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Everybody Out of the Pool: Ninth Circuit Determines That Only Customarily Tipped Employees May Participate in Tip-Pooling Arrangements Under Fair Labor Standards Act

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On February 23, 2016, the Ninth Circuit Court of Appeals determined that the Fair Labor Standards Act (the "FLSA") prohibits employers from requiring employees to participate in tip-pooling arrangements that include both customarily tipped employees and employees who are not customarily tipped. 

The Court's ruling effectively overturns its 2010 determination that the FLSA permits such tip-pooling arrangements so long as the employer pays its tipped employees at least the federal minimum wage and does not fulfill any part of its hourly minimum-wage obligation to employees with tip income ("taking a tip credit"). 

For Oregon and Washington employers—none of which may take a tip credit (with limited exceptions for "small employers" in Seattle, Washington)—the Court's ruling effectively prohibits tip-pooling arrangements that include employees who are not customarily tipped.

The Law Before February 23, 2016:  Tip-Pooling Arrangements Can Include Employees Who Are Not Customarily Tipped.

Six years ago, the Court addressed tip-pooling arrangements between customarily tipped employees and employees who are not customarily tipped in Cumbie v. Woody Woo, Inc., 596 F3d 577 (9th Cir 2010). 

The employee in Cumbie worked as a waitress. She received an hourly wage that exceeded federal minimum wage, and she also received tips that her employer required her to contribute to a tip pool that was then redistributed to all nonmanagement restaurant employees:  55 to 70 percent of the tip pool went to back-of-house staff, and the remaining 30 to 45 percent went to front-of-house staff in proportion to their hours worked. 

The employee challenged her employer's tip-pooling arrangement, arguing that it violated the minimum-wage provisions of the FLSA by redistributing tips to employees who are not customarily tipped in the restaurant industry. 

The employer responded that the FLSA prohibits tip-pooling arrangements that include distributions to employees who are not customarily tipped only when the employer takes a "tip credit" toward its minimum-wage obligations (a prohibited practice under Oregon law), and that because it did not take a "tip credit," its tip-pooling arrangement did not run afoul of the FLSA.

The Ninth Circuit sided with the employer. The Court recognized that an arrangement to redistribute tips is "presumptively valid" in the absence of "statutory interference," and that "an employment practice does not violate the FLSA unless the FLSA prohibits it." And because the FLSA "does not restrict tip pooling when no tip credit is taken," the practice does not violate the FLSA.

The Law Now:  Tip-Pooling Arrangements Cannot Include Employees Who Are Not Customarily Tipped.

The Court's February 23, 2016, majority opinion in Oregon Restaurant & Lodging Ass'n v. Perez marks a sharp reversal in course from Cumbie

The Perez opinion addresses two cases, both of which arose out of a rule promulgated in 2011 by the Department of Labor (the "2011 Rule").  The 2011 Rule clarified that:

"Tips are the property of the employee whether or not the employer has taken a tip credit under [the FLSA]. The employer is prohibited from using an employee's tips, whether or not it has taken a tip credit, for any reason other than that which is statutorily permitted * * *:  As a credit against its minimum wage obligations to the employee, or in furtherance of a valid tip pool."  (Emphasis added.)

The prior DOL rule stated, "In the absence of an agreement to the contrary between the recipient and a third party, a tip becomes the property of the person in recognition of whose service it is presented by the customer." Thus, employers could contract with their tipped employees to utilize tip-pooling arrangements that included both customarily tipped employees and employees who were not customarily tipped.

Perez involved two different lower-court cases:

  • Oregon Restaurant & Lodging v. Solis was an Oregon case in which the plaintiffs—a restaurant employee, a restaurant owner, and restaurant associations from Oregon, Washington, and Alaska—challenged the validity of the 2011 Rule. The Oregon federal court judge determined that Cumbie left no room for DOL to regulate employers that do not take a tip credit, and that the 2011 Rule was therefore invalid. 
  • Cesarz v. Wynn Las Vegas, LLC, was a Nevada case in which the plaintiffs—casino dealers at a Las Vegas hotel—sued their employer under the FLSA on the grounds that its tip-allocation arrangement, which required customarily tipped employees (servers and casino dealers) to share tips with employees who were not customarily tipped (kitchen staff and casino floor supervisors). The Nevada federal court judge dismissed the plaintiffs' case, holding that "DOL may not read the tip credit condition out of the [FLSA] via its regulations." 

On appeal, a majority of the Ninth Circuit reversed and remanded both cases. The majority reasoned that DOL's new interpretation of the FLSA in the 2011 Rule was entitled to "controlling weight" because (1) the DOL has delegated authority under the FLSA to make rules carrying the force of law, (2) the FLSA is silent on whether employers that do not take a tip credit may require tip-pooling arrangements that include employees who are not customarily tipped, and (3) the 2011 Rule was reasonable and "closely aligned" with the FLSA's congressional intent. 

The majority concluded that in light of the 2011 Rule, which unequivocally states that tips belong to the employee receiving them, and that employers may use an employee's tips only "in furtherance of a valid tip pool," employers may not include in tip-pooling arrangements employees who are not customarily tipped.

What Should Employers With Tip-Pooling Arrangements Do?

Employers that require employees to participate in tip-pooling arrangements that include both customarily tipped employees and employees who are not customarily tipped should immediately suspend their tip-pooling arrangements, or risk running afoul of the FLSA (as currently interpreted by the Ninth Circuit). 

Employers whose tip-pooling arrangements include only customarily tipped employees may continue their practices, since tip-pooling arrangements are "valid tip pool[s]" under the FLSA.

Is This the Last Word on Tip-Pooling Arrangements?

Not necessarily. The Court's decision in Perez was 2-1, and included a dissenting opinion from Judge Smith that sharply criticized the majority for not following Cumbie:

"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."

Judge Smith took issue with the majority's reliance on the 2011 Rule—which interprets the FLSA—when Congress's intent behind the FLSA is clear:  "if Congress's intent behind a statute is clear, that is the end of our inquiry. We need not defer to an agency's interpretation of this statute." 

Whether the employers in Perez will seek en banc review remains to be seen. But for now, employers should suspend mandatory tip-pooling arrangements that include employees who are not customarily tipped.