The Journal of The DuPage County Bar Association

Back Issues > Vol. 24 (2011-12)

Restaurant Guidelines for Paying Tipped Employees Under the Fair Labor Standards Act: Avoiding the Hook in the Bait
By Jeffry J. Knuckles and Nicholas R. Galasso

This article is designed to highlight cases which have recently interpreted various sections of the Fair Labor Standards Act, 29 U.S.C. §§ 201 et seq. (the “FLSA”), as it applies to tipped employees in the restaurant industry (wait staff, bartenders, etc.).  The law itself, of course, is not industry specific, and applies across the board to virtually every business or enterprise.  However, with the advent of class actions and an aggressive plaintiff’s bar of talented attorneys, restaurants and their owners have become “targets” in litigation.  A few simple examples from cases in the federal courts may serve to remind the restaurant industry of its federally mandated obligations to its hourly/tipped employees.  In that regard, a “self audit” of internal policies, record keeping, and compensation models may insulate the enterprise from liability.

"The internal, or self-audit, is vital for another, more practical reason:  claims and/or losses, and the defense thereof, are not insurable risks.  As a consequence, the cost of defense, payment of any adverse judgment, and payment of plaintiff’s attorney’s fees should the plaintiff “prevail”, comes from the pocket of the company and/or its owner-officers, not its insurer.  Hence, a small investment now, to tidy up policies and compensation matters, is a certain hedge against future, and more profound, losses due to claims under the FLSA.

"Finally, the negative publicity generated by litigation (regardless of the outcome) will certainly have an adverse local impact on customers, and revenue.  Since both former and current employees may be part of a plaintiff’s opt-in class against the employer/entity, a natural and often resentful attitude will result that will continue the downward spiral of the enterprise. 

This Article also includes a simple and important checklist that serves as a guideline to compliance for your internal policy audit—a shield, if you will, against the barbarous consequences of litigation.

"Legislative History. In order to give historical perspective to the following discussion, it’s important to appreciate the environment that existed at the time of the 1938 legislation that, after dozens of amendments, became the Fair Labor Standards Act, in particular its minimum wage aspects that pertain to “tipped” employees.

"The 1930s was a tumultuous period that endured the Great Depression and the challenges that came with it.  Also at this time, employers had significant leverage over their workforce.  There were no minimum wages, and so the “competition” in the free market of labor was the only mechanism by which wages were calculated.  Similarly, the number of hours worked in a given week was also unregulated, again with the demands of employers generally dictating labor standards.  This formula, combined with a struggling and rebuilding economy that garnered more demand for jobs than the supply of work, lead to nationwide unfair treatment of the labor force, especially in manufacturing and industrial-type enterprises.  Despite the employers’ argument that any minimum wage or maximum hours-worked standards would drive up costs for employers and businesses, thereby decreasing output and stalling the economy, the Congress thought better of it and laid the groundwork for the wage and hour system as we know it today.

The general purpose of the original bill was threefold:  (1) To provide a method of obtaining minimum wages and maximum working hours in industries engaged in the transportation of goods in interstate commerce.  (It is interesting to note that the original bill specifically excluded local businesses and the services industries from any minimum wage or maximum hours standards.); (2) to provide for (legal) action against those businesses/employers engaged in, or having a substantial effect on, interstate commerce and violating the bill’s provisions; and (3) to prohibit the transportation of goods produced by children in interstate commerce.[1]  It is clear that each of the three aims of the original bill required the involvement of interstate commerce in order for the bill’s provisions to apply.

The original bill contemplated that enforcement of the bill’s provisions would be vested in a labor board (e.g., the setting of minimum wages, causing suits to be filed on behalf of employees against employers, etc.).  However, the final version of the originally-enacted FLSA sought to defray the cost to the government, and thus the taxpayers, of enforcing the FLSA’s provisions by allowing employees to (i) file suit on their own and (ii) recover attorney’s fees for successfully demonstrating a violation of the FLSA by an employer.[2]  Thus, the purpose of the attorney’s fees provision was to shift the burden and cost of (meritorious) suits away from the government (i.e., taxpayers) and employees, and to the employer.  It seems fairly clear based on the Congressional Record that Congress envisioned a successful suit to mean some demonstration by the employee that the employer committed a grave, egregious, systematic or willful violation of the FLSA.

Over time, the FLSA has been expanded to include nearly every type of industry in any locale doing any type of business (and not just manufacturing/industrial businesses engaged in interstate commerce).  This expansion is attributable to both legislative amendments and nearly 75 years of case law interpreting the FLSA.

Minimum Wage and the Tipped Employee. Federal Regulations allow a restaurant a credit against paying the full minimum wage, so long as the employee customarily and regularly receives more than $30 per month in tips.[3]  The commonly understood prerequisites for the employer to pay less than the minimum wage (take advantage of the tip credit) require compliance with section 203(m) of the Act:  “In determining the wage of a tipped employee, the amount paid such employee by his employer shall be deemed to be increased on account of tips by an amount determined by the employer, but not by an amount in excess of 50% of the applicable minimum wage rate.”[4]

To take advantage of the credit, the following must occur: (1) The employee must be informed by the employer of the provisions of section 203(m); and (2) 29 C.F.R. § 516.28 requires that the employer also maintain and preserve the following records for a tipped employee: (a) A symbol or letter placed on the pay records identifying each employee whose wage is determined in part by tips; (b) Weekly or monthly amount reported by the employee; (c) Amount by which wages of each tipped employee have been deemed to be increased by tips as determined by the employer; (d) Hours worked each workday…in which the employee does not receive tips, and a total daily or weekly straight-time payment made by the employer for such hours; (e) Hours worked each workday…in which the employee receives tips, and the total daily or weekly straight time earnings for such hours; (3) The tipped employee retains all tips received (though 29 U.S.C. § 203(m) does not prohibit the pooling of tips among employees who customarily receive tips).

Conversely, failure to inform the employee that the restaurant would be receiving a tip credit to offset its minimum wage obligation voids the credit, makes the restaurant liable for the full minimum wage.  In other words, the tip credit does not turn on whether the employee actually received the tips, but on whether the restaurant statutorily met its notice requirements.  In Richard v. Marriott Corp.[5]  the court noted that the statute allows a restaurant employer a tip credit only if it precisely followed the language of section 203(m).

To qualify for the tip credit, an employer must demonstrate, among other requirements, that the “employee has been informed by the employer of the [tip credit] provisions….”[6]  However, there is conflicting authority on whether the employer must not only notify the employee but also explain the tip credit.[7]  The Sixth Circuit in Kilgore v. Outback Steakhouse of Florida, Inc[8] sought to answer two questions:  What information must the employer pass along to the employee and how may the employer convey that information.[9]

In Kilgore, the defendant-employer had provided its employees with a “file folder” containing various written materials, including a statement describing the employer’s tip policy.  This written statement fully quoted § 203(m) and expressly informed the reader that “tips will be used as a credit against the minimum wage as permitted by federal and/or state law.”[10]  The Sixth Circuit held that the written materials provided by the defendant adequately informed the employees of the tip credit, and therefore satisfied the employer’s § 203(m) notice requirement as to those employees who actually received these materials.[11]

The Sixth Circuit held that an employer “must inform the employee that it intends to treat tips as satisfying part of the employer’s minimum wage obligation.”[12]  The Sixth Circuit explained: “[W]e conclude that an employer must provide notice to the employees, but need not necessarily ‘explain’ the tip credit….  The statute requires that the employee be ‘informed’ of the tip credit.” [13] There court continued, “‘[I]nform’ requires less from an employer than the word ‘explain’ would.”[14]

"The U.S. District Court for the Northern District of Indiana in Davis v. B & S, Inc.[15] stated, “The Kilgore decision demonstrates that an employer may meet the notice requirement simply by providing conforming written materials to its employees.”[16]  The court continued, “This holding is supported by dicta from other decisions indicating that an employer can satisfactorily convey notice of the tip credit by way of a poster, if the content of the poster is otherwise sufficient and it is prominently displayed.”[17]  The court in Davis went on to extend the acceptable means by which notice may occur: “[I]f an employer can satisfactorily meet the notice requirement of § 203(m) by simply providing its employees with a file folder containing the relevant information or by prominently displaying a poster, then it follows that the notice can also be conveyed to employees through an individual co-worker regardless of whether that individual meets the technical definition of “employer” under the FLSA.”[18] 

"Therefore, a prominently displayed poster or file folder given to employees containing the relevant portions of the tip credit provision of the FLSA would likely satisfy the notice requirement under Kilgore and Davis.

"On May 5, 2011, the Department of Labor issued regulations which aim to clarify the meaning of “inform” as well as the employer’s requirements regarding notice.  The new regulations[19] provide that the employer must, in order to take the tip credit, inform its employees of the following: (1) The amount of the cash wage to be paid by the employer to the tipped employee; (2) The amount of tips to be credited as wages toward the minimum wage; (3) That all tips received by the employee must be retained by the employee except for tips contributed to a valid tip pool limited to employees who customarily and regularly receive tips; (4)That the tip credit shall not apply to any employee who has not been informed by the employer of the provisions for a tip credit; and (5) For employers that require tip pools, any required tip pool contribution amount or percentage, including notice that the tip credit may be taken only as to the amount the server actually receives, and that the employer may not retain any of the server’s tips for any other purpose. [20] While employers may give the foregoing notice orally, it is highly advisable to do so in writing and obtain each employee’s signature affirming his/her understanding of the notice’s provisions.

 "Opt-In Class Actions. Assuming that an employee can allege that the restaurant has, in some manner, violated the FLSA, then the single employee suddenly gains clout by filing a motion under section 216(b) asking the court to conditionally certify a class, consisting of all current and former (going back up to three years) employees.

"In short, the single employee now has the ability to convert a seemingly small claim into a far-reaching class representing himself…and other similarly situated employees.  There is a two-tiered approach applied: (1) The court must make a preliminary decision (the “notice” stage) whether a notice of the pending action should be sent to other current/former employees, giving them an opportunity to “opt-in” to the class; (2) After this conditional certification (which is leniently granted), the case proceeds through discovery (depositions, etc.) and then a final determination is made by the court as to the size of the class.

Imagine the consequences of each of your current, and former employees, receiving a written notice, describing the allegations against your restaurant, and giving them a written consent form to “opt in”, along with the name and phone number of their law firm.  Since most of the plaintiffs’ cases are prosecuted on a contingent fee, there aren’t even cost barriers to the employees, who’ve experienced similar wage problems, from opting into the case.  The case of Flores v. Lifeway Foods, Inc.[21] notes that a named plaintiff can show that others were similarly situated “by making a modest factual showing sufficient to demonstrate that they and potential plaintiffs together were victims of a common policy or plan that violated the law.”

"Given such a low bar, courts will routinely permit similarly situated current and former employees to join the action. 

"Attorney’s Fees. Once the case proceeds to either settlement or trial, one of the overriding financial issues restaurants must deal with relate to attorney’s fees.  Keep in mind that the defendant restaurant must engage its own counsel to defend the case.  The “hook in the bait”, as we call it, is simply that the plaintiff is also entitled to have his/her attorney’s fees paid by the defendant restaurant if plaintiffs are deemed to be the prevailing party under the statute: “A court shall, in addition to any judgment awarded to the plaintiff, or plaintiffs, allow a reasonable attorney’s fee to be paid by the defendant….”[22]  The Seventh Circuit had said, “While the award of fees is mandatory [under the FLSA], the district court has ‘wide latitude’ in determining the amount of the fee.”[23]

"The criteria for the award to plaintiff’s counsel of their fees, from the defendant, include: (1) Evidence that the plaintiff has, in some measure, prevailed; (2) Calculation of the “lodestar” (hourly rate times hours) as the base of the determination; (3) Other criteria applied by the court to determine the final fee award.[24]

"In order for a party to obtain “prevailing party” status, there must be some alteration in the legal relationship between or among the parties that arises from judicial imprimatur.[25]  In plainer English, the court must affirmatively weigh in on the case by, for example, entering a judgment against a party.  Settlement may also give rise to “prevailing party” status.

The most useful starting point for determining the amount of a reasonable award of attorneys’ fees under fee-shifting statutes, such as the FLSA, is calculated by multiplying the number of hours reasonably expended on the litigation by a reasonable hourly rate.[26]  This calculation, referred to as the “lodestar” figure, is intended to provide an “objective basis” by which to value a lawyer’s services.  The lodestar figure is the presumptively reasonable fee.[27]  However, the Supreme Court stated, “[i]f…a plaintiff has achieved only partial or limited success, the product of hours reasonably expended on the litigation as a whole times a reasonable hourly rate may be an excessive amount.”[28]  The Supreme Court further stated:

There is no precise rule or formula for making [modifications to the lodestar figure].  The district court may attempt to identify specific hours that should be eliminated, or it may simply reduce the award to account for the limited success. The court necessarily has discretion in making this equitable judgment.[29]

"Once the lodestar figure is calculated, the district court has wide latitude to make adjustments to the lodestar figure to arrive at a more appropriate award under the particular facts and circumstances of each case.  There are a number of factors a court may consider:  (1) the degree of success obtained; (2) the proportionality of fess to damages; (3) awards in similar cases; (4) the time and labor required; (5) the novelty and difficulty of the questions; (6) the skill requisite to perform the legal service properly; (7) the preclusion of employment by the attorney due to acceptance of the case; (8) the customary fee; (9) whether the fee is fixed or contingent; (10) time limitations imposed by the client or the circumstances; (11) the experience, reputation, and ability of the attorneys; (12) the undesirability of the case; and (13) the nature and length of the professional relationship with the client.  The most important factor to consider is the degree of success obtained.[30]

"“Even if plaintiff is a prevailing party, the district court may deny attorney’s fees – on the ground that no amount of fees would be reasonable – if plaintiff’s recovery is merely technical or de minimis.”[31]  Recoveries deemed de minimis include awards of nominal damages, however awards of actual or compensatory damages – however small – are not de minimis

"Compliance Checklist. In order to simply avoid the Hook (cost of attorney’s fees) in the Bait (settlement or trial), restaurants who engage “tipped” employees may consider the following as a part of the internal audit: (1) Each employee receives, and signs for, a company policy/handbook which includes a clearly highlighted notice that the restaurant is taking a credit against the minimum wage for the tips the employee will receive.  A copy of section 203(m) from the statute should be attached. (2) A notice from the Dept. of Labor (as required by local law) is posted as to the employees rights under the prevailing Minimum Wage Law. (3) A statement in writing is provided about your overtime policy, for example, “Overtime is and will be discouraged.  Scheduling is management’s responsibility and will be carefully assessed to avoid overtime.  However, in the event that you are asked to work overtime, you’ll be paid in accordance with the then prevailing law.” (4) A statement is provided in your policy regarding scheduling, for example that they will be expected to work from clock-in to clock-out; that they will not be paid for time they are not scheduled to work.

"Conclusion. Avoiding FLSA claims may be difficult in today’s litigious environment, particularly from disgruntled, terminated employees.  On the one hand, having a simple severance agreement with a Release (one week’s pay, for example) may avoid the issues we’ve outlined here.  On the other hand, should you find your company on the defense of such a FLSA claim, having these internal audit procedures may go far to protecting the company, and its owners.

[1]   "81 Cong. Rec. 7648 (July 27, 1937).

[2]   "83 Cong. Rec. 9264 (June 14, 1938).

[3]   "29 U.S.C. § 203(t); 29 CFR §§ 531.50, 531.56, 531.59.

[4]   "29 U.S.C. §203(m); 29 CFR §§ 531.50, 779.17.

[5]   "549 F.2d 303, 305 (4th Cir. 1977).

[6]   "29 U.S.C. § 203(m).

[7]   "Kilgore v. Outback Steakhouse of Florida, Inc., 160 F.3d 294 (6th Cir. 1998) (explanation not required); Brennan v. Haulover Shark and Tarpon Club, Inc., 1986 WL 587 (S.D. Fla. 1986) (explanation required).

[8]   "160 F.3d 294 (6th Cir. 1998).

[9]   "Id. at 298.

[10] "Id. at 299.

[11] "Id.

[12] "Id. at 298; see also Davis v. B & S, Inc., 38 F.Supp.2d 707, 718-19 (N.D. Ind. 1998).

[13] "Kilgore, 160 F.3d at 298.

[14] "Id.

[15] "38 F.Supp.2d 707.

[16] "Id. at 719.

[17] "Id. (emphasis added) (citing Marshall v. Gerwill, Inc., 495 F.Supp. 744, 753 (D.Md. 1980) (“There was no credible evidence proved or proffered as to what exactly had been told to the drivers concerning the tip credit provisions or even if any information was contained in any poster or bulletin provided to the drivers.”) (emphasis added); Bonham v. Copper Cellar Corp., 476 F.Supp. 98, 101, n. 8 (E.D. Tenn. 1979) (noting that a poster containing information relevant to the FLSA notice provision was displayed in the workplace, but holding that the poster did not satisfy the notice requirement because it was not prominently displayed, employees were not directed to it, and its contents were not introduced at trial).  Cf. Martin v. Tango’s Restaurant, Inc., 969 F.2d 1319, 1322 (1st Cir. 1992) (“[section 203(m)] could easily be read to require more – for example, notice of ‘the amount…determined by the employer’ to constitute wages….”).

[18] "Davis, 38 F.Supp.2d at 719.

[19] "29 CFR §§ 531.59(b), 531.54.

[20] "Id.

[21] "289 F. Supp. 2d 1042 (N.D. Ill. 2003).

[22] "29 U.S.C. § 216(b).

[23] "Uphoff v. Elegant Bath, Ltd., 176 F.3d 399 (7th Cir. 1999).

[24] "See, e.g., Uphoff, supra.

[25] "Dionne v. Floormasters Enterprises, Inc., 647 F.3d 1109 (11th Cir. 2011) (citing Buckhannon Board & Care Home, Inc. v. West Virginia Department of Health & Human Resources, 532 U.S. 598, 605-10 (2001)).

[26] "Hensley v. Eckerhart, 461 U.S. 424, 433 (1983).

[27] "Heder v. City of Two Rivers, 255 F.Supp.2d 947, 953 (E.D. Wis. 2003).

[28] "Hensley, 461 U.S. at 436.

[29] "Id.

[30] "Id. at 433-36.

[31] "Garcia v. R.J.B. Properties, Inc., 756 F.Supp.2d 911, 916 (N.D. Ill. 2010) (quoting Fisher v. Kelly, 105 F.3d 350, 352 (7th Cir. 1997)).  See also Farrar v. Hobby, 506 U.S. 103, 113 S.Ct. 566 (1992) (“[W]hen a plaintiff’s victory is purely technical or de minimis, a district court need not go through the usual complexities involved in calculating attorney’s fees….  Instead, it is enough for a court to explain why the victory is de minimis and announce a sensible decision to award low fees or no fees at all.”) (O’Connor, J., concurring).

Jeffry J. Knuckles is Of Counsel to the firm Nyberg & Cassioppi, LLC, located in Naperville.  Jeff graduated from the University of Illinois in 1968 with a Bachelor of Arts degree in Medieval Literature.  Jeff received his Juris Doctor from the University of Illinois in 1973.

Nicholas R. Galasso is an Associate with the firm Nyberg & Cassioppi, LLC, located in Naperville.  Nick graduated from Illinois Wesleyan University in 2007 with a Bachelor of Arts degree in Accounting and Economics.  Nick received his Juris Doctor from The John Marshall Law School in 2010.

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