A three-judge Ninth Circuit panel upheld a 2011 Department of Labor (DOL) rule barring employers from including employees in tip pools who do not customarily and regularly receive tips. The split Ninth Circuit decision in Oregon Restaurant and Lodging, et al. v. U.S. Department of Labor, et al. is perhaps a small step for Circuit Court deference to DOL rulemaking authority, but a giant leap for tip-earners in the restaurant and hospitality industries who do not wish to share tips with a pool of non-tip-earning co-workers.

The dispute over proper and improper tip-pooling arrangements arises out of the Fair Labor Standards Act of 1938’s (FLSA) requirement that employers pay their employees a minimum wage. [1] While determining an employee’s minimum wage is fairly straight-forward approach amongst most industries, it has traditionally been a bit more complicated in the restaurant and hospitality industries, which have a substantial amount of the workforce receiving their wages through tips. Taking this into account, the FLSA allows an employer to fulfill its obligation to pay the minimum wage by adding an employee’s tips to the employee’s regular wage received from the employer. This practice is known as taking a “tip credit.” In order to take a tip credit, § 203(m) of the FLSA requires employers to (1) give notice to employees; and (2) allow employees to retain all the tips they receive.

Sounds simple enough.

However, the complication arises out of § 203(m)’s carve-out for employers who wish to establish tip-sharing pools amongst their employees. § 203(m) expressly explains that nothing in the section shall “be construed to prohibit the pooling of tips among employees who customarily and regularly receive tips.” In other words, employers may take the tip credit even if the employee does not retain all the tips he or she personally receives from customers, as long as the employee receives all of the tips distributed from a tip pool comprised of employees who customarily and regularly receive tips.

In 2010, a creative group of servers brought a lawsuit, styled Cumbie v. Woody Woo, Inc.,[2] against their employer arguing that the employer’s established tip pool ran afoul of § 203(m), because the pool included other restaurant staff who did not customarily and regularly receive tips. The key fact in the Cumbie matter was that the employer was already paying its employees a cash wage that met minimum wage requirements and therefore, did not need to take a tip credit under § 203(m) in order to satisfy its minimum wage obligations. Nevertheless, plaintiffs argued that § 203(m) extended to all employers, regardless of whether those employers were taking a tip credit. The Ninth Circuit disagreed, explaining that “[t]he Supreme Court has made it clear that an employment practice does not violate the FLSA unless the FLSA prohibits it,” and unless an employer is taking a § 203(m) tip credit, nothing in the FLSA otherwise prohibits employers from requiring all employees – whether they customarily receive tips or not – from participating in a tip pooling arrangement.

The apparent victory for employers was short-lived.

The following year, in 2011, the Department of Labor (DOL) promulgated a conflicting formal rule to the Cumbie decision, extending the tip pool restrictions of § 203(m) to all employers, not just those who take a tip credit. The viability of the DOL rule was first considered by The Honorable Michael W. Mosman of the Oregon District Court who agreed with the National Restaurant Association and others that the DOL exceeded its authority when it issued its 2011 rule. This set the stage for yesterday’s somewhat surprising Ninth Circuit decision overruling Judge Mossman’s decision. The Ninth Circuit decision reasoned its earlier Cumbie decision was grounded in statutory silence, however, now that the DOL has spoken by issuing its 2011 post-Cumbie rule, the rule should be followed.

Judge N. Randy Smith dissented, explaining the “case is nothing more than Cumbie II,” and he and his colleagues are bound by circuit precedent whether they like it or not.

The end result: employers may not require employees to participate in tip pools with employees who do not customarily and regularly receive tips, even if the employer does not take a tip credit under § 203(m).