In O’Grady v. Merchant Exchange Productions, Inc., the California Court of Appeals held that a mandatory service charge could potentially be found to be a gratuity that must be distributed to service employees.  The issue in the case is whether a “service charge” can be a “gratuity” that Labor Code section 351 requires to be distributed, only to non-managerial employees actually serving customers.

Plaintiff, Lauren O’Grady, is a banquet server and bartender at the Julia Morgan Ballroom in San Francisco, which is operated by defendant Merchant Exchange Productions.  Plaintiff brought this class action alleging that her and the other non-managerial service employees were entitled to the 21 percent “service charge” added to every banquet bill.  Plaintiff alleged that the service charge constituted a gratuity that should be distributed to the non-managerial service employees pursuant to section 351.

The complaint alleged that the way the service charge was presented to customers “ was reasonable for [the customers] to have believed they were gratuities to be paid to the service staff.  Indeed, because of the way these charges are depicted to customers, and the custom in the food and beverage industry that gratuities in the range of 18-22% are paid for food and beverage service, customers have paid these charges reasonably believing they were to be remitted to the service staff.”  Plaintiff alleged causes of action under the Unfair Competition Law (Business & Professions Code Section 17200), intentional interference with advantageous relations, breach of implied contract, and unjust enrichment.

1. Labor Code section 350 and 351 protects gratuities as property of the employee.

The court explained that tips are protected under California law, and “[t]he Legislature wanted to protect employees from employers who used their positions to unfairly command a share of the employee’s tip.”  (Chau v. Starbucks Corp., 174 Cal.App.4th 692, 696, 699 [“section 351 was enacted to prevent an employer from pressuring an employee to give the employer tips left for the employee.”].)  Section 350 defines “gratuity” to “include any tip, gratuity, money or part thereof that has been paid or given to or left to 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.”

Section 351 provides that “No employer or agent shall collect, take or receive any gratuity or 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 a gratuity, or require an employee to credit the amount, or any part thereof, of a gratuity against and as part of the wages due the employee from the employer.”

2. The Court held that the term “service charge” can have different meanings.

The court also explained that the term “service charge” can have many different meanings, and “simply calling something a ‘service charge’ hardly ever explains what it is – or why it is being imposed.”  Therefore, the court held that at the early stage in this case, plaintiff had at least plead enough facts and a potential theory for recovery to continue with the lawsuit and avoid having it dismissed at this stage.

3. Prior holdings in Searle v. Wyndham International and Garcia v. Four Points Sheraton LAX.

Defendant argued that two cases, Searle v. Wyndham Internat. (2002) 102 Cal.App.4th 1327 and Garcia v. Four Points Sheraton LAX (2010) 188 Cal.App.4th 364, established a mandatory service charge which is automatically added to a customer’s bill and which a customer is required to pay is not a gratuity as a matter of law.

In Searle, a San Diego hotel charged a 17 percent service charge to every room service order, which was given to the server.  A customer sued complaining that the charge was deceptive because the guests were not informed that this service charge was given to the employee, and there was an additional line of the receipt for a tip.  The court in Searle held that this was not a deceptive practice.  Garcia involved a city ordinance for hotels near LAX “that in plain effect directed certain hotels to treat their mandatory service charges as owed ‘to workers who render the services for which the charges have been collected.’”  (Garcia, supra, 188 Cal.App.4th 364, 370.)  Both of these cases contain language that because service charges are mandatory, the employer can do what it wants to with the service charge.  Indeed, Garcia also clearly sets forth that “[a] gratuity is not a service charge…Thus, a service charge by definition is not a gratuity.  The Legislature has made clear that amounts due for services (which include service charges) are not gratuities.”  (Garcia, 188 Cal.App.4th 364, 377.)

4. The Court distinguished Searle and Garcia from the facts in this case.

In this case, the court distinguished the Searle and Garcia cases in finding 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 ultimately held that “[n]either, or both together, should be read, as defendant does, as categorially establishing that what may be called a ‘service charge’ by an employer can never be a gratuity.”

The Court noted that in addition to private agreements (as was the case in Searle) or by legislative command (as in Garcia), plaintiff here is alleging that custom in the hospitality industry is to treat amounts designated as “service charges” as gratuities for employee.  The court stated, “In other words, custom or usage can serve as a common law augmentation of section 350 and 351.”

The court held that plaintiff’s theory that a mandatory service charge could potentially be considered a gratuity by the customer, and therefore property of the server, not the employer, could proceed given the uncertainty of what is meant when a customer pays a “service charge.”

5. California employers should clearly notify customers and employees about mandatory service charges.

Based on the holding in O’Grady, California employers should review their descriptions of mandatory service charges, and if the employer wishes to retain these amounts and does not distribute them to the service employees, this must be made clear to the customers and employees.  This can be done through various notices (such as on contracts with customers, menus, and receipts) that the mandatory service charge is not a gratuity or a tip that the server receives, but it is an amount retained by the company.