In Oregon Rest. & Lodging Ass’n v. Perez, the Ninth Circuit ruled this week that federal law restricts a restaurant employer from maintaining a tip pool that includes “back-of-the-house” employees and requires directly tipped employees to share their tips, regardless of whether a tip credit is taken and employees are paid at least minimum wage.

The FLSA permits an employer to count a tipped employee’s tips toward its hourly minimum wage obligation.  This is known as a “tip credit.”  Section 203(m) of the FLSA requires employers who take a tip credit to give notice to employees and allow employees to retain all of the tips they receive, unless such employees participate in a valid tip pool.  Under section 203(m), a tip pool is valid if it is comprised exclusively of employees who are “customarily and regularly” tipped, commonly referred to as “front-of-the-house” employees.

The employers in Oregon Rest. & Lodging Ass’n, however, did not take a tip credit against their minimum wage obligation.  (Indeed, Oregon does not permit a “tip credit,” and requires that all employees receive the state-mandated minimum wage.)  Rather, the employers in Oregon Rest. & Lodging Ass’n paid their tipped employees at least the federal minimum wage and required their employees to participate in tip pools.  Unlike the tip pools contemplated by section 203(m), however, these tip pools included both front- and back-of-the-house employees.

In Cumbie v. Woody Woo, Inc., the Ninth Circuit previously held that tip pooling under these circumstances was lawful because the FLSA was silent regarding employers who did not take a tip credit.  Not long after Cumbie was decided, the Department of Labor (“DOL”) issued a formal rule that extended the tip pool restrictions of section 203(m) to all employers, not just those who take a tip credit.

Oregon Rest. & Lodging Ass’n actually involved two separate cases that were consolidated on appeal before the Ninth Circuit.  In the first case, the Oregon Restaurant and Lodging Association sued the DOL, challenging the new rule and seeking to prevent its enforcement.  The second case was brought by a group of casino dealers against the Wynn casino in Las Vegas, in which the casino dealers argued that the Wynn’s tip pooling practice violated DOL’s new rule.  In both cases, the employers paid their employees at least minimum wage and did not take a tip credit.  The trial courts in both cases ruled in favor of the employers and held, based in Cumbie, that the DOL rule was invalid because it was contrary to the legislature’s intent.  (Judge Michael W. Mosman in the District of Oregon and Judge Robert Clive Jones in the District of Nevada.)

In Oregon Restaurant and Lodging Association, Circuit Judge Harry Pregerson, writing for himself and Circuit Judge John B. Owens, the Ninth Circuit reversed the lower courts’ decisions in favor of the employers, finding that that the DOL had the authority to expand its tip-pooling regulations to cover employers who do not take the tip credit.  In doing so, the Ninth Circuit held that its earlier decision in Cumbie did not prevent the DOL from regulating tip pools under the FLSA, even for employers who do not take a tip credit.  The court reasoned that because the FLSA was silent as to employers that do not take a tip credit, the DOL acted within its authority when it issued its rule prohibiting the practice.

Circuit Judge N. Randy Smith issued a strongly-worded dissent.  Judge Smith reprimanded the panel for disregarding Cumbie, calling this case “nothing more than Cumbie II.”  Referring to Cumbie—and perhaps foreshadowing the next step in this case—he wrote, “Colleagues, even if you don’t like circuit precedent, you must follow it.  Afterwards, you call the case en banc. You cannot create your own contrary precedent.”  According to the dissent, based on Congress’ apparent intent as it relates to employers that maintain tip pools but do not take a tip credit, the panel should have affirmed both rulings below.

There is little doubt that this case will continue, and the state of the law regarding tip pools is in flux.  Employers who utilize tip-pools should consult with their employment counsel and industry groups to ensure compliance in this difficult area.