Labor & Employment Law Daily Automatic gratuities paid to restaurant workers not tips, but commissions, for purposes of FLSA exemption
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Wednesday, December 2, 2020

Automatic gratuities paid to restaurant workers not tips, but commissions, for purposes of FLSA exemption

By Robert Margolis, J.D.

While the FLSA does not define service charges, FLSA regulations provide that a “compulsory charge” for service, imposed on a customer by an employer’s establishment, is not a tip.

“Automatic gratuities,” a 20 percent surcharge added to restaurant bills for large parties in lieu of tips, are not “tips” under the FLSA, ruled the Fourth Circuit. Instead, for calculating whether the restaurant operator met its minimum wage and overtime obligations to the employees bringing an FLSA collective action, those gratuities can be considered as “commissions,” possibly allowing the employer to invoke an exemption to the FLSA’s requirements, the court held. It affirmed in part the summary judgment granted the employer by the district court, also vacating it in part and remanding the case back to the district court (Tom v. Hospitality Ventures LLC, November 24, 2020, Quattlebaum, M.).

Server compensation scheme. Servers at an upscale sushi restaurant were paid an hourly wage plus tips and automatic gratuities, generally consisting of 20 percent of the bill for parties of six or more. On most weeks, the hourly wage, tips, and automatic gratuities would exceed the FLSA minimum-wage and overtime requirements. The restaurant’s employees sued, claiming that the automatic gratuities cannot be considered in calculating whether the restaurant met its requirements because they were paid through an unlawful tip pool. The employees claimed that the tip pool was unlawful because it was shared by employees who did not customarily and regularly receive tips—which is an FLSA requirement for tip pools. When that tip pool money is excluded, the employees claimed, the restaurant underpaid them, entitling them to damages, and attorney fees and costs.

The district court granted summary judgment to the restaurant, holding that the automatic gratuities were not tips, but rather were commissions, which it held fell within an exception to the FLSA’s requirements—29 U.S.C. § 207(i) (the “7(i) exemption”). According to the district court, the 7(i) exemption applied to the automatic gratuities for most weeks at issue, and the tip pool was valid as a matter of law for the weeks that the tip pool did not satisfy the exemption.

Tipped employees. Restaurant employees typically are paid hourly wages below the FLSA-required minimum wage amount but also receive tips or gratuities. Can those tips/gratuities be used to satisfy a restaurant’s minimum-wage requirements, and if so, what are the governing rules? The FLSA provides three general categories of non-hourly compensation that could apply to restaurant workers—tips, service charges, and commissions—and the court discussed each one.

The FLSA defines a “tipped employee” as one who “customarily and regularly receives more than $30 per month in tips,” 29 U.S.C. § 203(t). Tips are “sum[s] presented by a customer as a gift or gratuity” and are “determined solely by the customer,” 29 C.F.R. § 531.52. Tips can satisfy the FLSA’s minimum-wage requirement, by use of the “tip credit” provision in 29 U.S.C. § 203(m)(2)(A). That provision allows employers to pay a $2.13 cash wage per hour, supplemented by tips of $5.12 per hour to meet the $7.25 federal minimum wage requirement, as well as the overtime wage rate of $10.88. An employer must notify its workers in advance if it intends to rely on the tip credit provision to meet FLSA requirements, 29 U.S.C. § 203(m)(2)(A).

Service charges. While the FLSA does not define service charges, FLSA regulations provide that a “compulsory charge for service, such as 15 percent of the amount of the bill, imposed on a customer by an employer’s establishment, is not a tip,” 29 C.F.R. § 531.55(a). This, instead, is a service charge, which may be used in their entirety to satisfy FLSA minimum-wage requirements.

Commissions. The FLSA provides that employers at “retail or service establishment[s]” may employ its employees in excess of the 40-hour work week if it pays them more than the time-and-a-half rate and more than half of the compensation represents commissions, 29 U.S.C. § 207(i). The 7(i) exemption “was enacted to relieve an employer from the obligation of paying overtime compensation to certain employees of a retail or service establishment paid wholly or in greater part on the basis of commissions,” 29 C.F.R. § 779.414. If compensation qualifies as commissions, the employer is exempted from the FLSA’s overtime requirements, though not its minimum-wage requirements.

The employees contended that the automatic gratuities were tips, which they argued cannot be used to satisfy the restaurant’s FLSA requirements because the restaurant required them to pool their tips with other staff members who did not “customarily and regularly receive tips.” For its part, the restaurant argued that the automatic gratuities were commissions, which can be used under the 7(i) exemption to satisfy the restaurant’s obligations.

7(i) exemption. The district court had found that the restaurant had met its FLSA obligations because the automatic gratuities were commissions, so the 7(i) exemption applied. On appeal, the employees made three arguments as to why this conclusion was wrong. First, they contended that the money should be classified as tips because the restaurant informed the employees that tips would be used as a credit against the restaurant’s FLSA obligations. The appeals court rejected this argument. While such notice is required to permit a restaurant to use the tip credit, giving such notice does not negate a restaurant’s ability to use other means to meet its obligations, the appeals court reasoned.

Next, the employees argued that the automatic gratuities were tips, since customers and servers occasionally asked management to remove the automatic gratuity from the bill. Thus, they argued, the automatic gratuities were flexible enough to be controllable by customers, so as to be considered tips. However, the district court agreed with the restaurant, that because managers had the final say, there was no customer discretion and therefore the automatic gratuities could not be tips. The appeals court found no error in that holding. To be a tip, the money had to be paid “solely” at the discretion of the customer. Where the payments were resolved by management, the customers did not have sole discretion. The appeals court made clear that this decision was driven by the facts of the case, and noted that other courts under different circumstances—such as where the added charge for large parties is “suggested” rather than automatically applied—could correctly reach a different conclusion.

Automatic gratuities. Even if the automatic gratuities were not tips, the employees argued that the district court erred by finding that the 7(i) exemption relieved the restaurant of both its minimum-wage and overtime obligations. The appeals court agreed with the employees, noting that exemption applies only to overtime obligations.

The employees also argued that the automatic gratuities do not qualify for the 7(i) exemption for commissions because that exemption only applies where commissions exceed 50 percent of employee compensation. The employees argued that tips had to be added to hourly wages, and could not be excluded, when calculating whether the automatic gratuities met the 50-percent threshold. Again, the appeals court agreed with the employees, and found the district court to be in error.

The appeals court pointed to the language of 29 C.F.R. § 779.415, which explains how to determine whether more than half of an employee’s compensation is made up of commissions. “All compensation” is to be included, “in whatever form or by whatever method paid.” This language “means what it says,” according to the appeals court. Therefore, the district court erred by excluding tips from the calculation.

The appeals court thus remanded the case to the district court to determine whether automatic gratuities qualify as commissions under the 7(i) exemption when the calculation is properly made. If they do, then the district court must also determine the extent to which they satisfy the restaurant’s overtime obligations.

Tip pool. Noting that on remand the restaurant may need to rely on the tip pool to meet its FLSA obligations, the court turned to whether the restaurant’s tip pool was valid. An employer may only pool tips “among employees who customarily receive tips,” 29 U.S.C. § 203(m)(2)(A). Courts look at the employees’ job duties rather than job description to determine which employees fall within this definition.

The employees argued that the kitchen closing supervisor and sushi chef helpers do not customarily receive commissions, so including them in the tip pool rendered the pool invalid. The district court resolved that question in favor of the restaurant, but the appeals court found disputed factual questions over the extent to which the kitchen closing supervisor interacted with customers. This should have precluded summary judgment on this question, even if no such question was created as to the sushi chef helpers. Thus, on remand, the district court must determine the validity of the tip pool based on the inclusion of the kitchen closing supervisor only.

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