Eleventh Circuit Distinguishes “Service Charges” From “Tips” Under the FLSA

By Benjamin Lagos - Allen Norton & Blue, P.A.

September 1, 2022

While applying a mandatory service charge to a customer’s bill in the service industry is not new, the COVID-19 pandemic led to the practice becoming more common. The justification given was to assist service workers, who were arguably the hardest hit by lockdowns and capacity limitations. However, it was yet to be determined whether mandatory service charges are “tips” under federal employment law.

In Compere v. Nusret Miami, LLC, a case of first impression, the United States Court of Appeals for the Eleventh Circuit recently addressed the question of whether mandatory service charges imposed by restaurants are “tips” under the Fair Labor Standards Act (FLSA). If the mandatory service charges were found to be tips, federal law would prohibit restaurants from using the fees to pay minimum and overtime wages to employees, but if the charges were not considered tips, establishments would be able to apply the fees toward employee wages.

The Eleventh Circuit case involved Nusret Miami, LLC (Nusret), a steakhouse in Miami. Since opening its doors in 2017, the restaurant has maintained a practice of adding a mandatory 18% service charge to customers’ bills. After collecting these payments, Nusret redistributes the fees to certain employees on a pro rata basis to cover the restaurant’s minimum and overtime wage obligations. Operating in this manner, Nusret uses a provision in the FLSA exempting certain retail and service establishments from paying overtime wages if “‘the regular rate of pay’ of employees exceeds one and one-half times the applicable minimum hourly rate.”

A group of tipped employees at Nusret challenged the restaurant’s compensation scheme in a collective action before the United States District Court for the Southern District of Florida. The employees alleged that they were paid less than the required federal minimum and overtime wages and were forced to participate in an illegal tip pool with non-tipped employees. The employees’ argument was premised upon the belief that, “although their portion of the service charges exceeded the statutory wage requirements (e.g., some employees made over $100,000 per year), Nusret still violated the FLSA because the 18% ‘service charge’ was not a service charge, but, in fact, a tip.” The employees reasoned that because tips were not part of their regular rate of pay, Nusret was unable to use the “tips” at issue to offset its wage obligations under the FLSA. Nusret’s argument on summary judgment was that the 18% fee was a “bona fide service charge”; that the evidence showed the employees were compensated above the statutorily required wage rate; that the decision to add a tip and determine the amount of the tip is entirely within the customer’s discretion; and “[b]ecause Nusret did not allow customers to refuse to pay the service charge, it was not a tip.” In response,the employees argued that Nusret was required to report the income from the mandatory service charges in gross receipts on the restaurant’s tax returns, if the 18% mandatory fee was in fact a bona fide service charge.

The district court rejected the employees’ argument and concluded that Nusret “satisfied the 29 U.S.C. § 207(i) exemption because: (1) it was a retail or service establishment; (2) it was undisputed that at all relevant times [Employees’] ‘regular rate of pay’ was more than one and one-half times the minimum wage; and (3) more than half of the Employees’ compensation for the relevant time consisted of commissions on goods or services.” The district court considered the definition of a tip as set forth in 29 C.F.R. § 531.52 and highlighted the fact that Nusret’s service charge was not paid directly to its employees; nor did customers have the option to direct receipt of the service charge to an individual employee. Relying on Ninth Circuit precedent, the district court observed that “the essential element of a tip is its voluntary nature” and noted that Nusret’s customers had no choice but to pay the service charge.

On appeal, the parties did not dispute “that if the service charge [was] properly considered part of the Employees’ ‘regular rate of pay,’ Nusret satisfied its overtime and minimum wage obligations under the FLSA because the Employees were paid well above 1.5 times Florida’s minimum wage per hour.” Instead, the primary issue before the Eleventh Circuit was whether the service charge was in fact a tip and therefore not eligible to be used to satisfy the restaurant’s wage obligations under the overtime exemption in 29 U.S.C. § 207(i) “because tips cannot count toward the hourly ‘regular rate of pay.’” The Eleventh Circuit affirmed the lower court’s findings and held that “Nusret’s service charge was not a tip under the FLSA or other [Department of Labor (DOL)] regulations and was therefore part of the Employees’ ‘regular rate of pay.’”

The Eleventh Circuit noted that the FLSA does not define “tip” nor “service charge”; however, DOL regulations explain that “the critical feature of a ‘tip’ is that ‘[w]hether a tip is to be given, and its amount, are matters determined solely by the customer.’” The court emphasized the distinction between “a payment of a charge, if any made for the service,” and a “tip,” which is presented by a customer “as a gift or gratuity in recognition of some service performed for the customer.” Accordingly, the Eleventh Circuit concluded that Nusret’s service charge is not a tip because the amount of the service charge and the decision to pay it are determined by the restaurant, rather than the customer. In that regard, the court noted the lead plaintiff conceded in deposition testimony that employees “were told that the service charge was supposed to be mandatory as if it was an item that a person ordered . . . [;] it had to be on the check.” Additionally, DOL regulations mention “examples of amounts not received as tips” and speak directly to the type of charge at issue, explaining that “[a] compulsory charge for service, such as 15 percent of the amount of the bill, imposed on a customer by an employer’s establishment, is not a tip . . . .”

The employees maintained that a service charge is a tip unless an employer includes the charge in its gross receipts for tax purposes. According to the employees, “Nusret failed to show that it included the service charges in its federal tax  returns,” and, therefore, a genuine issue of material fact existed as to whether the service charge was a tip.The Eleventh Circuit dismissed this contention, directly stating that  “Nusret’s tax forms are irrelevant” and holding, “as a matter of law, Nusret’s mandatory 18% service charge was not a ‘tip’ no matter how it was treated on Nusret’s tax returns.” Further, the Eleventh Circuit found that a DOL regulation explaining that “service charges and other similar sums which become part of the employer’s gross receipts are not tips” merely provides examples of non-tips and does not purport to define “tips” under the FLSA. Finally, the employees argued that Nusret’s service charge was not mandatory because “managers had the discretion to remove the charges on the bills of dissatisfied customers (much like a manager might ‘comp’ an entrée).” The Eleventh Circuit again emphasized that because the customers had no ability on their own to determine whether they would pay the service charge, it was “irrelevant that managers would sometimes remove the service charge for dissatisfied customers.”

In summary, the Eleventh Circuit concluded that the determination of whether a “mandatory service charge” is in fact a service charge, rather than a tip, is impacted by whether the decision to pay the charge—and the amount to pay—are determined by the customer or by the establishment.

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