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How to Avoid Tip-Related Traps

By Natalie Hrubos
July 12, 2012
Restaurant Hospitality

How to Avoid Tip-Related Traps

By Natalie Hrubos
July 12, 2012
Restaurant Hospitality

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Natalie HrubosIn recent months, celebrity chefs, national chain restaurants, Las Vegas casinos and even "mom and pop" taverns have all made headlines because their employees have filed class and collective action lawsuits challenging their pay practices. Generally, these employees allege that their employers failed to comply with the Fair Labor Standards Act (FLSA) and/or state wage and hour laws.

No-pay practices have caused restaurant operators more trouble than those that pertain to employees' tips. The FLSA permits an employer to allocate an employee’s tips to satisfy up to 50 percent of the statutory minimum wage requirement provided the following two conditions are met: (1) the employer must inform the tipped employees of certain provisions of the FLSA; and (2) tipped employees must retain all the tips received except those tips included in a tipping pool shared by employees who customarily receive tips.

Mandatory, employer-run tip pooling arrangements are generally permissible under federal and most state wage and hour laws, but there are some limitations. Recently, allegedly invalid tip pools have been the subject of much litigation. Most of the lawsuits filed allege either that: (1) employees who do not "customarily and regularly" receive tips illegally participated in the tip pool, or (2) the employer or agent of the employer illegally participated in the tip pool.

Tip pool participants must "customarily and regularly" receive tips

Many courts have held that an employee's level of customer interaction is the most significant factor in evaluating whether an employee qualifies as a "tipped employee." A tipped employee must perform important customer service functions. The U.S. Department of Labor has recognized certain hospitality industry occupations as either generally eligible or ineligible to participate in tip pooling arrangements. Janitors, dishwashers, chefs/cooks and laundry room attendants typically do not perform customer service functions and, therefore, cannot participate in a tip pool.

The following occupations, on the other hand, generally perform important customer service functions: waiter/waitresses; bellhops; counter personnel who serve customers; busboys/girls (server helpers); and service bartenders. While the Department of Labor recognizes that these occupations are generally eligible to participate in tip pooling arrangements, it's important to evaluate each employee's customer service functions to determine that employee's eligibility for a tip pool.

Several recent court decisions shed further light on the level and type of customer service required for tip sharing. In one case, servers employed by a chain restaurant argued that hosts at the restaurant were ineligible to share in a tip pool because they were not engaged in an occupation in which they "customarily and regularly" received tips. The court disagreed, finding that hosts performed important customer service functions: they greet customers, supply them with menus, seat them at tables and occasionally "enhance the wait." Although they were not the primary customer contact, they had more than a minimal interaction with customers.

Likewise, in another case, senior servers with some managerial duties were engaged in an occupation in which they customarily and regularly received tips because they had sufficient customer interaction: They helped serve food and drinks to tables, greeted customers and checked on tables during the dinner service.

In a recent case, waiters and servers at a steakhouse argued that their employer's tip pooling arrangement was invalid because the maître d's participated in the pool. The court found, however, that the maître d’s were highly involved in customer interaction and satisfaction and, therefore, "customarily and regularly" received tips. Specifically, they "engaged in guest interactions, helped servers with problems and with wine service, and generally did anything and everything that made the guest experience run efficiently and smoothly." Their responsibilities included "important customer service functions, such as assuring the tables were set in accordance with guest requests, serving food and drinks to tables, greeting customers, checking on tables, and performing table visits if a guest had a problem or question during the dinner service."

Both the quantity and the quality of an employee's interactions with customers are relevant to whether that employee qualifies as a tipped employee. Industry custom—in terms of who the industry decides to include in a tip pool—is irrelevant in determining whether an employee is a tipped employee under the FLSA. Industry custom from the patron's perspective, however, is relevant to this inquiry. As one federal court noted, "the federal regulations, as well as legislative history of the statute itself, indicate that it is the customer's expectation and intent that provides the basis for determining who qualifies as a "tipped employee." Thus, the determination of who is a "tipped employee" requires an analysis from the customer's perspective.

Employers are ineligible to participate in tip pools

The FLSA defines an employer as "any person acting directly or indirectly in the interest of an employer in relation to an employee." Though a low-level supervisor is not an "employer' under the FLSA, an employee with substantial managerial authority over the day-to-day operations of a business is the functional equivalent of the employer. If a manager functions as the employer in this regard, any tip sharing with that individual violates the FLSA.

Courts generally use the economic reality test to determine whether an individual qualifies as the employer. This test examines whether the individual (1) has the power to hire and fire employees, (2) supervises and controls employee work schedules or conditions of employment, (3) determines the rate and method of employees' pay and (4) maintains employment records.

An employee with limited managerial duties is a low-level supervisor, not the functional equivalent of the employer. In one case, senior servers helped with closing, supervised employees' work, handled complaints, operated the restaurant's safe, handled money, completed the nightly closing forms, sent employees home, contacted the restaurant owner when the restaurant needed additional staff or supplies, took inventory and maintained the restaurants' cleanliness.

Nonetheless, the senior servers were not employers under the FLSA because they had no authority to hire, fire or schedule employees. They did not determine the rate or method of employee compensation, nor did they maintain employment records beyond performing clerical duties such as completing the nightly closing forms.

With respect to hiring and firing authority, the question is whether the individual had final authority to hire, discipline and fire employees. In one case, maître d's who participated in a tip pool had authority to interview candidates and make recommendations for hiring and firing, but any final decisions belonged to the proprietor/general manager. The court stated that this weighed against a finding that the maître d's functioned as the employer.

Proactively minimizing legal risks

For many restaurant employers, taking tip credits and requiring tip pooling among employees makes good business sense. To minimize associated legal risks, however, restaurant employers should immediately review their policies and practices pertaining to employees' tips for compliance with all applicable laws.

In light of recent litigation trends, it's particularly important to evaluate tips pooling arrangements to ensure that they do not include (1) employees who do not "customarily and regularly" received tips or (2) employees with substantial managerial authority.

Additionally, prior to taking a tip credit, employers are required by federal law to inform employees of certain information, such as the amount of the cash wage to be paid by the employer to the tipped employee and the amount of tips to be credited as wages toward the minimum wage. It's an ideal practice for employers to communicate the information to employees in writing and to require employees to sign acknowledgement forms.

Finally, employers must also be mindful that mandatory tip pooling arrangements are prohibited in some states and may be subject to other restrictions depending on the jurisdiction. In general, when it comes to policies and practices relating to employees' tips, an ounce of prevention will save restaurant employers much more than a pound of cure.

Natalie Hrubos is an associate in the employment, labor, benefits and immigration practice group in Duane Morris' Philadelphia office. She represents and counsels management clients in all aspects of labor and employment law, including wage and hour law compliance.