Beware increased litigation over F&B service charges

A banquet hall
To avoid lawsuits over banquet service charges, hotels can change the name of the charge to be more descriptive about who actually will receive the money. Photo credit: qingwa/iStock/Getty Images Plus

Litigation over food-and-beverage service charges is increasing.  A California appellate court recently held that mandatory service charges added by banquet facilities to their contracts may need to be paid to banquet service employees essentially as a gratuity. Lawsuits also have been filed recently against food delivery provider DoorDash by customers in California and the District of Columbia government alleging that the company improperly kept part of tips provided to delivery drivers, misleading customers who thought that their entire tip would go to the driver.

In the California appellate case, O’Grady v. Merchant Exchange Productions, the employer added a 21 percent service charge to all banquet contracts for food and beverages. The company did not pay any of the service charge to servers. Rather, it distributed some of the money to managers and nonservice personnel and retained the rest. The plaintiff, a banquet server and bartender, sued her employer claiming the practice violated the California Labor Code and amounted to intentional interference with advantageous relations, breach of implied contract and unjust enrichment.

The employer argued that no such legal claims could be pursued, relying on previous cases stating that mandatory service charges are not gratuities under California Labor Code section 351. That statute provides that all tips and gratuities left by customers for service employees are solely the property of the employee and that employers may not take any portion of such gratuities. The lower court agreed with the employer and dismissed the claim.

The appellate court reversed, however. In its decision, the court maintained that to define gratuities only as those amounts of money left voluntarily by a patron for a service employee is to take too narrow a view. It noted that tip pooling, which is lawful in California, does not reflect the customer’s preference as to whom should be rewarded and by how much for the service provided. The court also recognized that many restaurants impose a mandatory gratuity for larger parties and most cruise lines impose a mandatory charge per day for gratuities for the ship’s crew. “In short,” commented the court, “the notion of an involuntary gratuity has perhaps become more widespread and accepted than in the past.”

The court concluded that a mandatory service charge may qualify as a gratuity as a matter of law. But because it was reviewing a case that the lower court dismissed on a demurrer (an early motion to dismiss the case), it had no facts before it from which it could develop a more specific rule for when a service charge will qualify as a gratuity. It did not address the situation where a portion of a service charge is specifically designated as a gratuity for employees, for example, and the remainder is reserved for management. Instead, it sent the case back to the lower court for further proceedings.

Effect on Hotels

The California court’s holding is broad enough to suggest that unspecified service charges imposed by hotels, banquet facilities, conference halls, event centers and similar businesses may have to be paid to employees providing the service. Mandatory service charges in other hospitality industry contexts, such as in-room dining, likely would fall within the court’s ruling as well.

Hospitality employers, therefore, should review their service charge practices in an effort to avoid legal challenges by employees and guests. There is no legal requirement that a gratuity or service charge be collected and paid to service employees. Banquet servers and bartenders often are paid a higher hourly rate than their counterparts in food-and-beverage outlets in recognition of the fact that the former typically will not enjoy the same level of tip income as the latter. If a mandatory charge is to be added, however, you should be transparent about where the money will go. Including a mandatory “service charge” on a banquet contract or guest check and not paying the money to employees who performed the service will be risky going forward. If the house wishes to retain a portion of the charge, the portion retained should be identified as a “management fee,” “setup fee” or similar term so that it is clear the money will not go to employees. Similar care should be used with respect to charges such as “corkage fees,” “carving fees” and the like.

The same goes for in-room dining charges. If a “delivery fee” is not paid to the server delivering the food it should be called something else. If a mandatory gratuity or service charge is automatically added to the bill, a line for the customer to add a further gratuity should be designated “additional gratuity” to prevent customers from claiming they were misled into paying a double gratuity. As is the case with banquet service charges, any service charge on the bill should be paid to the service employees unless a written disclaimer states otherwise.

The California court’s ruling is not necessarily the final word as it came early in the case, and the ruling is binding only in California. Other states may treat service charges differently. The California service charge case and the DoorDash lawsuits, however, suggest that more scrutiny will be applied by customers and employees to how service charges and mandatory gratuities are handled in the future. Because those challenges are likely to come in the form of expensive class-action lawsuits, hospitality employers would be wise to get ahead of this issue by providing more clarity with respect to these charges.

James J. McDonald Jr. is managing partner of the Irvine, Calif., office of the national labor and employment law firm Fisher & Phillips.