Private clubs have traditionally utilized service charges on food and beverage sales to supplement club revenue. In most cases, this revenue is used to pay higher wages to all of the employees at the club—including managers and employees not included in the definition of “tipped employees.” This system was developed to allow the clubs to retain valuable employees in the face of seasonal variations in the flow of business. Recently this system has come under fire by plaintiffs’ attorneys looking to take advantage of the language of state statutes to classify these service charges as “tips or gratuities” in order to demand that all service charges be disgorged by the club and paid to a class of past and present employees. They make this claim in spite of the fact that much of the money collected as a service charge is, in fact, paid to the employees as hourly wages. The cases are brought as class actions seeking to represent every employee of the club for a period dating back several years from the filing of the complaint. As a result, these cases can cover hundreds of employees and involve large damage claims.
Service Charge or Gratuity?
The fundamental issue in these cases is whether the service charge is, in fact, a gratuity that is the property of the employee that provided the service to the customer. Some states and localities have expressly addressed service charges in their laws regarding tips and gratuities, while many others do not address this issue at all. Club employers must follow whichever law—federal, state, or even local—is the most generous to employees.
- Minnesota law defines “gratuities” as “monetary contributions received directly or indirectly by an employee from a guest, patron or customer for services rendered and includes an obligatory charge assessed to customers, guests or patrons which might reasonably be construed by the guest, customer or patron as being a payment for personal services rendered by an employee and for which no clear and conspicuous notice is given by the employer to the customer, guest or patron that the charge is not the property of the employee.” Minn. Stat Ann. §177.23, Subd. 9.
- New York law provides that “[n]o employer or his agent or an officer or agent of any corporation, or any other person shall demand or accept, directly or indirectly, any part of the gratuities, received by an employee, or retain any part of a gratuity, or of any charge purported to be a gratuity for an employee.” N.Y. Lab. Law §196-d. Courts in New York have held that whether a mandatory service charge is a gratuity covered by this law is dependent on whether customers reasonably believed that the charges were in fact gratuities for the employee. Some of the factors considered by the New York court included whether the customer was explicitly informed the service charge was not a gratuity and whether the terminology for the service charge was consistent throughout the customer’s experience. Spicer v. Pier Sixty LLC, 269 F.R.D. 321 (S.D.N.Y. 2010).
- Massachusetts law specifically addresses and defines a “service charge” as “a fee charged by an employer to a patron in lieu of a tip to any wait staff employee, service employee or service bartender, including any fee designated as a service charge, tip gratuity, or a fee that a patron or other consumer would reasonably expect to be given to a wait staff employee, service employee, or service bartender in lieu of, or in addition to, a tip.” Mass. Gen. Laws. Ann. §152A.
- Hawaii’s statute plainly states within its statutory text that “[a]ny [h]otel or restaurant that applies a service charge for the sale of food or beverage services . . . shall distribute the service charge directly to its employees as tip income.” [This includes private, nonprofit clubs.] Haw. Rev. Stat. Ann. §481B-14.
- Washington’s state statute requires that “An employer that imposes an automatic service charge related to food, beverages, entertainment, or porterage provided to a customer must disclose in an itemized receipt and in any menu provided to the customer the percentage of the automatic service charge that is paid or is payable directly to the employee or employees serving the customer.” Rev. Code of Wash. § 49.46.160(1).
- Wisconsin law specifically defines a tip separate from a service charge: “Tip means a sum presented by a customer as a gift or gratuity in recognition of some service performed for them. It is to be distinguished from payment of a charge, if any, made for the service. Whether a tip is to be given, and its amount, are matters determined solely by the customer, and generally they have the right to determine who shall be the recipient of their gratuity.” Wisc. Admin. Code § 272.03(2)(c).
The issue identified in each jurisdiction in which this issue has been raised (other than Hawaii) is what the customer reasonably believed the service charge to be. If, under the circumstances, a service charge could reasonably be interpreted to be charged in lieu of leaving a tip, it is likely a court would find that service charge to be subject to the requirements imposed on any tip or gratuity. Also, any finding that the service charge was misrepresented to customers can lead to the filing of additional legal claims, like consumer fraud or breach of contract claims.
Consequences and Risks
If it is determined that service charges were improperly controlled by the employer for an entire class of past and present employees, the club could be required to disgorge all of the service charges collected over the period allowed by the statute and to be paid to the employees. Most states would subject the employer to a penalty for withholding wages that would more than double the amount to be paid to the employee class.
In addition to legal claims over the proper classification and allocation of service charges collected by the club, many clubs are increasingly being sued or audited by government agencies over the handling of employee tips in general. As one example, many private clubs claim to prohibit the payment of tips to its employees, or are “no tipping” establishments. But in reality, these policies are not being enforced. As a result, tips are not properly recorded or reported to state and federal taxing authorities. To avoid these problems, clubs must be sure to strictly audit and enforce policies, and comply with all legal requirements.
Legal claims also arise when management requires (or employees choose) pooling and later distributing tips collected. Some states prohibit mandatory tip sharing practices, and many others prohibit the inclusion of supervisors in tip pool or sharing arrangements. Allocation methods for tip pools have also come under recent scrutiny and generally must be based on hours worked.
More, service charges paid to employees are typically included in the calculation of an employee’s regular or base hourly wage rate for the purpose of calculating overtime due to non-exempt employees. This is unlike a tip, which is not considered part of an employee’s regular rate of pay when calculating overtime. A tip is distinguishable from a service charge because it is voluntarily left by the customer or patron of the club and not provided by the employer. These general rules can differ, however, based on whether your state or local law allows employers to take a “tip credit” deduction and pay employees less than the mandatory minimum wage. When service charges and tips are part of compensation, these legal nuances make it difficult to properly calculate wages due.
Worse yet, service charges are typically distributed in irregular amounts depending on what is received and who worked during a specific shift, causing the regular or base hourly wage rate to constantly fluctuate. Calculating the proper overtime rate payable to an employee in any given work week is dependent on properly calculating an employee’s regular or base hourly wage rate. To stay compliant, clubs must insure they fully understand the local, state and federal laws that apply to tips and service charges.
One of the biggest surprises to private clubs facing these types of claims is that these claims are virtually uninsurable. A claim for the payment of wages is almost always excluded from insurance coverage. At best, a club will be able to insure against the cost of defending a claim of this nature. However, many clubs that are faced with this type of claim are forced to cover the costs of defending the claim and any potential damages on their own.
Here are some steps to take to avoid or minimize these risks:
- Audit existing service charges and tip practice to determine the proper collection, distribution and classification of such funds;
- Review internal documents and communications for references to service charge and tip policies to avoid allegations of any misrepresentations;
- Review compensation structure of club employees and payment of service charge revenue and any gratuities or tips for compliance with applicable law;
- Review notice provisions to employees and customers for compliance with applicable law; and
- Ensure appropriate training of management and staff regarding service charge and tip policies and procedures.
Perry Glantz and Carrie Francis are partners at Stinson Leonard Street, a law firm that represents clubs in areas such as governance, membership programs and day-to-day operations. Glantz can be reached at [email protected] or 303-376-8410. Francis