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Home » Minimum Wage » 5th Cir.: Restaurant Cannot Take Tip Credit Where Retained Portion of Tips to Offset Credit Card Processing Costs in Excess of Its Direct Costs of Collecting Credit Card Tips

5th Cir.: Restaurant Cannot Take Tip Credit Where Retained Portion of Tips to Offset Credit Card Processing Costs in Excess of Its Direct Costs of Collecting Credit Card Tips

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Steele v. Leasing Enterprises, Limited

This case was before the Fifth Circuit on the parties’ cross-appeals.  As discussed here, the case concerned an employer’s ability to withhold a percentage of an employee’s tips received by credit card to offset the fees associated with collecting credit card tips under the Fair Labor Standards Act (“FLSA”).  Specifically, the issue was whether the 3.25% that the defendant-restaurant admittedly retained of all credit card tips exceeded its actual costs of processing same, such that the employer forfeited any entitlement to take the tip credit with regard to its tipped employees.  The district court held that the defendant was not entitled to take the tip credit because this deduction exceeded the direct costs of collecting credit card tips for Perry’s’ tipped employees.  The Fifth Circuit affirmed the finding and held that the retention of tips in excess of the actual cost of collecting those tips violated 29 U.S.C. § 203(m).  As such, the employer was not entitled to benefit from the tip credit and was instead required to pay all tipped employees the regular minimum wage for all hours worked.

Describing the relevant facts, the court explained:

Instead of paying servers their charged tips through their bi-weekly pay checks, Perry’s chose to pay its servers their charged tips in cash on a daily basis. Perry’s voluntarily started this practice in response to servers’ requests. In order to pay its servers their charged tips in cash on a daily basis, Perry’s arranged for armored vehicles to deliver cash to each of its restaurants three times per week. Perry’s’ Chief Operating Officer testified that such frequent deliveries were necessary due to security concerns associated with keeping a large amount of cash on its premises.

In August 2009, Plaintiffs initiated this collective action. In their third amended complaint, they alleged that Perry’s had violated the FLSA by charging its servers the 3.25% offset fee. On August 31, 2010, the district court entered a partial interlocutory judgment, holding that Perry’s may offset credit card issuer fees, but not other costs associated with computers, labor, or cash delivery…

Following a bench trial, the district court issued findings of fact and conclusions of law, holding that Perry’s’ 3.25% offset violated the FLSA because the offset exceeded Perry’s’ credit card issuer fees. The court also held that Perry’s’ cash-delivery expenses could not be included in the offset amount because “[t]he restaurant’s decision to pay it[s] servers in cash is a business decision, not a fee directly attributable to its cost of dealing in credit” and that Perry’s had failed to prove fees related to cancellation of transactions and manual entry of credit card numbers, and therefore could not rely on these amounts to justify the amount of its offset. Finally, the court held that Perry’s may not include other expenses, such as costs associated with bookkeeping and reconciliation of cash tips, in the offset amount because those costs are incurred as a result of ordinary operations only indirectly related to Perry’s’ tip policy. The court concluded that even if it included all of Perry’s’ indirect costs, the 3.25% offset fee exceeded Perry’s’ total costs.

After discussing the law regarding the tip credit generally, the Fifth Circuit framed the issue before it as follows:

In this case we must determine whether an employer may offset employees’ tips that a customer charges on a credit card to recover the costs associated with collecting credit card tips without violating § 203(m)’s requirement that the employee retains all the tips that the employee receives. Specifically, we must determine if the employer violates that requirement when it offsets credit tips to recover costs that exceed the direct fees charged by the credit card companies. Perry’s contends that it may offset both credit card issuer fees and its own cash-delivery expenses and still claim a tip credit under 29 U.S.C. § 203(m). Plaintiffs assert that Perry’s may offset only an amount no greater than the total amount of credit card issuer fees.

The court then discussed the only prior circuit court decision to discuss this issue at length, and relevant DOL regulations and guidance:

Both parties rely on the only circuit court decision to address this issue, Myers v. Copper Cellar Corp., 192 F.3d 546 (6th Cir. 1999). In Myers, the employer deducted a fixed 3% service charge from employee tips whenever a customer tipped by credit card to account for the discount rate charged by credit card issuers. Id. at 552. Because the employer always deducted a fixed percentage, the deduction sometimes rose above or fell below the fee charged on a particular transaction. Id. at 553. The employees challenged this deduction, arguing that any withholding of tips violates § 203(m). The Sixth Circuit disagreed, holding that “an employer may subtract a sum from an employee’s charged gratuity which reasonably compensates it for its outlays sustained in clearing that tip, without surrendering its section 203(m) [tip credit].” Id. The Sixth Circuit determined that an employee does not “receive” a charged tip under § 203(m) until the “debited obligation [is] converted into cash.” Id. The court noted that this conversion is predicated on the “payment of a handling fee to the credit card issuer.” Id. at 554.

To reach that conclusion, the Sixth Circuit relied on 29 C.F.R. §§ 531.52 and 531.53. Section 531.52 defines tip as “a sum presented by a customer as a gift or gratuity in recognition of some service performed for him.” Section 531.53 further clarifies that tips include “amounts transferred by the employer to the employee pursuant to directions from credit customers who designate amounts to be added to their bills as tips.” The Sixth Circuit held that these two regulations make it clear “that a charged gratuity becomes a ‘tip’ only after the employer has liquidated it and transferred the proceeds to the tipped employee; prior to that transfer, the employer has an obvious legal right to deduct the cost of converting the credited tip to cash.” Myers, 192 F.3d at 554. The court noted that “payment of a handling fee to the credit card issuer” is “required” for that liquidation. Id. at 553–54.

As recognized by the Sixth Circuit, the Department of Labor has long interpreted its regulations to permit employers to deduct credit card issuer fees. U.S. Dept. of Labor Field Operations Handbook § 30d05(a) (Dec. 9, 1988).  In Myers, the Sixth Circuit added that such a deduction is allowed under the statute even if, as a consequence, some deductions will exceed the expense actually incurred in collecting the subject gratuity, as long as the employer proves by a preponderance of the evidence that, in the aggregate, the amounts collected from its employees, over a definable time period, have reasonably reimbursed it for no more than its total expenditures associated with credit card tip collections.

Myers, 192 F.3d at 554. Following Myers, the Department of Labor amended its position to allow employers to deduct an average offset for credit card issuer fees as 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.” See U.S. Dept. of Labor Wage and Hour Division Opinion Letter FLSA2006-1.5 The parties do not contest that an employer may deduct a fixed composite amount from credit card tips, so long as that composite does not exceed the total expenditures on credit card issuer fees, and still maintain a tip credit. We agree. Credit card fees are a compulsory cost of collecting credit card tips. As a result, an employer may offset credit card tips for credit card issuer fees and still satisfy the requirements of § 203(m).  However, our inquiry does not end with this holding.

Applying the law to the facts at bar, the court concluded that the employer’s 3.25% chargeback was an impermissible offset, because here the defendant-employer was seeking an offset for costs above and beyond their actual direct cost of collecting credit card tips.  In so doing, the Fifth Circuit like the court below rejected the employer’s argument that it should be entitled to build its indirect costs of processing the credit card tips (that it voluntarily incurred based on its business decision) in addition to the direct cost of processing the credit card tips.  The court reasoned:

Perry’s concedes that its 3.25% offset always exceeded the total credit card issuer fees, including swipe fees, charge backs, void fees, and manual-entry fees. Perry’s submitted demonstrative exhibits which showed that the total offset for each restaurant exceeded all credit card issuer fees by at least $7,500 a year, and by as much as $39,000 in 2012. As a result, Perry’s argues that an employer may also deduct an average of additional expenditures associated with credit card tips and still maintain a tip credit under § 203(m). Although Perry’s justified its 3.25% offset based on a number of other expenses before the district court, Perry’s now maintains that credit card issuer fees and its cash-delivery expenses alone justify the 3.25% offset. In support, Perry’s shows that on an aggregate basis (and across all restaurants), Perry’s’ expenses for collecting and distributing credit card tips to cash—including both credit card issuer fees and expenses for cash-delivery services—always exceeded the offset amount. We must determine whether deducting additional amounts for cash-delivery services violates § 203’s requirement that the employee must keep all of his or her tips.

A Perry’s corporate executive testified that it made a “business decision” to receive cash deliveries three times a week in order to cash out servers’ tips each day and to decrease security concerns associated with keeping too much cash in the register. Importantly, this executive testified that it was only necessary to cash out servers each night because of employee demand, and that if it instead transferred the tips to the servers in their bi-weekly pay checks, the extra cash deliveries would not be necessary. The district court found that Perry’s’ cash-delivery system was “a business decision, not a fee directly attributable to its cost of dealing in credit.” We agree.

In Myers, the Sixth Circuit allowed the employer to offset tips to cover reasonable reimbursement for costs “associated with credit card tip collections” and highlighted that credit card fees were “required” to transfer credit to cash.9 192 F.3d at 554–55 (emphasis added). That court emphasized that the employer’s deductions were acceptable because “[t]he liquidation of the restaurant patron’s paper debt to the table server required the predicate payment of a handling fee to the credit card issuer.” Id. at 553–54. The Department of Labor incorporated a reading of Myers in an opinion letter:

The employer’s deduction from tips for the cost imposed by the credit card company reflects a charge by an entity outside the relationship of employer and tipped employee. However, it is the Wage and Hour Division’s position that the other costs that [an employer] wishes the tipped employees to bear must be considered the normal administrative costs of [the employer’s] restaurant operations. For example, time spent by servers processing credit card sales represents an activity that generates revenue for the restaurant, not an activity primarily associated with collecting tips.

U.S. Dept. of Labor Wage and Hour Division Opinion Letter FLSA2006-1. While it is unnecessary to opine whether any costs, other than the fees charged directly by a credit card company, associated with collecting credit card tips can ever be deducted by an employer, we conclude that an employer only has a legal right to deduct those costs that are required to make such a collection.

Perry’s made two internal business decisions that were not required to collect credit card tips: (1) Perry’s responded to its employees’ demand to be tipped out in cash each night, instead of transferring their tips in their bi-weekly pay checks, and (2) Perry’s elected to have cash delivered three times a week to address security concerns.11 Unlike credit card issuer fees, which every employer accepting credit card tips must pay, the cost of cash delivery three times a week is an indirect and discretionary cost associated with accepting credit card tips. As the district court noted, this cash delivery was “a business decision, not a fee directly attributable to its cost of dealing in credit.” Moreover, Perry’s deducted an amount that exceeded these total costs—credit card issuer fees and cash-delivery expenses—in nine of the relevant restaurant-years.

Thus, the court concluded that:

Allowing Perry’s to offset employees’ tips to cover discretionary costs of cash delivery would conflict with § 203(m)’s requirement that “all tips received by such employee have been retained by the employee” for employers to maintain a statutory tip credit. Perry’s has not pointed to any additional expenses that are the direct and unavoidable consequence of accepting credit card tips. Because Perry’s offset always exceeded the direct costs required to convert credit card tips to cash, as contemplated in § 203(m) and interpreted by the Sixth Circuit, we hold that Perry’s’ 3.25% offset violated § 203(m) of the FLSA, and therefore Perry’s must be divested of its statutory tip credit for the relevant time period.

Click Steele v. Leasing Enterprises, Limited to read the entire Fifth Circuit decision.

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