On February 23, 2016, in a surprise ruling, a divided Ninth Circuit Court of Appeals (which covers the states of California, Nevada, Oregon, Washington, Arizona, Alaska, Idaho, Montana and Hawaii) ignored its prior precedent issued in 2010 and reversed  federal district court orders invalidating 2011 revisions to the Department of Labor’s (DOL’s) tip-pool regulation. Oregon Restaurant and Lodging Association v. Perez, No. 13-35765 (9th Cir. Feb. 23, 2016).

The majority held the DOL acted within its authority when it promulgated the rule change.  As revised, the tip-pool regulation prohibits an employer from including non-tipped staff in tip pools even when it does not take the tip credit, but instead pays the full statutory minimum wage. The majority concluded that the Fair Labor Standards Act’s (FLSA's) “clear silence as to employers who do not take a tip credit” has left room for the DOL to promulgate the 2011 rule and rejected the notion that the appeals court had foreclosed the agency’s ability to do so by virtue of its 2010 decision in Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010). This decision means that even in states where no tip credit exists, employers can no longer mandate a tip-pool distribution that includes employees who are not in the chain of service or do not have direct contact with customers, such as cooks or dishwashers. These employees are by this decision properly prohibited under the regulation from being part of a tip pool. 

History of Tip-Pool Restriction

FLSA section 203(m) allows employers to institute a tip pool among workers who “customarily and regularly” receive customer tips for their efforts. The federal law on tip pooling adopts standards that are protective of employees’ right to tips. The type of employees that are usually viewed as “customarily and regularly” receiving tips are waiters, waitresses, bellhops, bussers and service bartenders. Some cases have found that hosts/ hostesses who perform direct customer service, such as greeting the customer, can be included in a tip pool. Also, the FLSA forbids any arrangement where any part of the tip received becomes the property of the employer. A tip is the sole property of the tipped employee or employees.

The FLSA makes  it clear that the rationale for the restriction on which employees can share in tips is to protect workers in states that allow a tip credit. Section 3(m) of the FLSA permits an employer to take a tip credit toward its minimum wage obligation for tipped employees equal to the difference between the required cash wage (which currently must be at least $2.13 per hour) and the federal minimum wage. By restricting the distribution of tips in a tip-pool to only workers who “customarily and regularly” interact with customers, the DOL is attempting to protect these workers from wage inequities and making sure employees in the service industry can maximize their wages since these employees rely on tips to at least reach the minimum wage.  Historically, states have also had similar definitions of allowable tip-pooling

Tip pools, whether voluntary or mandatory, are generally permitted for employees so long as:

• Tip pool participants are limited to those employees who contribute to the chain of service bargained for by the patron

• No employer or agent of the employer takes or receives any part of the tips intended for employees

• The tips are distributed among the pool participants in a fair and reasonable manner.

Pooling tips for redistribution is not required, nor is a written agreement or policy required to allow a tip pool.  

Employers in states that did not allow them to take a tip credit began challenging the tip credit restrictions to allow tips to be shared by all employees, even those who did not have direct customer contact.  These employers argued that even employees who did not have direct customer contact were vital to the customer’s positive experience and contributed to any tip the customer elected to leave. In 2010, in the Cumbie decision, the Ninth Circuit held that an employer who did not take the tip credit against its obligation to pay the statutory minimum wage was entitled to use a tip pool comprising tipped and non-tipped employees. The rationale and reasoning was section 203(m) of the FLSA was silent as to employers that do not take the tip credit, and the appeals court found such a tip pool permissible under these circumstances.

Many industries, in particular hospitality (restaurants, hotels and resorts, golf clubs), adopted tip-pooling agreements that recognize the importance of all employees to the experience of a guest or customer and to address income inequality between tipped and non-tipped employees. Such tip-pooling arrangements included a standard that (1) distributes the majority of the pooled gratuities to those employees with direct customer contact, i.e., wait staff and bartenders, (2) followed by a smaller percentage to bussers, (3) a still smaller percentage to other categories of employees who provide limited direct table service and (4) an even smaller percentage to employees who had little to no contact with the customers, such as back of the house cooks and dishwashers.

Shortly after the Cumbie decision, the DOL revised its tip-pool regulation so that the restriction now applied to all employers, regardless of whether they take a tip credit. It did so despite the holding in Cumbie – and notwithstanding comments that the agency received in response to a 2008 notice of proposed rulemaking and comment request on this very issue – that suggested that section 203(m)’s tip-pooling restrictions should only apply to employers that take the tip credit.  

On April 5, 2011, the DOL issued regulations that directly conflicted with the holding in Cumbie. At that time, it was unclear whether the DOL would enforce the new regulations against employers in the Ninth Circuit. In early 2012, the DOL clarified its position on tip pooling by fully rejecting the Ninth Circuit’s decision in Cumbie. As a result, employers could no longer require mandatory tip pooling with back of the house employees. In conjunction with this announcement, the DOL issued an advisory memo directing its field offices nationwide, including those in the Ninth Circuit, to enforce its rule prohibiting mandatory tip pools that include those employees who do not customarily and regularly receive tips.   

The District Court’s Decision in Oregon Restaurant and Lodging Association

Several trade groups stepped up to challenge the DOL’s 2011 rule.  The Oregon Restaurant and Lodging Association’s  challenge resulted in the District of Oregon’s holding that the DOL had exceeded its authority when it issued regulations on tip-pooling restricting restaurants that did not take the tip credit.  In Oregon Restaurant and Lodging Assn. v. Solis, No. 3:12-cv-01261 (D. Or. June 7, 2013), the court held that the language of section 203(m) of the FLSA is clear and unambiguous; it only imposes conditions on employers that take a tip credit. Quoting the Ninth Circuit’s opinion in Cumbie, the court explained that “[a] statute that provides that a person must do X in order to achieve Y does not mandate that a person must do X, period.”  As a result, this decision extended the Cumbie holding allowing mandatory tip pools that include employees who do not normally receive tips so long as a tip credit was not taken to reach the minimum wage. This case has not been appealed to date and is good law subject to citation especially in states located in the Ninth Circuit where no tip credit exists.

In response to Oregon Restaurant and Lodging, and other cases, the DOL appealed but stipulated that it would not attempt to enforce the 2011 tip-pooling rules within states in the Ninth Circuit that do not allow a tip credit.

Scaling Back Cumbie

Despite the uniformity of the District Court’s decisions applying Cumbie, the Ninth Circuit reversed, rejecting the lower court’s application of Cumbie as well as its analysis of the DOL’s action.

In attempting to reconcile Oregon Restaurant and Lodging with Cumbie, the majority stated that the task in that case was merely to decide whether a particular restaurant’s tip pool violated section 203(m), it explained. “We did not hold that the FLSA unambiguously and categorically protects the practice in question.”  In so holding, the majority relied on the U.S. Supreme Court’s reasoning in Christensen v. Harris County decided in 2000, an FLSA case involving compensatory time, which it had cited in Cumbie. According to the Ninth Circuit, Christensen “illustrates the crucial distinction between statutory language that affirmatively protects or prohibits a practice and statutory language that is silent about that practice.” In that case, the Supreme Court construed the FLSA’s silence on the matter to be in favor of the employer, but it did not preclude the agency from enacting regulations in the future that would prohibit the policy at issue. Likewise, the Ninth Circuit majority decision reasoned that the DOL’s 2011 rules are  still valid as the matter occurred prior to the revisions to its regulations.

The appeals court also held that the DOL’s interpretation of section 203(m) was a reasonable one. The agency saw a “loophole” in the law as written, one that was being unfairly exploited as a result of statutory silence; moreover, the AFL-CIO, the National Employment Lawyers Association, and the Chamber of Commerce all agreed (in public comments) that the statutory provision was “confusing” or “misleading.” Consequently, “it was certainly reasonable to conclude that clarification by the DOL was needed.” And the legislative history of the Act supported the agency’s interpretation in making the clarification, despite the employers’ assertions to the contrary.

The dissent by Judge Smith is not kind and states in pertinent part: “Colleagues, even if you don’t like circuit precedent, you must follow it.…Afterwards, you call the case en banc. You cannot create your own contrary precedent.” According to Smith, the case before the Ninth Circuit “is nothing more than Cumbie II,” identical to its predecessor. “The DOL’s promulgation of this new rule changes nothing,” and the matter should have been resolved by a memorandum disposition and upholding the district court decisions.

Practical Guidance for Compliance

As a result of the Ninth Circuit decision in Oregon Restaurant, a company located in the jurisdiction of the Ninth Circuit is no longer allowed to impose a tip pool that allows employees who are not directly in the line of service to be a part of a tip-pool arrangement. “Back of the house” employees such as cooks, kitchen staff and dishwashers who have no contact with the customer going forward are barred from sharing in a tip pool even in a state where the tip credit does not apply.

However, given the DOL’s position not to enforce while the appeal was pending, employers are likely not subject to retroactive application of the regulations. The restaurant organizations and Wynn Las Vegas can ask for the entire Ninth Circuit Court of Appeals to reconsider the decision of the three-judge panel and an appeal can be made to the U.S. Supreme Court. However, it is unknown if these avenues will be considered. Moreover, a reversal by an en banc Ninth Circuit is rare and even less likely would be the U.S. Supreme Court electing to take such an appeal.  

As a result, going forward, employers should take the following steps to limit liability on tip-pooling claims:

• Only include employees who actually contribute to the chain of service and per industry custom regularly are subject to receiving tips. Such individuals typically include those who provide direct service to the customer.  

• Rely on what the employee actually does in his/her job instead of on their job title. For example, an employee carrying the title of “waitress” whose only job is to prepare food outside the view of patrons or without personal contact with patrons will not be appropriately included in a tip pool. Also an employee who has greater contact with the customer should receive a greater percentage of the tip pool than employees who have less direct interaction with the patron.

• Do not distribute any portion of a tip pool to any manager or supervisor, even if that manager or supervisor provides direct table service and/or the tip was left by the patron specifically for that individual.

• Make sure that the tip pool is distributed to participating employees in a reasonable manner, proportionate with the employees’ direct interaction with the customers.

• Review your current tip-pooling arrangement and revise it as needed to comply with this new decision.