As appeared in AHLA's Lodging Law online magazine, March 2010.

Wage and hour lawsuits are not new for the hospitality industry but, in recent years, plaintiffs have been focusing on a new niche of claims related to tip pooling and banquet service charges. Hotels with operations in states with employee-friendly laws, such as Massachusetts, New York, and California, have seen a surge in class actions regarding compulsory tip pools and distributions of service charges to employees. Moreover, the Department of Labor (DOL) is gearing up for an aggressive enforcement agenda in 2010. Labor Secretary Hilda Solis and Solicitor General Patricia Smith both have publicly endorsed an increase in resources to investigate wage and hour claims.

Tip Pools and Service Charges

Under the Fair Labor Standards Act (FLSA) and many state laws, hoteliers are permitted to require tip pooling among their wait staff. Under a pooling arrangement, all employees subject to the pool have to share a portion of their tips, which are then divided among a group of employees. Importantly, an employee cannot be required to pay more into the pool than is customary and reasonable, and the employee must be able to keep at least the full minimum wage (that is, the employee cannot be required to pay any part of the tips the employer is counting towards the minimum wage into a tip pool).

If the hotel is using the "tip credit" to satisfy the minimum wage, then only employees who regularly receive tips are eligible to participate in the pool. Thus, employees who are paid less than the minimum wage cannot be required to share their tips with employees who do not usually receive their own tips, like dishwashers or cooks. Also, employers are not permitted to share in the pool, including owners, managers, or supervisors. A violation of a tip pool arrangement can lead to high exposure for employers, not only for the amount wrongfully withheld from employees, but it also potentially creates a tip credit violation.

Under the FLSA, a service charge is not a "tip" because customers are not given the discretion to determine whether to pay it or how much to provide to the server. Accordingly, under federal law, a hotel may retain any or all of the service charge, and the hotel must decide whether to distribute some, or any, of the service charge to an employee, so long as the employee earns at least the minimum wage for all hours worked.

Some state laws, however, vary and require employers to distribute 100 percent of the service charge to the servers or other members of the wait staff. In Massachusetts and New York, for example, no portion of the service charge may be distributed outside of the non-supervisory wait staff if the customer reasonably believed the charge constituted a gratuity. In 2008, the New York State Court of Appeals concluded in Samiento v. World Yacht, Inc. that when a service charge has been represented to the customer as compensation for the wait staff in lieu of a tip or gratuity, the charge must be distributed to the wait staff.

In reaction to Samiento, the New York State Department of Labor (NY DOL) is modifying its state Wage Order to bring its regulations in line with the decision. Once the NY DOL's regulations are implemented, there will be a presumption that any charge associated with a banquet or special function, on top of food and beverage costs, is a gratuity to be distributed to wait staff, unless the hotel provides clear, written notice to customers that the charge is not a gratuity. The Massachusetts Tip Statute, which was amended in 2004 to clarify who is defined as wait staff, similarly restricts any non-wait staff personnel (such as banquet captains or wine stewards) from sharing in the distribution of the service charge. In 2008, Massachusetts amended its statute to provide for mandatory treble damages for a violation of the wage and hour law.

Recent Case Developments

A luxury New York hotel is the latest target in a constant stream of wage and hour class actions against the hotel and restaurant industry challenging the industry's practices relating to tip pools and service charges. An issue in the lawsuit filed in February 2010 is the common practice in the hotel and restaurant industry of charging private dining/banquet customers a mandatory service charge in lieu of the customer leaving a voluntary tip or gratuity on the day of the event. According to the plaintiffs' complaint, a 21.5 percent service charge is added to the customer's bill for the event, but only 15 percent of that amount is distributed to the wait staff. The complaint asserts that customers are led to believe that the entire service charge is a gratuity to be paid to the employees who worked the event. The plaintiffs also complain about the hotel's practice concerning special banquet gratuities, which are received from customers and distributed to non-banquet employees - instead of to the wait staff who worked the particular event. The plaintiffs claim to represent a class of more than 100 employees and seek more than $5 million in damages.

Hospitality employers have received some good news from courts recently. In early February 2010, employers in Massachusetts received a favorable opinion in Hernandez v. Hyatt Corp., when the Chief Judge of the Business Law Section determined that the 2008 amendment calling for mandatory treble damages only applies prospectively. On February 23, 2010, the U.S. Court of Appeals for the Ninth Circuit issued its opinion in Misty Cumbie v. Woody Woo, and concluded that, under the FLSA, an employer is permitted to require its wait staff to participate in a tip pool that redistributes some of the tips to the kitchen staff, so long as the employer does not use the tip credit to satisfy an employee's minimum wage.

Action Steps for Compliance

With the flood of class actions, hoteliers must make compliance with federal and state wage and hour laws a top priority throughout 2010. To avoid the customer confusion and exposure as highlighted by these class actions, banquet documentation given to customers should clearly delineate how much is billed for a service charge intended as compensation for employees, and how much is billed as an administrative fee, which the hotel retains to cover overhead and other costs. Moreover, hoteliers should communicate to their employees how much they receive of the service charge, and who shares in the service charge or tip pool arrangement.

Conducting regular self-audits, in consultation with legal counsel, should be a best practice for all hoteliers. Every investigation and lawsuit is unique, and cannot be defended with a cookie-cutter defense. Having as part of your team a counsel who knows the hospitality industry and the unique challenges facing your hotel will assist in keeping companies out of court and exposure to a minimum.