California (December 6, 2019) - Last month, in O'Grady v. Merchant Exchange Productions, Inc., the California Court of Appeal held that a mandatory "service charge" may be considered a "gratuity" for purposes of Labor Code section 351. As a result, an employer who charges a mandatory "service charge," but then retains all or some of the service charge, may be in violation of section 351. However, the O'Grady decision did not create a bright-line rule as to when service charges are considered gratuity, which will likely leave the door open for ongoing litigation on this issue.
Labor Code § 351 and the Definition of "Gratuity"
The Court of Appeal's decision is based on the intent of the patron. In other words, whether a service charge will be considered gratuity appears to rest on whether the customer intended to leave a tip for the waiter or waitress. Moreover, the Court of Appeal did not hold that a mandatory service charge will always be considered a "gratuity." Rather, the holding merely states that "there is no categorical prohibition why what is called a service charge cannot also meet the statutory definition of a gratuity."
A brief look at the statutory language helps frame the issue presented in the case. The relevant portions of section 351 read: "No employer or agent shall collect, take, or receive any gratuity or a part thereof that is paid, given to, or left for an employee by a patron, or deduct any amount from wages due an employee on account of gratuity, or require an employee to credit the amount, or any part thereof, of a gratuity against and as a part of the wages due the employee from the employer. Every gratuity is hereby declared to be the sole property of the employee or employees to whom it was paid, given or left for." Furthermore, "gratuity" is defined as "any tip, gratuity, money, or part thereof that has been paid or given to or left for an employee by a patron of a business over and above the actual amount due the business for services rendered or for goods, food, drink, or articles sold or served to the patron."
The O'Grady Decision
In O'Grady, the plaintiff – a self-described "banquet server and bartender" – brought a putative class action for herself and similarly situated employees alleging that her employer was in violation of section 351. She alleged her employer had a practice of "automatically imposing a 21% 'service charge' to every food and beverage banquet bill." The supposed violation of section 351 arose when her employer allegedly failed to remit "the total proceeds of [the mandatory service charge] to non-managerial employees who served the food and beverages," but instead retained the service charge for itself or its other non-service employees. Notably, the service charge was 21%, which falls in line with standard tipping practices, lending the impression to customers that it was being paid to the server.
The employer-defendant argued that a "service charge" does not meet the definition of a "gratuity," and cited to the Court of Appeal's previous decisions in Searle v. Wyndham Int'l, Inc. and Garcia v. Four Points Sheraton LAX. The trial court agreed and sustained the employer's demurrer without leave to amend. However, the Court of Appeal disagreed and reversed. The Court distinguished Searle and Garcia on multiple grounds, but focused on the fact that "[n]either Searle nor Garcia involved what we have here – an employee who alleges that what the ballroom customer meant for employees to have is being kept by the employer." The Court of Appeal concluded "[n]either [Searle nor Garcia], or both together, should be read... as categorically establishing that what may be called a 'service charge' by an employer can never be a gratuity."
Best Practices for Imposing "Service Charges" in Light of O'Grady
Because O'Grady came to the Court of Appeal on an appeal from a demurrer, and there has been no dispositive ruling, it is unclear whether the employer-defendant's practice of charging the 21% service charge will actually constitute a violation of section 351. At this juncture, the only certainty is that retaining all or some of a service charge meant to be gratuity for staff "may" be a violation. Given the Court of Appeal's rationale in O'Grady, the ultimate determination rests entirely upon the intent of the customer.
Following the O'Grady decision, employers charging customers mandatory "service charges" should review their service charge practice to determine whether they are in conformity with Labor Code section 351's prohibition on employers taking "gratuity" left by patrons. The holding in O'Grady only implicates employers who retain all or part of the service charge for themselves or share the service charge with non-service staff. Employers who impose mandatory service charges but remit all of the service charge to service staff do not need to worry about their practices since they are, by definition, not in violation of section 351.
For those employers who do retain a portion of the mandatory service charge, we recommend examining how the service charge is presented to the customer, and asking "would the customer believe the service charge is being kept by the waiter/waitress or by the establishment?" If the answer is "by the waiter/waitress," the service charge must either be paid to the waiter/waitress, or the presentation of the service charge should be reconfigured so customers are fully aware that it is being retained by the establishment. One way to achieve this is to include a disclaimer on the receipt which explicitly states that the service charge will be solely retained by the establishment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
