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Restaurateurs Rush to Review Tip-Sharing in Light of Surprising Ninth Circuit Decision

On February 23, 2016, a divided three judge panel of the Ninth Circuit Court of Appeals validated regulations by the Department of Labor (“DOL”) that significantly limit employers’ ability to maintain tip pools that extend beyond “customarily and regularly tipped” employees. The controversial 2-1 decision in Or. Rest. &  Lodging Ass’n v. Perez (2016 BL 50460, 9th Cir., No. 13-35765, 2/23/16) reverses two federal district court rulings that relied on the Ninth Circuit’s 2010 ruling in Cumbie v. Woody Woo, Inc. (596 F.3d 577).

The Ninth Circuit surprisingly ruled that the DOL has the authority to regulate tip-pooling practices even where the employer does not take a tip credit. More specifically, the court upheld a 2011 DOL rule that employers cannot require that tips given to waiters, casino dealers and other service staff be shared with support staff such as dishwashers and cooks, even if the tipped employees are paid minimum wage. In overturning rulings by district courts in Nevada and Oregon (consolidated on appeal), the Ninth Circuit ruled that the DOL regulation was reasonable and consistent with Congress's goal of ensuring that tips stayed with the employees who initially receive them.

In the aforementioned 2010 Woody Woo Decision, the Ninth Circuit had invalidated tip pools that included employees that did not regularly receive tips, but the ruling applied only to those employers who claimed a tip credit. Thus, it remained an open legal question whether tip pools including “back of house” employees were valid in situations where the employer did not claim a tip credit. In response to this legal ambiguity, in 2011 the DOL issued new federal regulations regarding tips which interpreted the Fair Labor Standards Act (FLSA) as mandating that tips are the property of the tipped employee regardless of whether the employer claims a tip credit. As a result of these updated regulations, an employer was prohibited from using an employee’s tips except as a credit against minimum wage or as part of a tip pool that only includes employees who customarily and regularly receive tips.

Following the issuance of the DOL regulations in 2011, there was some uncertainty about the applicability of these new requirements to employers operating in the Ninth Circuit in light of the narrow scope of the Woody Woo decision. However, the DOL adopted a firm stance on the matter, directing regulatory personnel to reject the Woody Woo decision and regulate all tip pooling in the Ninth Circuit. This directive came under challenge from the Washington and Oregon restaurant associations, and after an initial victory in district court, plaintiffs were rebuffed by last week’s surprising Ninth Circuit decision.

The ruling generally applies in states that require workers to be paid the minimum wage on top of any tips, including: Alaska, California, Minnesota, Montana, Nevada, Oregon and Washington. The plaintiffs in the litigation are considering their legal options in light of the Ninth Circuit decision. There remains a possibility that the ruling will be reconsidered by 11 judges of the court (called an en banc hearing), or reviewed on appeal by the United States Supreme Court. 

In the meantime, restaurants and other businesses in the hospitality industry located in the states impacted by the Ninth Circuit decision should be aware of this new precedent and prepare to make changes to their tip pools. Businesses should assess the scope of their risk in light of the likely appeal of this decision, but at a minimum, employers with mandatory tip pools should consider altering the parameters of their programs to eliminate sharing with employees who do not customarily receive tips. One available alternative, if permitted by local law, is to consider implementing a non‑discretionary service charge that is shared among employees (an approach that is becoming increasingly common).

Further, there is little direct guidance in the Ninth Circuit or from other federal courts regarding the application of federal law to employees working in fast casual or quick/counter service dining establishments (where there is merely a cashier and no traditional servers). Therefore, in light of the recent Ninth Circuit decision, it is difficult to predict how a federal court would rule in the case of mandatory tip pooling arrangements involving traditionally non-tipped employees. Notably, California courts have held that restaurant employees who participate in the “chain of service” may participate in mandatory tip pools, including cooks, dishwashers and other kitchen staff.  Etheridge v. Reins Intern. California, Inc., 172 Cal. App. 4th 908, 921 (2009).  Moreover, in Jou Chau v. Starbucks Corp., the California Court of Appeals notes in dictum that “[b]y leaving a tip in a collective tip box, a customer would necessarily understand the tip will be shared among the employees who provide the service.  The obvious purpose of a tip box is for the customer to leave a tip to be shared among the service employees.” 174 Cal. App. 4th 688, 697 (2009). 

In light of the recent Ninth Circuit decision, restaurants with a more traditional service model should look to eliminate any tip pools involving back of house staff, unless such a pool is separate and distinct from the customarily tipped (front of house) personnel and made known to the customer. However, counter service establishments are operating in more legally murky territory; compliance may depend on the amount of customer service and direct customer interaction by kitchen staff (i.e., chefs, dishwashers, prep cooks). The conservative approach would be to limit any sharing of such tips to those providing counter service, and excluding cooks and other staff that traditionally perform back of house duties identified by federal courts and the DOL as not “customarily and regularly” receiving tips.

This landmark decision will affect different employers in different ways depending on their specific approach to wages, but one thing is clear: tip pooling arrangements are under considerable legal threat, and it is exceedingly important that employers immediately review their compliance with FLSA regulations, as well as state and local laws. Time is of the essence.

This article is not offered as, and should not be relied on as, legal advice. You should consult an attorney for advice in specific situations.