unless such employee has been informed by the employer of the provisions of this subsection, and all tips received by such employee have been retained by the employee, except that this subsection shall not be construed to prohibit the pooling of tips among employees who customarily and regularly receive tips.

I have represented many restaurant workers and other tipped employees in disputes involving illegal tip pools. The typical fact pattern is that an employer pays tipped minimum wage (or at least something less than full minimum wage) and then either retains some portion of employee tips or requires employees to distribute those tips to non-tipped workers. For example, maybe a restaurant requires its servers to give 3% of their total food sales to a tip pool, which is then distributed to kitchen staff or managers. Or, maybe a bar requires its bartenders to give 10% of their credit card tips to the bar, even though the bar only has to pay a 3% fee to the credit card company (i.e., the bar pockets the extra 7%).

In the typical situation, the rules are clear. The employer did not meet all of the requirements to pay less than full minimum wage, so the employer now owes back wages equal to the difference between full minimum wage and tipped minimum wage. Tips received don’t count in this.

But, what happens when an employer pays more than full minimum wage to tipped employees? Can an employer keep part of the employee’s tips?

In Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010), it seemed like the 9th Circuit answered those questions. Basically, the court held that nothing in the FLSA prohibits an employer from keeping tips, if the employer pays at least full minimum wage. In other words, the FLSA’s rules only come into play if the employer intends to take advantage of the tip credit.

The next year, in 2011, the Department of Labor issued a new rule that dealt with this subject. The new rule stated that tip money always belongs to the employee that earned it, and the money cannot be used for any purposes not in 203(m), even if the employer doesn’t take a tip credit. The language (from 29 C.F.R. 531.52) is below:

Tips are the property of the employee whether or not the employer has taken a tip credit under section [20]3(m) of the FLSA. The employer is prohibited from using an employee’s tips, whether or not it has taken a tip credit, for any reason other than that which is statutorily permitted in section [20]3(m): As a credit against its minimum wage obligations to the employee, or in furtherance of a valid tip pool.

With that background in mind, we get to the new decision in Oregon Restaurant. The Ninth Circuit has now said that, because the FLSA is silent on the issue of tip pooling when employees are paid full minimum wage, the Department of Labor can make rules on the subject. Because the 2011 rule from the DOL prohibits employers from using tip money for anything other than what is authorized under 203(m), it is prohibited under the FLSA.

Judge Smith wrote a dissent that chastised the majority for reversing prior circuit precedent. Judge Smith also noted that a law’s silence on a subject does not grant an administrative agency the ability to make any rules that it wants. As one commentator noted, this decision is likely to be challenged.

The Oregon Restaurant decision raises a lot of questions.

If this rule stands, and an employer violates the rule, what are the damages that an employee can collect? In a normal case, the employee can collect the unpaid full minimum wages. Here, full minimum wages will have been paid.

If the rule doesn’t stand, then what prevents an employer from paying its servers/bartenders/waitresses full minimum wage, but then keeping all employee tips? The practical effect is that the employer can just use those tips to pay its employees “full” minimum wage, thereby skirting the FLSA’s requirements. In fact, under that scenario, an employer is better off paying full minimum wage, but keeping tips rather than paying tipped minimum wage and following 203(m)’s rules.

Maybe the solution is to simply do away with tipping/tipped minimum wages completely. After all, according the comedy show Adam Ruins Everything, tipping “shortchanges servers, inconveniences customers, and makes the dining experience worse for everyone.” (Warning: crude language.)

For more information, contact Andy Biller, Of Counsel to Markovits, Stock & DeMarco and author of Wage and Hour Information Resource; (614) 604-8759.

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