A service fee can provide a welcome boost to a company’s bottom line, but employers need to manage and mitigate the risk of lawsuits, reimbursement and damages.
Recent developments across the country are a reminder that employers in the hospitality industry should carefully consider applicable limits and requirements before adding mandatory service charges to guest checks and event contracts, especially in states such as New York, California and Washington.
Alleged Misdisclosed service fee leads to major settlement in Washington
In December 2018, a former employee of a large and prominent Seattle-based restaurant group filed a class action lawsuit, primarily claiming that the defendants violated a Washington law (RCW 49.46.160) requiring an employer to impose “ automatic service charge related to food, beverage, entertainment or porterage provided to a customer must disclose in an itemized receipt and in any menu provided to the customer the percentage of automatic service charge paid or payable directly to the employee or employees who serve the customer. The band reportedly included the following disclosure on its receipts and menus: “20% Service Fee: 100% of these funds are distributed to our team in the form of salaries, sales commissions, benefits and revenue sharing. revenue” or “20% service charge added”. . 100% of these funds are distributed to our team. According to the plaintiff, this disclosure was insufficient because the service employees would not have received 100% of the service fee proceeds.
Following mediation, and without the court finding that the language was inadequate, the defendants recently agreed to pay $2.4 million to settle the claims of 1,360 class members and also to give the band members $200 gift cards – a high price for an allegedly misleading phrase.
Service charges now qualify as tips in California
On October 31, the California Court of Appeals ruled on a 21% service charge that a San Francisco ballroom added to food and beverage bills for its banquets and was allegedly partially withheld . The question before the court was whether this practice complied with a California law (Labour Code 351) that prohibits employers and their agents from retaining any portion of a gratuity – specifically, if the service charge qualified gratuity under the law.
Breaking with the apparent rule of previous court rulings and directions from the labor commissioner, the court held that a service commission may comparable to a gratuity, the full amount of which should then be distributed to service employees. Because of the way the case came to court on appeal, the court declined to provide a more specific definition as to exactly when a mandatory service fee could be considered a gratuity. Employers now find themselves in a risky bind where the legality of maintaining service fees is unclear.
The disclaimer must appear on all documents listing service charges in New York
In New York, as in California, employers and their agents cannot withhold gratuities in whole or in part (Labour Law § 196-d). For the hospitality industry, this means that service charges – defined as those “in addition to charges for food, beverages, lodging and other specified materials or services” – are presumed to be tips. One way to overcome this presumption is to include a disclaimer of very specific requirements on menus and invoices. Standard wording provided by the Department of Labor explains that the service charge “is for the administration of the banquet, special function or package, is not intended to be a gratuity, and will not be distributed as gratuities to employees who provided service to guests.”
In Ahmed vs. Morgan’s Hotel Group Management, LLC, the Appeals Division ruled that employers can rebut the presumption that a service charge is a gratuity as long as a “reasonable customer” understands that the service charge is not a gratuity, regardless of the omission of the disclaimer. However, recent court decisions have refocused attention on the wording of the disclaimer, indicating that an employer may find it difficult to overcome the presumption unless adequate language is included on all documents shared. with the customer and not only on menus and invoices.
Additional risks: taxes and calculation of overtime
Employers should exercise caution for additional reasons described in a previous alert that discusses tax issues surrounding the distinction between tips and service charges. First, pursuant to a tax ruling, the Internal Revenue Service does not consider money paid by a customer to be a tip unless the payment meets four factors:
- The customer presents the money without constraint.
- The customer has the unlimited right to determine the amount.
- The amount is not subject to negotiation or dictated by employer policy.
- The client can dictate and determine the recipient.
Obviously, a mandatory service fee fails this test on several counts. There are a few undesirable effects that result, including the loss of FICA tip credit and the treatment of service charges as income for the employer.
Second, because the mandatory service charge is not treated as tipping under the Fair Labor Standards Act (and some state labor laws), the portion of the service charge passed on to each employee must be factored into their “normal rate”, which is used to calculate their overtime rate. A large distribution to an employee of a mandatory service charge has the potential to significantly increase their overtime rate, which the employer must remember to recalculate and pay accordingly or they will be held liable for overtime. underpaid.
As laws and court rulings vary from state to state, it is essential to know and understand the requirements and limitations on service fees under federal law and applicable state law. . Although the safest strategy is an optional gratuity, in an amount selected by the client, and fully distributed to service personnel, service fees can be used to the benefit of the employer when executed well. . Exercising with caution and consulting advice can help mitigate a number of risks and can help businesses position themselves to increase revenue.