In a decision with important implications for employers throughout the service industry, the federal Ninth Circuit Court of Appeals ruled on February 23 that employers cannot implement policies requiring tipped employees to share their tips with untipped employees. The 2-1 decision inOregon Restaurant & Lodging Assoc. v. Perez, — F.3d –, No. 13-25765 (9th Cir. Feb. 23, 2016) (“Oregon Restaurant”) upheld a regulation issued by the federal Department of Labor (“DOL”) in 2011 and reversed trial court decisions to the contrary from Oregon and Nevada.

Section 203(m) of the Fair Labor Standards Act (“FLSA”) permits an employer to fulfill part of its hourly minimum wage obligation to a tipped employee with tips the employee receives from customers – a so-called “tip credit.” An employer can take a tip credit as long as it (1) notifies its employees of the practice, and (2) allows tipped employees to keep all tips they receive or to participate in a valid “tip pool” whereby tips are combined and then distributed amongst employees who are “customarily and regularly” tipped.

An employee customarily and regularly receives tips if he or she (1) has more than de minimis interaction with the customers who leave the tips, and (2) is engaged in customer service functions.[1]  The employee’s job title is irrelevant.  Thus, for example, a sushi chef who serves diners directly at a counter may be a tipped employee, while a chef who works in a kitchen and does not interact with diners is not.[2]

In 2010, the Ninth Circuit ruled in Cumbie v. Woody Woo, Inc. that section 203(m) did not apply to employers that do not take tip credits; as a result, such employers could use tip pools to benefit both tipped and untipped employees.[3]  The DOL responded to the Cumbie ruling in 2011 by issuing a regulation that limits tip pooling to customarily tipped employees regardless of whether their employers take tip credits.[4]  It reasoned that this was necessary to close a “loophole” in section 203(m) whereby employers could use tip pooling to subsidize the wages of untipped employees.  In 2013, a federal district court in Oregon held the regulation invalid based onCumbie[5]  A district court in Nevada followed suit in 2014. [6]

The Ninth Circuit reversed both district courts in Oregon Restaurant.  Writing for the majority, Senior Circuit Judge Harry Pregerson wrote that Cumbie did not render the DOL regulation invalid.  The majority read Cumbie to say that section 203(m) was silent regarding the tip pooling method at issue, which gave the DOL room to issue regulations interpreting the statute.  The court further held that the specific regulation under dispute was a reasonable interpretation of section 203(m) based on the statute’s legislative history.

Writing in dissent, Circuit Judge N. Randy Smith argued the majority’s ruling effectively allowed the DOL to codify its unsuccessful argument from Cumbie.  The dissent argued this was both inconsistent with the precedent set by Cumbie, which interpreted section 203(m) clearly and unequivocally to permit the disputed tip pooling method, and beyond the agency’s regulatory power, which is limited to interpreting ambiguities within the statute and not prohibiting conduct that the statute clearly allows.

The Oregon Restaurant ruling comes as a surprise.  In addition to the Oregon and Nevada district courts that were reversed, several others in the Ninth Circuit and elsewhere have either invalidated or expressed doubt regarding the 2011 regulation.[7]  Others have deemed the disputed tip pooling method permissible under section 203(m) without ruling on the regulation itself.[8]

Oregon Restaurant may be reconsidered en banc or appealed to the U.S. Supreme Court.  Until then, the law under this new case does not permit mandatory tip pools that include anyone who does not “customarily and regularly receives tips.”  In light of this significant change, it is highly encouraged that employers – especially those in the Ninth Circuit – seek legal counsel and review their tip pooling arrangements carefully to ensure compliance with the current state of the law.