Here's a tip

A recent $100 million verdict against Starbucks in a California tip-pooling class action has jolted employers around the country with every bit the kick of a Venti extra-shot Caramel Machiato.
“This verdict has put tip-pooling on everyone’s radar screen,” said Terry Chapko of San Diego, co-counsel for the 120,000 baristas who sued Starbucks for allowing shift supervisors to share in customer tips. “People just can’t believe how much money is in tip jars, but it’s a big percentage of the economy.”
Tip-pooling disputes are brewing all over the country. Companies in the restaurant, hotel, gaming, transportation, delivery and professional sports industries have all faced lawsuits in recent years.
“Employers have continued to recklessly violate the law on tip-pooling,” asserted Boston attorney Shannon Liss-Riordan, who has obtained more than a dozen class action settlements and several big-ticket verdicts for tipped employees. “Some employers are trying to cut their labor costs by allocating tips paid as gratuities to a wider pool of workers.”
Atlanta lawyer Arch Stokes, who has defended employers in tip-pooling cases, said tip-pooling decisions often involve “a complicated labyrinth of legal considerations, and damage calculations can be a seven-figure math problem.”
State and federal regulations have created some dicey grey areas on who can share in tip pools, and the federal Fair Labor Standards Act has exemptions from minimum wage and overtime regulations for certain tipped employees.
“All these rules fit together like a Florentine mosaic,” Stokes said.
Employers can be exposed to damages beyond lost tips if they fail to comply with this complex web of regulations, said Ariel D. Cudkowicz of Seyfarth Shaw’s Boston office, including overtime pay and minimum wage violations, as well as retroactive increases in social security, Medicare, unemployment and retirement contributions.
Not only that, managers and officers run the risk of significant personal exposure in tip-pooling disputes.
“Management often gets named in these cases, especially when they try to referee disputes,” said Houston defense attorney Rachel Powitzky Steely. “Managers can’t be individually liable for most labor violations, but that’s not the case with tip-pooling decisions.”

Trip wires everywhere

Because statutory, regulatory and common law sources often conflict, employers are vulnerable to liability.
The Starbucks verdict illustrated one of the perils for large companies. “Starbucks had one national policy on tip-pooling, but it just did not fit all the states,” said Chapko. “It might have passed muster under federal law to include shift supervisors in the tip-pool because they actually served customers, but California [law] states you can’t have ‘managers or agents of the employer’ in the pool.”
Liss-Riordan, who obtained a $2.5 million verdict for money steered from wait staff to managers at one Boston-area restaurant, said, “Massachusetts courts have made it clear that even managers who assist in customer service cannot participate in tip-pools under our statute. If someone has any managerial authority, that is a no-no for tip-sharing. Likewise, if they are not directly serving patrons, that’s a no-no too.”
Statutes in California, Massachusetts and other states have led to some line-drawing litigation, particularly as to who is serving patrons. Shift supervisors, hostesses, greeters, drink servers and others may fall into different groups in different states. Kitchen or back-room personnel generally must be compensated only by the employer and by voluntary tip-outs from servers who receive gratuities.
At least one state – Minnesota – prohibits management from creating tip-pools for anyone.
Steely said employers should be familiar with FLSA tests for what constitutes a “tip” and “a tipped employee.”
She added that federal law generally permits employers to create tip-pools, but it also dictates who can share in the pool and how much they can be asked to contribute. “Contributions up to 15 percent of tips received will usually pass muster under the ‘customary and reasonable’ test, but contributions calculated as a percentage of sales can be risky,” she said.
Most court battles have centered on who is a “tipped employee,” according to Steely. “Employees can be required to share their pooled tips only with workers who ‘customarily and regularly receive tips,’” she said.
Much litigation has ensued over which employees have degrees of managerial authority that prohibit their participation in tip-pools under state or federal law, said Boston attorney Cudkowicz. “There is no easy definition, so you can’t be sure where someone like a banquet captain might fall, but our Attorney General likens the [Massachusetts] management test to the FLSA test,” he said.
This leads to some plaintiffs asserting they are not managers for wage and hour purposes while other plaintiffs assert that those same complainants are managers for purposes of excluding them from tip-pooling.
Parties frequently dispute the definition of a “tip.”
“Under the FLSA, a ‘service charge’ is not presumed to be a tip, but that is not always the case under state laws,” Cudkowicz said. A customer’s expectations often play a major role in any determination under state or federal law.
The next big wave of litigation will involve the adding of percentage sales charges at function facilities for hotels, clubs and casinos, predicted Liss-Riordan. Massachusetts and New York courts have extended the protections of tip-pooling statutes to some gratuities labeled as “service charges.”
“The question is not what you call the charge, but what the patrons’ expectations are as to who they are compensating with their tips,” she said.
Liss-Riordan has also pursued common law claims of breach of implied contract and tortuous interference with advantageous relations with customers, winning one recent jury verdict in Massachusetts for skycaps who sued American Airlines when “service charges” for curbside check-in cut into their tips.
According to Steely, competitive pricing pressures have forced many employers into hard decisions.
“When you get $2.15 per hour for a tip credit [against your minimum wage obligations] toward the salaries of ‘tipped employees,’ that provides a really strong motivation to expand the pool of those who share tips,” she observed.
“But such a decision could prove to be foolish if squabbles result over the tips,” Steely added. “You have to look at all of the costs and all of the potential liabilities or else your bottom line will suffer.”

Short-lived gains

Employers who lower labor costs by adjusting job descriptions to expand the number of employees in a tip-pool may find their gains to be short-lived and very costly.
Tipped employees who do too many tasks outside of direct service to customers – such as servers who clean floors – may become non-exempt under overtime regulations. Similarly, those who split their tips with too many others could fall below minimum wage floors during a slow week, even after inclusion of applicable tip credits.
If overtime and minimum wage exemptions for tipped employees are lost because of overaggressive tip-pooling, then an employer’s liability could far exceed workers’ share of lost tips.
“Potentially, there are millions of dollars in backup withholdings at stake,” according to Stokes, “so this stuff can bankrupt you. Retroactively, you could end up paying the full minimum wage to all affected employees, recalculating overtime for those who worked longer hours, and adjusting your employer contributions [for social security, Medicare, unemployment and retirement plans].”
More than half of all states provide more favorable minimum wages than the federal government, so it’s tricky to precisely calculate safe practices and exposures for nationwide employers, Stokes cautioned.
“This stuff gets so complicated that damage calculations in a nationwide class are a total nightmare,” said Michael Mankes of Littler Mendelson’s Boston office. “The federal penalties are bad enough, but some states even provide for attorneys’ fees and for treble damages, which could either be mandatory or discretionary.”
The FLSA contains a “presumption” of double damages, which can only be rebutted by proof of an employer’s good faith in decision-making, according to Liss-Riordan.
Record-keeping requirements associated with broader tip pools are a burden as well. Employers must not only record the tips and wages for all who participate in the pool for minimum wage and tax purposes, but they must record hours worked for any employee who loses an overtime exemption. Some state laws and some courts will even mandate specific forms of record-keeping after the commencement of a case.
“If you are not keeping any records for hours worked when someone should have been non-exempt, then you simply can’t rebut their claims of working 50 or 60 hours per week,” said Cudkowicz. “This could become the fastest growing area of wage and hour litigation.”
Another serious concern for employers is classifying customer payments as “service charges” to avoid tip-pooling procedures. “There is no need to collect sales tax on a tip, but a ‘forced gratuity’ might have to be collected in some states,” Stokes explained. “Some employers may be unwittingly taking on a major tax exposure by admitting something is a ‘sales charge’ instead of a ‘tip.’”

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Staying out of trouble

Companies can avoid or minimize statutory tip-pooling liabilities, experts say, by comparing their job descriptions and tip-sharing policies against applicable state and federal laws on a regular basis.
Also, employers can establish a good faith defense under the Fair Labor Standards Act by conducting employment law compliance audits every few years, said Atlanta defense lawyer Arch Stokes.
An audit can also shed light on grey areas in job descriptions that leave doubts about an employee’s legal status as a tipped employee.
According to Houston defense attorney Rachel Powitzky Steely, “You might have to change someone’s job description or leave them out of the tip pool if you want them to remain exempt [from overtime or wage and hour regulations], but that is much less expensive than a lawsuit.”
Companies need to pay especially close attention to multi-tasking job descriptions. “At times, even a waitress might not be able to share in tips if her other [non-serving] duties predominate during her shift,” Steely explained.
Assigning more tasks to tipped employees has led to litigation under the FLSA, which prohibits any tip credit for time spent on non-tipped tasks, and also prohibits tipped employees from spending more than 20 percent of their time not serving patrons.
State statutes are still evolving, as well, which means it’s essential to stay abreast of new developments. For example, the Massachusetts Legislature recently imposed mandatory treble damages for any violation of the state wage laws.
Employee organizations are also likely to push for legislation that would treat “service charges” as “tips” for hotels, casinos, and other facilities, according to Ariel D. Cudkowicz of Seyfarth Shaw’s Boston office.
Employers who are sued can minimize potential harm by attempting to settle early on. “An employer has one big advantage – employees generally need the money sooner than later. They will settle if you come up with a reasonable solution,” said Steely. “But you have to be careful because a heavy-handed approach will create more claims, and settlements involving wage and hour rights generally have to be approved through the courts.”