Restaurant’s Fee Deduction Program Violates FLSA

Restaurant's Fee Deduction Program Violates FLSA

Employers whose workers earn most of their compensation through tips, such as restaurant employees, know that they walk a fine line to ensure compliance with the Fair Labor Standards Act (“FLSA”) and numerous other laws.  Last month the Fifth Circuit rejected a program instituted by a restaurant operator in Texas that deducted certain fees before paying tips to its restaurant workers that were earned by customers using credit cards. While the ruling does not close the door on such arrangements, employers who utilize such programs will be under scrutiny to ensure strict compliance with the FLSA.

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In Steele v. Leasing Enterprises, Ltd., the defendant owned and operated a number of Perry’s restaurants, primarily in Texas. Its servers were paid $2.13 per hour in base pay in accordance with 29 U.S.C. §203(m) and 29 C.F.R. §§531.52, 531.59, plus tips received from customers. However, if a server received a tip paid by credit card, the restaurants retained 3.25% of the tip to offset credit card issuer fees and other costs the restaurants incurred in collecting and distributing the tips. Specifically, the restaurants had instituted a program to ensure cash deliveries by armored vehicle three times a week to meet their employees’ demands they be paid their tips daily as well as additional accounting and related expenses in making these payments.

In August 2009, the plaintiffs brought a class action challenging this fee deduction program and following a bench trial, the lower court found that the restaurants’ 3.25% offset violated the FLSA because it exceeded the actual credit card issuer fees incurred by the restaurants.  The trial court found, however, that the restaurants did not willfully violate the FLSA and declined to award liquidated damages or attorneys’ fees to Plaintiffs.   Both sides appealed the trial courts findings to the Fifth Circuit.

As to whether the fee deduction program complied with the FLSA, the Fifth Circuit began by recognizing that it requires employers pay employees a minimum wage of $7.25 per hour; however, employees who receive tips may be paid a base pay of $2.13 per hour if the total amount of tips equal or exceeds the national minimum wage.  This pay structure essentially allows the employer to claim a “tip credit” in connection with meeting its minimum wage obligations. However, an employer may only claim a tip credit if “all tips received by [a tipped] employee have been retained by the employee” (subject to an exception not relevant in this case).  The employer has the burden of proving that it is entitled to a tip credit.

Only one other circuit, the Sixth, had previously considered a similar fee deduction arrangement in connection with paying tips earned by credit cards to its employees.  In Myers v. Copper Cellar Corp., 192 F.3d 546 (6th Cir. 1999), the Court upheld a fixed 3% deduction from employee tip pools whenever a customer tipped by credit card to account for the credit card issuer fees.  In that case, there was evidence that these fees both exceeded and fell below the 3% fixed service charge. However, the employer had met its burden by showing in the aggregate that its 3% service charge was less than the actual issuer fees charged by credit card issuers.  The Sixth Circuit also recognized that the DOL had long acknowledged an employer’s right to deduct credit card issuer fees in connection with the payment of tips to its employees.

Following the Myers decision, the DOL issued amended guidance recognizing that employer could deduct for credit card issuer fees so long as “the employer reduces the amount of credit card tips paid to the employee by an amount no greater than the amount charged to the employer by the credit card company.”  In light of this, the Fifth Circuit agreed with the restaurants that credit card fees are a compulsory cost of collecting credit card tips and that an employer could deduct a fixed composite amount from credit card tips “so long as that composite does not exceed the total expenditure on credit card issuer fees”.

Unfortunately for the Perry’s restaurants, they had to concede that the 3.25% offset they charged their employees exceeded the total credit card issuer fees incurred, which included “swipe fees, charge backs, void fees and manual entry fees.”  The evidence demonstrated that the amounts deducted by Perry’s exceeded the actual credit card issuer fees by at least $7,500 a year and by nearly $40,000 in 2012.  Given this, Perry’s argued that an employer could also deduct the additional expenditures associated with paying credit card tips and still maintain the tip credit.  In essence, Perry’s argued that the additional cost that it was incurring in paying its employees credit card fees, such as arranging for armored car deliveries to its restaurant, should be considered in determining whether it was still entitled to the tip credit.

The evidence showed, however, that Perry’s had made a “business decision” to arrange for the armored car cash deliveries to pay its employees in order to decrease security concerns associated with keeping too much cash in each of its restaurants to make such payments.  The Court concluded that this “business decision” was discretionary and not “a fee directly attributable to its cost of dealing in credit.”   The Court concluded that allowing Perry’s to deduct what were in essence “discretionary costs” was in conflict with the FLSA’s mandate that “all tips received by such employee have been retained by the employee” in order to maintain the statutory tip credit.  The Court found that because the offset “always exceed the direct cost required to convert credit card tips to cash,” it was in violation of the FLSA and the defendant “must be divested of its statutory tip credit for the relevant time period.”

However, the Court upheld the determination that the restaurants were not liable for liquidated damages because its conduct was in good faith.  The Court found it significant that Perry’s offset was less than 1% higher than the national average of credit card issuer fees and that it had previously undergone a DOL investigation, which had concluded that its offset conformed with the FLSA.  The Court found that Perry’s executives acted in good faith in relying on the investigator’s determination in continuing to operate the fee deduction program, even in spite of a 2010 interlocutory order by the district court finding that it violated the FLSA.

Finally, the Fifth Circuit turned to the Plaintiffs’ appeal of the denial of attorney’s fees to them.  The lower court found that several of its claims were “superfluous” and had “needlessly increased the cost of litigation for all parties” in justifying its denial of any attorney’s fees to the plaintiffs.  The Fifth Circuit found that the FLSA provides that “reasonable attorney’s fees are mandatory” when there is a violation of section 206.  Although the lower court has discretion in determining what is reasonable in making an award of attorneys’ fees, it does not have discretion to prohibit them outright.  The Fifth Circuit remanded the issue back to the court to determine the amount of attorney’s fees to be awarded to the Plaintiff.

Employers who operate within the confines of the Fifth Circuit Court of Appeals, primarily Texas, and seek to claim a “tip credit” under the FLSA are reminded to ensure that they are deducting no more than the actual costs incurred in paying tips to their employees which have been charged by credit card. To the extent the employer institutes a program that seeks to utilize an average cost system, employers should make sure that it can prove that such a rate does not exceed the actual cost of tips paid by credit cards. Employers who wish to institute such programs are also advised to confer with legal counsel before instituting such a practice to ensure compliance with the FLSA.

Contributor:  James Kachmar, Shareholder | Weintraub Tobin

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