A recent California appellate court decision has held that a banquet hall’s “mandatory service charge” could, under the right circumstances, be a “gratuity” that must be paid to employees under California Labor Code § 351. In O’Grady v. Merchant Exchange Productions, the defendant-employer added on a percentage service charge for all banquet contracts for food and beverages. Some, but not all, of the service charge was distributed to managers who did not serve food or beverages at the banquet. Plaintiff brought a putative class action alleging that the defendant’s practice of distributing the service charge proceeds to non-managerial banquet staff violated California Labor Code § 351, which states that gratuities are the sole property of the employees, and the employer (including managers) may not take any portion of the gratuity. The trial court held as a matter of law that a service charge cannot be a tip or gratuity under § 351 and dismissed the case.

In reversing the trial court’s decision to dismiss the case, the appellate court determined that a mandatory service charge could still qualify as a gratuity depending on the circumstances. In so holding, the court observed that the term “service charge” is sometimes used interchangeably with the terms “tip” and “gratuity.” Thus, simply referring to an item on an invoice as a “service charge” does not necessarily indicate what its purpose is or why it is charged.

Notably, the court did not definitively decide that a service charge is a gratuity. It simply held that the mere label of a payment as a “service charge” does not necessarily mean the payment is not a gratuity under § 351. Instead, the facts and circumstances matter. The court’s opinion suggests that an employer can improve its chances of prevailing against similar claims if it makes clear to the customer that the charge is not a tip and will not be shared with the employee. The teachings of O’Grady are straight-forward – employers should not simply rely on labels to conclude that a service charge is not a gratuity under § 351. Instead, employers should analyze the facts and circumstances surrounding the charge (including but not limited to the customer’s expectations with respect to the charge) before reaching this conclusion.